Comments on Housing and Mortgage Markets Part I American Securitization Forum Las Vegas, NV January 30, 2006 Amy Crews Cutts Deputy Chief Economist

1 Office of the Chief Economist Mortgage Rates Are Still Very Low 30-Year Fixed Mortgage Rate Annual Average Interest Rate (Percent) 10-Year Treasury June % June 13, % 0.5 points July % July % 0.5 points Source: American Council of Life Insurers (ACLI), Freddie Mac (PMMS SM ), Federal Reserve Forecast

2 Office of the Chief Economist Mortgage Rates Remain Low in 2006 Source: Freddie Mac’s Primary Mortgage Market Survey SM 1998 Refi Boom Refinance Boom 1.7 points 3.36% 1-Year, ARM Rate 30-Year, Fixed Rate 6.5% 8.2% 8.6% 7.3% Weekly Mortgage Interest Rate (Percent) 3.9 points 3.4 points 5.2% Forecast

3 Office of the Chief Economist Foreclosure Rates Are Directly Related to Employment Source: Mortgage Bankers Association of America, Freddie Mac, National Bureau of Economic Research, Bureau of Labor Statistics Change in Non-Farm Payroll Employment (in thousands) – Recession Percent of prime loans in foreclosure (inventory at end of quarter) Employment (right scale) Foreclosure Rate (left scale)

4 Office of the Chief Economist Source: Mortgage Bankers Association of America, Freddie Mac, National Bureau of Economic Research, Bureau of Labor Statistics Foreclosure Rates Are Directly Related to Employment: Ohio Change in Non-Farm Payroll Employment (in thousands) – National Recession Percent of prime loans in foreclosure (inventory at end of quarter) Employment (right scale) Foreclosure Rate (left scale)

5 Office of the Chief Economist Source: Mortgage Bankers Association of America, Freddie Mac, National Bureau of Economic Research, Bureau of Labor Statistics Foreclosure Rates Are Directly Related to Employment: Michigan Change in Non-Farm Payroll Employment (in thousands) – National Recession Percent of prime loans in foreclosure (inventory at end of quarter) Employment (right scale) Foreclosure Rate (left scale)

Comments on Housing and Mortgage Markets Part II American Securitization Forum Las Vegas, NV January 30, 2006 Amy Crews Cutts, PhD Deputy Chief Economist

7 Office of the Chief Economist Bubbles, Bubbles Everywhere The following discussion is based on a working paper that I wrote recently with Frank Nothaft, Chief Economist at Freddie Mac, called: “Reversion to the Mean Versus Sticking to the Fundamentals: Looking to the Next Five Years for Housing Price Growth” The study is available here as a working paper:

8 Office of the Chief Economist U.S. Home Prices Have Grown Every Year Since 1950 – Remain Strong in Recession Year Annual National House Price Growth (Percent) Source: E. H. Boeckh and Associates, Bureau of Labor Statistics, U.S. Census Bureau, Freddie Mac Forecast 5.0%: Growth Rate

9 Office of the Chief Economist Source: Freddie Mac Conventional Mortgage Home Price Index 2Q2005 release for period 1Q Q2005. Regional Annual House-Price Growth United States 6.1% Pacific 8.6% Mountain 5.9% West South Central 4.4% East South Central 4.9% South Atlantic 6.0% Middle Atlantic 7.0% East North Central 5.7% West North Central 5.3% New England 7.7%

10 Office of the Chief Economist What If the U.S. Housing Market Was Mean Reverting? Mean reversion implies that over some period of time the trend will revert to the mean Another way to say this is “what goes up, must come down” Suppose we pretend that the housing market is mean reverting  That a correction will occur over the next five years  That national growth will average 5% over the period  That regional growth will also average the 50-year national average growth rate of 5% This is the result of such a thought experiment…

11 Office of the Chief Economist Annual Growth Rate of Home Prices in the U.S – Recession Year Source: Conventional Mortgage Home Price Index ( ), Author’s calculations A C B 5.0%: Growth Rate

12 Office of the Chief Economist A Pure Mean Reverting View of Annual House Price Growth United States 0.9% (4.6%) Pacific- 3.9% (-17.9%) Mountain 2.3% (12.2% West North Central 2.5% (12.9%) West South Central 5.1% (28.4%) East South Central 5.6% (31.5%) East North Central 4.3% (23.2%) Middle Atlantic -1.7% (-8.2%) South Atlantic -0.1% (-0.7%) New England -3.3% (-15.3%) Source: Authors’ calculations on Conventional Mortgage Home Price Index data. Values in parentheses are the 5-year cumulative growth rates.

13 Office of the Chief Economist What If the U.S. Housing Market Was Based on Fundamentals? We know that local factors affecting supply and demand ultimately determine home prices Put another way, “Land is a scarce commodity” Suppose we model regional housing markets on some market fundamentals  Mortgage interest rates  Population growth  Real per capita disposable income This is the result of such a thought experiment…

14 Office of the Chief Economist A Fundamental Economics View of Annual House Price Growth Source: Authors’ calculations using Economy.com projections of regional real household income, population growth and 30-year fixed conventional and conforming mortgage rate projections. Values in parentheses are the 5-year cumulative growth rates. United States 5.0% Pacific 6.5% (37.0%) Mountain 3.1% (16.5%) West South Central 3.1% (16.5%) East South Central 3.1% (16.5%) South Atlantic 3.5% (18.8%) Middle Atlantic 6.4% (36.4%) East North Central 6.2% (35.1%) West North Central 6.0% (33.8%) New England 5.4% (30.1%)

15 Office of the Chief Economist Figure 8: Forecast of Home Prices Based on Macroeconomic Fundamentals Source: Conventional Mortgage Home Price Index and Authors’ calculations using Moody’s Economy.com projections of interest rates, CPI, GDP, and housing starts. B – Recession Year A B Macro- Fundamental Forecast 6.1%: 1Q Q2005 Growth Rate

16 Office of the Chief Economist The Trouble With Bubbles… Source: Used with Permission. © Washington Post/ Universal Syndicate

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