Assessing Housing Risk

Housing debt typically is on the short list of key sources of risk in modern financial systems and economies. The reasons are simple: there is plenty of it; it often sits on the balance sheets of leveraged intermediaries, creating a large common exposure; as collateralized debt, its value is sensitive to the fluctuations of housing prices (which are volatile and correlated with the business cycle), resulting in a large undiversifiable risk; and, changes in housing leverage (based on market value) influence the economy through their impact on both household spending and the financial system (see, for example, Mian and Sufi).

In this post, we discuss ways to assess housing risk—that is, the risk that house price declines could result (as they did in the financial crisis) in negative equity for many homeowners. Absent an income shock—say, from illness or job loss—negative equity need not lead to delinquency (let alone default), but it sharply raises that likelihood at the same time that it can depress spending. As it turns out, housing leverage by itself is not a terribly useful leading indicator: it can appear low merely because housing prices are unsustainably high, or high because housing prices are temporarily low. That alone provides a powerful argument for regular stress-testing of housing leverage. And, because housing markets tend to be highly localized—with substantial geographic differences in both the level and the volatility of prices—it is essential that testing be at the local level….

Read More

Better capitalized banks lend more and lend better

Many people seem to think that when authorities increase capital requirements, banks lend less. The advocates of this view go on to argue that, since credit is essential for economic growth, we should not impose overly tough constraints on banks. Put another way, a number of people believe that we have gone too far in making the financial system safe and the cost is lower growth and employment.

Treasury Secretary-designate Steven Mnuchin appears to share the view that financial regulation has restrained the supply of credit: in a recent interview, he is quoted as saying “The number one problem with Dodd-Frank is that it’s way too complicated and cuts back lending.” One interpretation of this is that Secretary-designate Mnuchin will support proposals like House Financial Services Chair Jeb Hensarling’s Financial CHOICE Act to allow banks to opt for a simple capital standard as an alternative to strict regulatory scrutiny.

Our reaction to this is three-fold. First, for most banks, which are very small and pose little threat to the financial system, a shift toward simpler capital requirements—so long as they are high enough—may be both effective and efficient; for the largest, most systemic intermediaries, higher capital requirements should still be accompanied by strict oversight. Second, we see no evidence that higher bank capital is associated with lower lending. In fact, quite the opposite. Third, given that the 2007-09 financial crisis was the result of too much borrowing—and that over-borrowing is a leading indicator of financial crises—it follows that not all reductions in lending are bad. We take each of these points in turn...

Read More

Rolling the dice, again

The headline on Reuters at Mon Oct 20, 2014 6:05pm EDT read “U.S. regulator targeting lower down payments on mortgages.” At first, we thought perhaps the headline was from 2004, not 2014. After the financial crisis of 2007-2009, it seemed inconceivable that U.S. authorities would again put some of the largest U.S. intermediaries – or the taxpayers who provide for them – at risk of failure. Sadly, we were wrong...

Read More

Still Riding the GSE Train

Will the U.S. federal government ever exit mortgage finance? Not any time soon.Let us explain why.
In September 2008, as investors shunned the debt of Fannie Mae and Freddie Mac, the U.S. Treasury put these government-sponsored enterprises (GSEs) into federal conservatorship, kicking off the most intense months of the financial crisis. Not long after, the CBO estimated the fair value of the GSEs losses at $291 billion (or more than 5% of their end-2009 mortgage portfolios)...
Read More