Transcript Power Point ( 3.4M ) - St. Louis Fed

Dealing With Financial
Turmoil: The Fed’s Response
David C. Wheelock*
Federal Reserve Bank
of St. Louis
November 6, 2008
*Views expressed are not necessarily official positions of the Federal
Reserve Bank of St. Louis or the Federal Reserve System.
The Housing Slump: Root of the Crisis
•
•
•
•
Declining sales and rising vacancy rates
Less construction
Falling house prices
Rising foreclosure rates
– Cause mortgage-backed securities to decline in
value, resulting in large financial losses and
uncertainty about viability of counterparties.
Annual Rate
Sales of Existing Homes
7,500,000
7,000,000
6,500,000
6,000,000
5,500,000
5,000,000
4,500,000
4,000,000
2001
2002
2003
Last Observation: Sept 2008
2004
2005
2006
2007
2008
Home Vacancy Rate
Percent
3.0
2.8
2.6
2.4
2.2
2.0
1.8
1.6
1.4
1.2
1.0
2000
2001
2002
Last Observation: Q3:2008
2003
2004
2005
2006
2007
2008
Months Supply of New and Existing Single
Family Homes
Months
12.0
10.0
New Single Family Homes
8.0
Existing Single Family
Homes
6.0
4.0
2.0
0.0
2000
2001
2002
Last Observation: Sept 2008
2003
2004
2005
2006
2007
2008
U.S. Building Permits and Housing Starts
Thousands
2350
Building Permits
2150
Housing Starts
1950
1750
1550
1350
1150
950
750
2003
2004
Last Observation: Sept 2008
2005
2006
2007
2008
Median Sales Price of Existing Single
Family Homes
Year over Year % Change
20.0%
15.0%
10.0%
5.0%
0.0%
2000
2001
2002
-5.0%
-10.0%
-15.0%
Last Observation: Sept 2008
2003
2004
2005
2006
2007
2008
The Growth In House Prices:
United States Average
Year over Year % Change
20%
Case Shiller
OFHEO Purchase Only
15%
10%
5%
0%
1998
1999
2000
-5%
2001
2002
2003
2004
2005
2007
2006
2Q:2008
-4.77%
-10%
-15%
-20%
Last Observation: 2008:Q2
2Q:2008
-15.38%
2008
The Housing Boom (Bubble?)
• Many economists discounted the “bubble”
notion:
– Income growth was high
– Interest rates were low
• But, house prices rose much faster than GDP,
rents, or median household income
House Price and GDP Growth
S&P/Case Shiller Home Price Index and U.S. GDP Growth, 2001 = 1
1.8
1.7
1.6
1.5
1.4
House Price Index
GDP
1.3
1.2
1.1
1
2001
2002
Last Observation: 2Q 2008
2003
2004
2005
2006
2007
2008
House Prices Compared to Rent
1.8
1.6
1.4
1.2
1
Avg. 1987 to 1997
0.8
0.6
1987
1989
1991
1993
1995
1997
Case Shiller Price Index to Rent Ratio
Last Observation: 2008:Q2
1999
2001
2003
2005
2007
OFHEO Purchase Only Index to Rent Ratio
Note: OFHEO Purchase only index begins in Q1:1991. Value set
equal to C-S index for Q1:1991. Rent Price is from CPI index.
House Prices Compared to Median Income
2.60
2.40
2.20
2.00
1.80
1.60
1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Year
US Ratio
CA Ratio
FL Ratio
MO Ratio
KY Ratio
Note: Income is Nominal U.S. Median Income. US Ratio is C-S HPI. Regional Ratios are OFHEO HPI.
What Caused the Boom?
House prices had been rising since the mid1990s, but accelerated in 2002-03, coinciding
with:
– Low interest rates
– Rising household incomes
– Mortgage market innovations (“originate to
distribute” – subprime loans and securitization)
House Price and Personal Income Growth
Percent
14%
12%
HPI
10%
8%
6%
4%
2%
personal income
growth
0%
1998 - Q1 1999 - Q1 2000 - Q1 2001 - Q1 2002 - Q1 2003 - Q1 2004 - Q1 2005 - Q1 2006 - Q1 2007 - Q1 2008 - Q1
-2%
-4%
Last Observation: 2008:Q2
House Price Growth and Mortgage Rate
HPI growth rate
Mortgage rate
16%
8.5
14%
8
HPI
(left scale)
12%
7.5
10%
8%
7
6%
Mortgage Rate
(right scale)
4%
6.5
2%
6
0%
5.5
-2%
-4%
1998 Q1
5
1999 Q1
2000 Q1
Last Observation: 2008:Q2
2001 Q1
2002 Q1
2003 Q1
2004 Q1
2005 Q1
2006 Q1
2007 Q1
2008 Q1
Large Increase in Non-Prime Mortgages,
1995 - 2006
Mortgages, $ Billions
(Debt/ Income)
700
1.1
600
1
500
0.9
400
0.8
300
0.7
Debt/Income (right scale)
200
0.6
Subprime
Alt- A
100
0.5
0
0.4
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
What Ended the Boom?
House price appreciation began to fall in the
second half of 2005, coinciding with:
– Slowing of U.S. personal income growth
– Rise in mortgage rates
– Hurricane’s Katrina and Rita
Consequence of the housing slump…
Financial Distress
Falling House Prices and Financial Distress
• Rise in mortgage defaults and foreclosures
– Mainly on subprime, adjustable rate loans
• Significant losses on mortgage-backed
securities and derivatives (especially privatelabel MBS’s, even highly-rated securities)
• Uncertainty about the viability of
counterparties caused risk spreads to increase
and trading in financial markets to fall sharply.
House Prices and Foreclosure Rate
Rate of New Foreclosures
% Change in House Prices Case-Shiller Index
1.0
20%
0.9
15%
0.8
10%
0.7
5%
House Price Grow th
(right scale)
0.6
0%
0.5
-5%
0.4
-10%
Foreclosure Rate
(left scale)
0.3
-15%
Last Observation: 2008:Q2
20
08
20
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
-20%
19
99
19
98
0.2
U.S. Foreclosure Rates by Loan Type
Rate of New Foreclosures
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2005
2006
All M ortgages
Subprime ARM s
Last Observation: 2008:Q2
2007
Subprime FRM s
Prime ARM s
2008
Prime FRM s
How this Became a Crisis
• “Originate to Distribute” lending model
– Principal/agent problems – originators often didn’t
have skin in the game
– Investors relied on ratings agencies that used
backward-looking valuations and had their own
principal/agent issues
• Fannie Mae and Freddie Mac had conflicting
objectives, were highly leveraged but lightly
regulated.
• Credit default swaps and other over-thecounter derivatives ($50+ trillion!)
Interest Rate Spreads and Illiquid Markets
Percent
8.00
7.00
Fed lowers
Primary Credit
Rate 50 basis
points to 5.75%
Term Auction
Facility (TAF)
Introduced,
December 12,
2007
6.00
Lehman
Brothers files
for Bankruptcy,
Sept 14, 2008
%
5.00
4.00
3.00
Fed approves $30 billion
for Bear Stearns
takeover by J.P. Morgan
Chase
2.00
1.00
1 Month EuroDollar
1 Month CD Rate
3 Month LIBOR
Funds Target
0.00
1/1/2007
4/11/2007
7/20/2007
Last Observation: October 31, 2008
10/28/2007
2/5/2008
5/15/2008
8/23/2008
Commercial Paper Outstanding
Seasonally Adjusted, Billions of Dollars
Financial
Asset backed
Non Financial
1400.0
250.0
1200.0
200.0
1000.0
150.0
800.0
600.0
100.0
400.0
50.0
200.0
Financial
0.0
2005
Asset
Non Financial
0.0
2006
Last Observation: October 22, 2008
2007
2008
The Fed’s Response
The TAF, TSLF, and PDCF
• Term Auction Facility (TAF): Fed auctions
fixed amount of reserves to DIs; provides
liquidity while avoiding the stigma of
borrowing at the discount window.
• Term Securities Lending Facility (TSLF): Fed
lends Treasury securities to DIs in exchange for
other marketable assets.
• Primary Dealer Credit Facility (PDCF):
Lending facility for all primary dealers,
including non-DIs.
Bailouts and Non-Bailouts
• Bear Stearns (March ’08): Fed lent $30 billion
to facilitate JPMorgan’s acquisition of Bear.
Concern about systemic risk.
• Fannie/Freddie (Sept. ’08): Treasury places in
conservatorship, replaces CEOs.
• Lehman (Sept. ’08): Allowed to fail.
• AIG (Sept. ’08): Fed lends up to $85 billion
(increased later to $120); CEO replaced.
Systemic risk – huge amount of credit default
swaps outstanding.
The $700 Billion TARP
Troubled Asset Relief Program
• Capital Purchase Program – Treasury will
purchase preferred stock in a qualifying
financial firm.
$125 billion in nine largest banks
$125 billion in other banks that apply and qualify
• Other program(s) may include purchases of
MBSs and loans, insurance of troubled assets,
and assistance to borrowers.
Commercial Paper, Money Market Funds
• Commercial Paper Funding Facility (CPFF):
Fed will purchase highly-rated unsecured and
asset-backed commercial paper.
• Money Market Mutual Fund Liquidity Facility
(AMLF): Fed loans to banks to purchase assetbacked paper from MMMFs.
• Money Market Investor Funding Facility
(MMIFF): Sets up special vehicles to buy
money market instruments. Fed committed up
to $540 billion.
Old Fashioned Monetary Policy
• The FOMC has sharply cut the fed funds rate
target – negative real rate throughout 2008.
• Monetary base growth – up sharply since
September (“quantitative easing”).
Target Fed Funds Rate minus Yr/Yr CPI
Inflation
Percent
5.00
4.00
3.00
2.00
1.00
0.00
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
-1.00
-2.00
-3.00
-4.00
Forecast
Last Observation: Sept 2008
Expected Fed Funds Futures, CPI MA Forecast
St. Louis Adjusted Monetary Base, Yr/Yr
Growth, SA
Percent
40.00%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
1/1/2007
4/1/2007
7/1/2007
Last Observation: 10/20/08
10/1/2007
1/1/2008
4/1/2008
7/1/2008
10/1/2008
Summary (1)
• The financial crisis was triggered when house
prices began to decline and subprime mortgage
defaults increased.
• Subprime accounts for about 10 percent of
mortgage market. Subprime ARMs represent
about 7 percent of loans, but 43 percent of
foreclosures.
• Some $85 billion of losses on non-prime
mortgage loans has mushroomed into some
$1.4 trillion of losses world wide (IMF
estimate).
Summary (2)
• Systemic failure centered in MBSs and other
derivatives that have lost substantial market
value.
• The Fed (and other agencies) have attempted to
contain the crisis and re-start financial markets
by providing liquidity and acting as lender of
last resort.
Questions?