Policy Seminar on the Mortgage Markets

Friday, February 27, 2009
George Shultz Conference Room, Herbert Hoover Memorial Building


Frank Nothaft (Chief Economist, Freddie Mac), Peter Fisher, George Shultz, John Taylor, Kenneth Scott, John Shoven, Michael Boskin, John Cogan, Monika Piazzesi, Martin Schneider, John Ciorciari, and Matthew Gunn.


  • Recent Government Actions in the Mortgage Markets. Frank Nothaft opened the meeting by discussing some recent government actions related to the mortgage markets, including the decision to put Fannie and Freddie under conservatorship in September and Treasury’s purchase of roughly $50 billion in mortgage-backed securities (MBS) from the GSEs. He also touched on the Fed’s plans to buy about $500 billion in MBS by mid-2009 and Treasury’s plans to buy up to $100 billion of debt from Fannie and Freddie by the end of 2009. Participants drew attention to the slow pace of purchases thus far and discussed the legal implications of such large-scale government intervention in the mortgage markets.

  • Effects of the Interventions. Nothaft presented data to show that the government’s “effective backing” of Fannie and Freddie has recently helped push down yields on GSE debt and MBS. He noted that government actions have pushed 30-year fixed mortgage rates to the lowest level in decades. However, the spread between primary and secondary mortgage market rates remains high after a dramatic increase in late 2008. Nothaft explained that wider spreads largely reflect the higher cost to lenders of purchasing options to hedge its mortgage pipeline. He cited uncertainty about mortgage approvals as a key reason for the increased cost of hedging. Participants briefly discussed the possible economic merits of an explicit federal guarantee of the GSEs.

  • Trends in the Housing Markets. Nothaft then shifted to an analysis of broader trends in the U.S. housing market. He argued that housing starts may already be bottoming in some markets, but housing prices probably will not hit bottom until late 2010. He presented a forecast suggesting an eventual peak-to-tough decline of 30% in real terms (25% in nominal terms) but noted that some other analysts project an even larger fall in housing process. States with large excess inventory—such as Florida, California, and Michigan—could take longer to recover and experience a sharper price drop. Nothaft anticipated an increase in default rates as housing prices slide.

    In discussion, participants reviewed some of the pros and cons of the Case-Shiller Index and government surveys for assessing housing prices. They also cited rental and seasonal vacancies—as well as vacant homes for sale—as a relevant factor in examining the scale of the challenge in housing markets. Participants touched on the importance of considering that some homeowners occupy excessively costly homes and will likely be forced to “scale back.” Lastly, the group reviewed government plans to help ailing homeowners through the $75 billion loan modification program, discussing the problem of providing certain performing borrowers with perverse economic incentives.

  • The Subprime Market. Nothaft then analyzed developments in the subprime and alt-A markets. He showed that the relative share of such mortgages has declined precipitously since 2006 from over 33% of all originations in 2006 to less than 5% in 2008. Today, subprime loans amount to roughly 12% of the total mortgage market (approximately 6 million loans out of a total of 55 million).

    Nothaft noted that roughly 13% of Freddie first mortgages are now underwater, and some national estimates exceed 20% as more subprime and alt-A mortgages reset. Nothaft explained that the effects of the subprime markets on GSEs have been largely indirect. Freddie did not buy many subprime loans directly; it purchased AAA-rated tranches of private-label MBS, partly to fulfill its mandate to promote affordable housing in certain geographic areas and for certain segments of the population. Participants noted that by 2004, home inventories were already rising steeply, but policy and business decisions continued to promote increased homeownership through subprime lending.

  • Policy Options. In the final portion of the meeting, participants reflected on government purchases of toxic assets and other policy options in the mortgage markets. Nothaft explained that Freddie currently has a moratorium in place on foreclosures, which keeps people in the “default pipeline” for a longer period of time. Participants raised the possibility of swapping deeds for rental contracts as a way to keep people in their homes and avoid costly foreclosures. Nothaft noted that Fannie and Freddie have not implemented such an arrangement to date. Finally, the group discussed the future evolution of Fannie and Freddie. Nothaft argued that keeping the GSEs intact as large market players would be justified, because economies of scale and diversification were important for them to be effective. He also argued that they would need flexibility in managing their portfolios to respond to credit needs in the economy.

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