AEI’s Subprime Seminar – II
Richard Brown is the Chief Economist of the Federal Deposit Insurance Corporation (FDIC). As such, he is on record as asserting that the subprime meltdown taken by itself is a manageable problem. Therefore, he’s intensely interested in the concept of spillover, the idea that problems in subprime might affect other classes of mortgages. He waited for the very end of the AEI seminar  to ask about this, but the responses were illuminating.
If you listen carefully at the end, you’ll see that Tom Zimmerman made a semi-serious offer to come up with a quantative estimate of subprime’s influence on the other sectors. Transcript times represent the audio recording of the seminar. The video times run about 20 seconds greater.
Rich Brown (1:54:05): Rich Brown with the FDIC. Prime mortgage delinquencies are going up from cyclical lows, I had a question, I heard something, at least one of the panelists talked about a spillover from the problems in subprime and Alt-A to the prime market. I’d like to get your views for how high you think prime delinquencies and foreclosures will go and also what is precisely the mechanism of spillover. What is it about the turmoil in the subprime and Alt-A markets that’s going to lead prime borrowers to stop paying on their mortgages and give up their homes.
Alex Pollock: Chris?
Chris Whelan (1:54:40): We always seem in our society to artificially divide subjects into subsets and then defend or attack the proposition that the subset next to it is somehow going to affect it. Real estate is real estate, and whether your neighbor down the street has a subprime loan and you don’t or vice versa, it doesn’t really matter. What matters is: what’s the flow of sales; are the comps holding up or are they going up or down. I can tell you in Westchester County, New York, things are kind of quiet. We’ve got a couple of million-and-a-half dollar homes down the street from me that they’ve stopped working on. Which is unusual, if you know what the taxes are in our area, that’s costing that builder a lot of money. But he decided to stop work on the house rather than complete. I don’t like seeing signs like that.
There’s other issues, but what I’m saying is I wouldn’t necessarily … I think spillover is going to be a function of what happens in the marketplace as a result of the withdrawal of financing and the fact that The Street [stock exchanges largely based around Wall Street, NYNY] is not having an easy time selling this stuff through. That’s what’s going to determine the outcome in the market overall.
Tom Zimmerman (1:55:44): The other thing is if you saw the charts  I put up, you know that showed losses and loss severity and defaults, versus HPA [Home Price Appreciation – year-over-year], it looked almost the same in … the scales were different … but it was the same in prime as Alt-A as … it fits all markets … When you have a roaring housing market there’s no problem with defaults anywhere. You slow it down, defaults go right back up again.
Rich Brown (not on mic, almost inaudible): And how high ??? it ???
Alex Pollock: OK …
Tom Zimmerman: I don’t know what the number would be, but I’m saying … I could get a number for you but I don’t have it.
Alex Pollock (1:56:16): I think in your profession you’d really like to have that number, wouldn’t you Rich? [laughter] I don’t know if he could be giving any Reps and Warranties  with it. [laughter] … All right, I think this was a great panel, and let’s show our appreciation for our speakers. [applause] …
Notes and References: "Subprime Loan Problems, Stock Market Declines: A Result of Lax Lending Practices, Not Identity Theft and Fraud", CreditLock blog, March 14, 2007.
Despite the seriousness of the current situation, considering that only 6% of outstanding mortgages are subprime mortgages with adjustable rates, it is unlikely that a major financial shock will ensue. An article by David Gaffen, “Be Cautious, Don’t panic”, published on WSJ Online in February, illustrated such perspective.
Richard Brown, FDIC chief economist recently remarked that FDIC insured banks hold about $2.2 Trillion in mortgages, probably with 85% to 90% being prime mortgages. The total size of the mortgage market is about $10.2 Trillion. About $5.5 Trillion have been securitized. The total size of the Subprime mortgage market is about $1.3 Trillion. If 30% of such mortgages default, and banks are only able to recoup 60% of lent monies, that would result in losses of $156 Billion. It is estimated that FDIC insured banks generated about $145.7 Billion in profits in 2006 alone.
What if the Subprime problems affect the overall mortgage market? It is estimated by the Mortgage Bankers Association that 35% of homeowners own their homes outright. Furthermore, an additional 47% are estimated to hold a Fixed Rate Mortgage. Unless there is a substantial loss of jobs, it is unlikely that the Subprime problems will cause a serious economic shock.
: "Mortgage Credit and Subprime Lending: Implications of a Deflating Bubble", seminar, American Enterprise Institute, March 28, 2007. : slides – "The U.S. Subprime Market: An Industry in Turmoil", March 2007. Zimmerman’s assertion is that year-over-year Home Price Appreciation (HPA) makes the same quantitative difference to loss, default, etc. experience across all quality classes of MBS (only the scale changes with quality). The slide deck comes up as a pop-up menu when you go to the AEI event site and click on "Zimmerman Presentation." The slides he refers to here are ## 3-6 (slide number on slide, there’s a title page before slide "1" so subtract 1 from the browser’s count). In slides 4,5,6 the values "0-5","5-10",…,"25+" refer to percent-rise values of year-over-year home price appreciation for the houses backing the mortages. Titles are as follows:
- Impact of Prepayments & HPA on Subprime Losses—September 2005 (House Price Appreciation values in second column)
- Impact of Slower HPA: Higher Defaults (HPA cohorts represented by different colors)
- Higher Loss Severities (HPA is the x-axis)
- The Impact of HPA on Losses (HPA is the x-axis)
: Pollock’s remark is jocular. Representations & Warranties Insurance …
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