00:00:13
I'm G to talk about three things uh I'll
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try first not to bore you to death with
00:00:19
some statistics on the housing market I
00:00:21
think it's worth at least going over a
00:00:23
few numbers just to understand how we
00:00:26
got in a situation so dire that a couple
00:00:30
of firms that survive the Great
00:00:31
Depression couldn't survive a credit
00:00:34
crisis and a and a housing market
00:00:36
collapse uh I'm then going to talk about
00:00:38
Fanny May and Freddy Mack which I think
00:00:41
is a really important policy issue we
00:00:45
are going to face in the next few years
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and really should be on the top of the
00:00:50
next president's agenda um that may not
00:00:53
interest it no one from whon ever wants
00:00:55
to go work there and you really won't
00:00:57
want to now that they're part of the
00:00:58
treasury um but we're talking A5
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trillion dollar business platform and
00:01:03
it's really important how we work that
00:01:05
out and last but least um I'm I think
00:01:09
one of my roles today is as the
00:01:11
pessimist compared to to Jeremy I don't
00:01:14
think we're out of the water yet um
00:01:16
partly because I still think we have a
00:01:18
ways to go on housing and also because I
00:01:21
think there are emerging problems on the
00:01:23
commercial site of real estate that are
00:01:25
going to stress the banking sector a bit
00:01:27
further so with that get on your meds
00:01:30
um and we'll we'll go from from there
00:01:33
okay the housing boom Jeremy called it a
00:01:35
bubble I think we don't have really good
00:01:37
models of bubbles but I think that's
00:01:39
accurate um from 2000 to
00:01:43
2006 real housing prices after inflation
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Rose by 45% it's a 6.4% real compound
00:01:51
annual rate in nominal terms housing
00:01:53
prices Nationwide doubled since
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1995 if you look over multi-decade
00:01:59
period periods a normal real
00:02:02
appreciation rate for homes would be
00:02:04
between 1 and 1 and a half% so what we
00:02:07
saw this this new decade was three to
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four times the norm and it's hard to
00:02:13
come up with a rational reason to
00:02:14
explain that behavior nothing nothing
00:02:16
changed by that much so one we had one
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heck of a boom and it lasted a long long
00:02:22
time whenever you see a boom like that I
00:02:25
can assure you that no matter what the
00:02:27
property sector if prices go up far
00:02:29
enough often banks are willing to lend
00:02:31
developers will oversupply the market
00:02:33
and that is exactly what happened in
00:02:35
housing I will not bore you with those
00:02:38
numbers but basically in 2004 2005 and
00:02:42
2006 the number of housing units was
00:02:45
grossly in excess of true demographic
00:02:47
need need to replace worn out stock um
00:02:51
and and the like unfortunately in 2007
00:02:55
there was very little whittling down of
00:02:58
that excess Supply Y which brings us to
00:03:01
to this year permits fell a lot in 2007
00:03:05
but completions didn't okay you know we
00:03:07
basically completed about the right
00:03:09
number of of homes if we didn't have
00:03:11
excess Supply which has helped cause
00:03:14
this the beginnings of a real price
00:03:16
collapse in housing that we see now my
00:03:19
estimates are this thing will the excess
00:03:23
Supply will wear off by the end of 2009
00:03:26
but not before so 2009's a pretty tough
00:03:29
year I think that's part of why Fanny
00:03:31
and Freddy went under and part of why
00:03:34
the prices on the mortgage back
00:03:35
Securities the investment Banks had to
00:03:37
Mark were so low because the sort of the
00:03:40
end of this debacle keeps getting put
00:03:43
off and and and put off Beyond overb
00:03:46
building which is going to be cured um
00:03:49
in another year to 18 months I think um
00:03:52
we also dramatically lowered credit
00:03:54
quality for home buyers um a little
00:03:56
history is instructive here um in 1940
00:04:00
it's the first census of Housing and 42
00:04:04
to 43% of American households owned we
00:04:07
were coming out of the Great Depression
00:04:09
um 20 years later in 1960 after the
00:04:12
second world war and a great rise in
00:04:13
wealth in the 1950s just under 60% of
00:04:17
households Zed over the next 30 Years
00:04:20
that number Rose to about 63% so in 30
00:04:23
years you got a 3 percentage Point rise
00:04:26
in the home ownership rate and and just
00:04:28
really marginal in increases and then
00:04:30
roughly from 1988 to 08 we had a 6
00:04:34
percentage Point rise in the home
00:04:36
ownership rate and who was that among it
00:04:38
was among you the young and other sort
00:04:41
of high-risk less good credit quality
00:04:44
borrowers and we set up a big industry
00:04:47
in mortgage Finance to service those
00:04:50
folks and it's what I call the nonprime
00:04:53
market and the nonprime is what Jeremy
00:04:56
noted is the subprime market think of
00:04:59
that as people with impaired Credit in
00:05:02
technical terms they have low FICO
00:05:03
scores and subprime borrowers tend to be
00:05:07
in the bottom third of the distribution
00:05:09
of people on this credit score quality
00:05:12
then alt a um that Jeremy also mentioned
00:05:16
think of this as low documentation loans
00:05:18
you don't actually have to submit your W
00:05:20
to you don't have to prove um your
00:05:22
income and the like and you can get a
00:05:24
loan at a at a somewhat higher rate home
00:05:27
equity loans are an important component
00:05:29
of that market and then there are the
00:05:31
the government programs FHA and and VA
00:05:33
for veterans and very very lowincome
00:05:36
households that market got really really
00:05:39
big between 2004 and 2007 we issued 5.3
00:05:45
trillion do of nonprime loans 5.3
00:05:50
trillion in the flow of funds from the
00:05:53
Federal Reserve first quarter of 2008
00:05:55
there was 10.6 trillion of home
00:05:57
mortgages outstanding in from for the
00:06:00
household sector so this became a very
00:06:02
large market and in 2006 For the First
00:06:05
Time subprime loan volume exceeded
00:06:08
conventional and conforming loan volume
00:06:10
in the United States in a normal year
00:06:12
that ratio would be tended to it' be you
00:06:15
know one t to one of of the the prime
00:06:19
Market as as it were so we greatly
00:06:21
expanded the pool of of owners we made
00:06:24
very high loan devalue loans with all
00:06:27
types of exotic terms and the like so
00:06:29
levered up um with high-risk households
00:06:33
um we overbuilt the housing market
00:06:35
ultimately the bubble burst and what we
00:06:38
got um as of now forclosures
00:06:42
083 these are numbers from a mortgage
00:06:44
Banker survey which is a really good one
00:06:46
um
00:06:48
83% of mortgages in their sample
00:06:51
nationally are in foreclosure and by
00:06:54
that I mean they're past delinquent and
00:06:55
it's basically the bank wants the house
00:06:58
so a little less one in 100 um 5.8% are
00:07:03
delinquent at least 30
00:07:06
days you know one in 20 rounding if you
00:07:09
go to the subprime pool subsample um 20%
00:07:13
one in five of those loans is delinquent
00:07:16
um 5.3% are in foreclosure where again
00:07:19
colloquially I'm defining that as you
00:07:21
you haven't paid enough the bank would
00:07:23
like the home thank you very much so you
00:07:25
know about one in 20 of of those
00:07:27
borrowers how did this SP spiral down
00:07:30
over the abyss where it could kill great
00:07:32
firms like I said they Survived the
00:07:34
Great Depression which strikes me as a
00:07:36
little worse than than what's happening
00:07:38
right now um partly it's because the
00:07:41
underlying problem um always kept
00:07:44
getting worse and you can see it in the
00:07:47
loan vintage data and I I'll give you
00:07:49
three snapshots of of data for you um
00:07:52
now I'm into sort of 60-day delinquent
00:07:55
subprime loans so people who got loans
00:07:57
with somewhat impaired credit
00:08:00
historically by the way we've had a
00:08:01
subprime market for 20 years it's not
00:08:03
entirely new um it's it grew enormously
00:08:08
recently but it's been around for a
00:08:09
while um and historically subprime pool
00:08:14
delinquency rate 60-day plus delinquency
00:08:17
rates would Peak at about 20% after two
00:08:20
and a half to to three years beginning
00:08:23
in
00:08:23
2005 it became clear the underlying
00:08:26
credit quality of these loans
00:08:28
deteriorated because the 2005 vintage
00:08:31
loans peaked above 30% after two and a
00:08:35
half years 2006 vintage has not peaked
00:08:38
the latest data we have after 29 months
00:08:41
is 42% of those guys are delinquent 60
00:08:44
days or more the 2007 vintage is the
00:08:47
worst by a wide margin and that's saying
00:08:50
something because it's 42% on
00:08:53
2006 Al actually looks good lower the
00:08:57
numbers by about half on on on that um
00:09:00
the good news about this is there's no
00:09:03
more alte and subprime there were under
00:09:05
$5 billion of Al and subprime
00:09:09
securitizations in the first half of
00:09:11
2008 so that problem ultimately will go
00:09:13
away because we're just not doing those
00:09:16
those loans anymore at least you have to
00:09:18
hold them on your balance sheet if
00:09:19
you're going to issue them you can't
00:09:21
securitize them anymore um so I think
00:09:24
we're beginning to get a handle once we
00:09:26
see how bad the ' 06 and 07 vintages are
00:09:29
people will be able to price and my
00:09:31
point here is as things kept
00:09:33
deteriorating over time people couldn't
00:09:36
price these things so they just started
00:09:38
giving massive haircuts to the prices of
00:09:40
these Securities and they ultimately
00:09:42
became toxic there was a buyer strike no
00:09:44
one wanted to own them I suspect
00:09:46
someone's going to make a decent amount
00:09:47
of money um buying some of these because
00:09:50
one not everybody's going to default and
00:09:52
if they default you still have recovery
00:09:55
you've actually got a house with a roof
00:09:56
on it you're going to recover some of
00:09:58
the value when you sell it to someone
00:10:00
but the thing that I I think really hurt
00:10:04
um Leman and hurt Fanny and Freddy um in
00:10:08
the last month has been the the
00:10:11
surprising rise in the 60-day
00:10:14
delinquency rate in the prime loan
00:10:16
Market okay in the past typically the
00:10:20
after a three years of seasoning less
00:10:23
than one in a 100 Prime loans would be
00:10:26
60 days or more delinquent um the 2005
00:10:30
and 2006 vintages were were above that
00:10:34
um they peaked out at about 2% and then
00:10:37
the 2007 vintage is already at 2%
00:10:41
delinquency through a year and a half
00:10:43
and there are a lot of prime loans and
00:10:45
that's really starting to scare people
00:10:47
and they're starting to connect it with
00:10:48
the Fallen house prices there are two
00:10:50
major house price series out there the K
00:10:53
Shiller indexes um which if you have not
00:10:56
checked out the Chicago mertile Exchange
00:10:58
you can download these just by you know
00:11:00
giving them your email and they only
00:11:02
modestly spam you after you've done that
00:11:04
so it's not too bad um but you really
00:11:06
want to look at those data and then what
00:11:08
used to be the oo index the office of
00:11:10
federal housing Enterprise oversight
00:11:13
which has a new name because there's a
00:11:15
new regulator um for Fanny and Freddy
00:11:17
now the the case Schiller index is the
00:11:20
broader index it includes subprime alte
00:11:23
and the like us housing prices in that
00:11:26
index which is what's called a repeat
00:11:28
sales and think of that as a constant
00:11:30
quality of House Index they're pricing
00:11:32
essentially the same home over time down
00:11:36
15.4% in the last calendar year from
00:11:39
second quarter of 07 to second quarter
00:11:41
of 08 there's a lot of variance across
00:11:43
markets some are only you know modestly
00:11:47
bad Dallas and Charlotte in that index D
00:11:50
Charlotte's down a point Dallas down 3.2
00:11:53
Vegas Miami and Phoenix are all down at
00:11:55
least 28% in that index in the oo index
00:11:59
things don't look nearly as dire again
00:12:01
remember they don't have they're not
00:12:03
pricing changes in home home values on
00:12:06
subprime and Al it's only Fanny and
00:12:08
Freddy conforming stuff it's down 4.8%
00:12:11
over the last year um Dallas is actually
00:12:14
up so is Charlotte in that index but
00:12:17
Vegas Miami and Phoenix are all down
00:12:19
double digits um Vegas leading the pack
00:12:21
at 18% over the last year those are just
00:12:25
unprecedented nominal price drops and I
00:12:29
I think the people pricing these
00:12:31
Securities are starting to wonder if
00:12:34
it's not just a subprime and alte
00:12:36
problem where we lent to people we
00:12:38
shouldn't have lent to but folks who
00:12:40
played by the rules who put down 10 or
00:12:42
20% are now in a position where they've
00:12:44
lost their equity and they're thinking
00:12:46
do I really want to pay this this loan
00:12:48
off and I think that's really starting
00:12:50
to scare people um in the in in the
00:12:53
business and it's it's causing a real it
00:12:56
it it made those Securities toxic
00:12:59
basically so that there was a buyer
00:13:00
strike and basically there isn't a price
00:13:02
at which people want to want to hold
00:13:04
those things anymore looking forward um
00:13:08
I I think we're not out of the water as
00:13:09
you know there'll be a lot of geographic
00:13:11
heterogeneity I think the commodity farm
00:13:14
and energy belts the United States are
00:13:16
going to do pretty well um over the next
00:13:18
couple of years ultimately Florida Las
00:13:21
Vegas Phoenix the Inland Empire of
00:13:24
California will grow their way out of
00:13:25
this problem people still want to live
00:13:28
there they still want to work there um
00:13:30
and when housing prices fall enough and
00:13:32
they are going to fall a decent amount
00:13:34
more I think um those those problems
00:13:37
will get cured but it's not an 09
00:13:39
Solution by any means in in my view
00:13:42
other thing is I don't think there'll be
00:13:43
pricing power in the long run one of the
00:13:46
reasons is mortgage lock in it turns out
00:13:48
most people who go negative on their
00:13:51
house they have negative equity they
00:13:52
don't actually default they just stay in
00:13:55
their home they're locked in to move
00:13:57
they would have to put up cash
00:13:59
to cure you know the the the negative
00:14:02
equity and they can't their liquidity
00:14:04
constraint so transactions volumes in
00:14:06
this market are going to be low for a
00:14:09
number of years um and I think there's
00:14:11
just not going to be a lot of a lot of
00:14:13
pricing power the Wild Card of course is
00:14:15
recession and how bad that gets real
00:14:18
quickly Fanny and Freddy um I want to
00:14:21
raise the issue with you and hope you
00:14:23
start thinking about what are we going
00:14:25
to do with these guys um first to
00:14:27
describe them for those of you who don't
00:14:29
know Fanny May and Freddy Mack are
00:14:30
government sponsored Enterprises um
00:14:33
which have provided liquidity to the
00:14:34
housing market and they are huge this
00:14:37
was Fanny's balance sheet um and owner
00:14:40
and Assets in the first quarter of 2008
00:14:43
before things crashed um very recently
00:14:47
$39 billion in equity 761 billion in
00:14:51
debt of which a quarter trillion came
00:14:53
due within a year um they held on their
00:14:56
balance sheet $737 billion in mortgages
00:15:00
in 08 first quarter and they had $2.5
00:15:03
trillion in mortgage guarantees so they
00:15:06
basically had a $3 trillion book and
00:15:09
less than $40 billion in equity and they
00:15:12
were playing the yield curve they were
00:15:14
you know taking out short-term money um
00:15:17
and and lending long Freddy was just the
00:15:20
mirror image except believe it or not
00:15:22
even worse capitalized and and worse run
00:15:25
so they went broke um they went broke
00:15:28
because things started to default people
00:15:30
started to repic these Securities and it
00:15:33
turns out Fanny and Freddy own a lot
00:15:36
more than conforming loans they have
00:15:39
affordable housing goals and the United
00:15:42
States government for a long time has
00:15:44
run its affordable housing program off
00:15:46
balance sheet to to a very large extent
00:15:49
through Fanny and Freddy and this is the
00:15:51
dangerous thing it it's what got us in
00:15:53
trouble um Fanny and Freddy own hundreds
00:15:57
of billions of dollars of this subprime
00:15:59
and Al Day stuff and it's in service of
00:16:02
their affordable housing goals because
00:16:04
those loans are basically made to
00:16:06
lowincome people or to people in what
00:16:08
are called geographically underserved
00:16:10
areas in the in the legislation um this
00:16:13
is a really unwise structure for a
00:16:17
couple of reasons one because in general
00:16:19
we ought to run real programs on balance
00:16:22
sheet so that we actually know what they
00:16:24
cost um and number two Fanny and Freddy
00:16:26
had an implicit guarantee which became
00:16:28
explicit last week at least their debt
00:16:31
um guarantee became explicit so the
00:16:34
incentives for management to take all
00:16:36
types of crazy risks were were right
00:16:38
there they were playing with The house's
00:16:40
money um and they they certainly did and
00:16:43
as we're going to find out they they
00:16:45
lost it as it were um it's going to be a
00:16:48
huge cost but down the road I think it's
00:16:51
really important for all of us it's a
00:16:53
multi-trillion dollar problem where I
00:16:56
think the underlying the real costs are
00:16:58
going to exceed billion bucks which is a
00:17:00
lot of money even by government
00:17:01
standards um in in the future and we got
00:17:03
to rethink how are we going to help our
00:17:07
least fortunate citizens in terms of
00:17:09
housing consumption and how are we going
00:17:11
to align incentives at these agencies
00:17:14
which carry really great systemic risk
00:17:16
and to me the scariest thing I saw in
00:17:18
the last couple of weeks was those guys
00:17:20
going under and International Banks
00:17:22
refusing to buy their debt I will leave
00:17:25
the commercial stuff that's enough
00:17:27
depressing stuff we'll leave it to the Q
00:17:29
and A but that's the nominal commercial
00:17:32
real estate prices over the last six
00:17:34
years doubl if if you've got a good
00:17:37
reason why real estate became so
00:17:39
productive you're not worried if you
00:17:41
don't have a good reason yes this is
00:17:43
starting to smell like housing
