by Calculated Risk on 8/20/2012 07:34:00 PM

Fed Working Paper by Paolo Gelain, Norges Bank, Kevin Lansing, Federal Reserve Bank of San Francisco and Norges Bank, and Caterina Mendicino, Bank of Portugal: House Prices, Credit Growth, and Excess Volatility: Implications for Monetary and Macroprudential Policy

The researchers looked at the house bubble and several possible policy responses. It appears the most effective policy - for limiting the bubble - would have been to require lenders to focus more on loan-to-income.

From the paper:

Our final policy experiment achieves a countercyclical loan-to-value ratio in a novel way by requiring lenders to place a substantial weight on the borrower’s wage income in the borrowing constraint. As the weight on the borrower’s wage income increases, the generalized borrowing constraint takes on more of the characteristics of a loan-to-income constraint. Intuitively, a loan-to-income constraint represents a more prudent lending criterion than a loan-to-value constraint because income, unlike asset value, is less subject to distortions from bubble-like movements in asset prices. Figure 4 [see below] shows that during the U.S. housing boom of the mid-2000s, loan-to-value measures did not signal any significant increase in household leverage because the value of housing assets rose together with liabilities. Only after the collapse of house prices did the loan-to-value measures provide an indication of excessive household leverage. But by then, the over-accumulation of household debt had already occurred. By contrast, the ratio of U.S. household debt to disposable personal income started to rise rapidly about five years earlier, providing regulators with a more timely warning of a potentially dangerous buildup of household leverage.

We show that the generalized borrowing constraint serves as an “automatic stabilizer” by inducing an endogenously countercyclical loan-to-value ratio. In our view, it is much easier and more realistic for regulators to simply mandate a substantial emphasis on the borrowers’ wage income in the lending decision than to expect regulators to frequently adjust the maximum loan-to-value ratio in a systematic way over the business cycle or the financial/credit cycle.
...
... the most successful stabilization policy in our model calls for lending behavior that is basically the opposite of what was observed during U.S. housing boom of the mid-2000s. As the boom progressed, U.S. lenders placed less emphasis on the borrower’s wage income and more emphasis on expected future house prices. So-called “no-doc” and “low-doc” loans became increasingly popular. Loans were approved that could only perform if house prices continued to rise, thereby allowing borrowers to refinance. It retrospect, it seems likely that stricter adherence to prudent loan-to-income guidelines would have forestalled much of the housing boom, such that the subsequent reversal and the resulting financial turmoil would have been less severe.

Click on graph for larger image.

From the paper:

Figure 4: During the U.S. housing boom of the mid-2000s, loan-to-value measures did not signal a significant increase in household leverage because the value of housing assets rose together with liabilities. In contrast, the debt-to-income ratio provided a much earlier warning signal of a potentially dangerous buildup of household leverage.

Something to remember when the next lending bubble comes along. Also note that debt-to-income is still very high and there is more deleveraging to come.

by Calculated Risk on 8/20/2012 04:55:00 PM

David Leonhardt writes at Economix: The 14 Potential Causes of the Income Slump

Why has median household income just endured its worst 12-year stretch since the Great Depression?

The immediate answer to that question is that economic growth has slowed and inequality has risen. The pie isn’t growing very quickly, and the few new slices are going to a disproportionately small portion of the population.

But that answer is really just an accounting answer. The more important questions are why economic growth has slowed and why inequality has risen – not just over the last 12 years but, less severely, since the early 1970s as well.

Leonhardt has a poll for readers to rank 14 potential causes on why American household income has stagnated including globalization, demographics, fiscal policy, innovation and much more. Leonhardt concludes:

In coming days, I’ll be writing posts about what economists see as the major causes.

Should be in interesting series.

by Calculated Risk on 8/20/2012 01:42:00 PM

In addition to Case-Shiller, CoreLogic, and LPS, I'm also watching the FNC, Zillow and other house price indexes.

FNC released their June index data today. FNC reported that their Residential Price Index™ (RPI) indicates that U.S. residential property values increased 1.1% in June (Composite 100 index). The other RPIs (10-MSA, 20-MSA, 30-MSA) increased between 1.1% and 1.3% in June. These indexes are not seasonally adjusted (NSA), and are for non-distressed home sales (excluding foreclosure auction sales, REO sales, and short sales).

The year-over-year trends continued to show improvement in June, with the 100-MSA composite down 0.2% compared to June 2011. This is the smallest year-over-year decline in the FNC index since year-over-year prices started declining in 2007 (five years ago).

Click on graph for larger image.

This graph is based on the FNC index (four composites) through June 2012. The FNC indexes are hedonic price indexes using a blend of sold homes and real-time appraisals.

Some of the month-to-month gain is seasonal since this index is NSA. The key is the indexes are showing less of a year-over-year decline in June. If house prices have bottomed, the year-over-year decline should turn positive soon.

The June Case-Shiller index will be released Tuesday, August 28th.

by Calculated Risk on 8/20/2012 11:20:00 AM

Binyamin Appelbaum at the NY Times reviews some of the Obama administration's missed opportunities: Cautious Moves on Foreclosures Haunting Obama Here is an excerpt on mortgage cramdowns:

Former Representative Jim Marshall, a centrist Georgia Democrat who lost his House seat in 2010, was a staunch advocate of the administration’s economic policies. He supported the banking bailout. He opposed a similar bailout for homeowners.

The administration made just one mistake, he said in a recent interview: it failed to rewrite the bankruptcy code.

Congressional Democrats wanted to change the law to permit “cramdown” — a term that meant letting bankruptcy courts cut mortgage debts — to put pressure on mortgage companies to modify loans and to provide a backup plan for borrowers who could not get the help they needed.

“There was another way to deal with this, and that is what I supported: forcing the banks to deal with this,” Mr. Marshall said. “It would have been better for the economy and lots of different neighborhoods and people owning houses in those neighborhoods.”

Mr. Obama sponsored cramdown legislation as a senator, endorsed it as a presidential candidate and called on Congress to pass it in the Arizona speech.

But he also repeatedly pressed the pause button. When proponents sought to add a cramdown to the Emergency Economic Stabilization Act in September 2008, Mr. Obama, who had flown back to Washington from the campaign trail, persuaded them to postpone the “partisan” effort as an example to Republicans, who said the measure would violate existing contracts.

In February 2009, after Mr. Obama became president, the White House asked Democrats not to attach the measure to the American Recovery and Reinvestment Act, fearing it would cost votes. In March, a watered-down version finally passed the House, but the mortgage industry rallied opposition to block it in the Senate.

Some officials said the White House had tried and failed. But other officials and participants, including Mr. Marshall, said it simply was not a priority.

“There wasn’t enough political capital, time or energy,” said Mr. Barr, the former Treasury deputy.

Both Tanta and I urged changing the bankruptcy laws to allow mortgage cramdowns. Here was a piece from Tanta in 2007 (yes, 2007) explaining mortgage cramdowns and why they were the appropriate policy: Just Say Yes To Cram Downs (For new readers, Tanta was my former co-blogger and mortgage banker. You can read about her here).

Cramdowns in bankruptcy are still an appropriate policy, and hopefully the candidates will be asked in the debates about what policies they will pursue to help the unemployed and to address foreclosures - and be asked specifically about cramdowns.

by Calculated Risk on 8/20/2012 08:30:00 AM

The Chicago Fed released the national activity index (a composite index of other indicators): Index shows economic activity increased in July

Led by improvements in production-related indicators, the Chicago Fed National Activity Index (CFNAI) increased to –0.13 in July from –0.34 in June. ...

The index’s three-month moving average, CFNAI-MA3, decreased slightly from –0.18 in June to –0.21 in July—its fifth consecutive reading below zero. July’s CFNAI-MA3 suggests that growth in national economic activity was below its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests subdued inflationary pressure from economic activity over the coming year.

This graph shows the Chicago Fed National Activity Index (three month moving average) since 1967.

Click on graph for larger image.

This suggests growth was below trend in July.

According to the Chicago Fed:

A zero value for the index indicates that the national economy is expanding at its historical trend rate of growth; negative values indicate below-average growth; and positive values indicate above-average growth.