The Financial Crisis and the Economic Outlook

Ted GayerDecember 16, 2009

2

Housing Bubble and Financial Crisis Culprits

Housing Bubble

• Psychology (animal spirits).

• Global imbalances (searching for yield).

• Fed funds rate (Greenspan’s put).

• Housing tax policies.

• Government-sponsored enterprises (GSEs).

• Deteriorating underwriting standards.

Financial Crisis

• Poor risk-based models (mispriced risk).

• Credit rating agencies.

• Risk-based capital requirements and regulatory arbitrage.

• High leverage and low liquidity.

3

Case-Shiller Home Price Indices

S&P/Case-Shiller 10 and 20-city composite indices.

0

5 0

1 00

1 5 0

2 00

2 5 0

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

20002001200220032004200520062007200820092010

Com posite-1 0 Com posite-2 0

4

Depositor

Traditional Bank

Borrower

Insured Savings

Mortgage

$

$

Traditional BankingGary B. Gorton and Andrew Metrick, “Securitized Banking and the Run on Repo.” Working Paper 15223 (Cambridge, Mass.: National Bureau of Economic Research, August 2009): figure 1.

5

Investors

BankDirect Lenders

Borrowers

CDO Pool of ABS

SPV Pool of Loans

Mor

tgag

es

Mortgages

Mor

tgag

es

$

$

$

$

Collateral

Tranches

$

$

ABS

$ABS

Securitized BankingAdaptation of Gorton and Metrick (2009), figures 2 & 6.

6

Weak Labor Markets

Federal Reserve Economic Data (FRED), Federal Reserve Bank of St. Louis, & BLS.

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

20002001200220032004200520062007200820092010

Pe

rce

nt

Unemployment Rate Underemployment Rate

7

Plunge in Household Wealth

3.5

4

4.5

5

5.5

6

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

Ra

tio

Household wealth relative to income Average since 1980

Federal Reserve Board, Flow of Funds, & FRED.

8

Lending Conditions: CRE and Small Businesses

Q4

Banks tighteningstandards onCRE loans

Q4Small businesses findingloans less available

-20

0

20

40

60

80

Net percent

0

5

10

15

Net

per

cent

19951995 19971995 1997 19991995 1997 1999 20011995 1997 1999 2001 20031995 1997 1999 2001 2003 20051995 1997 1999 2001 2003 2005 20071995 1997 1999 2001 2003 2005 2007 2009

Federal Reserve Board, “Senior Loan Officer Opinion Survey on Bank Lending Policies” (Oct. 2009), & National Federation of Independent Business “Small Business Economic Trends.”

9

Vacant for rent

Vacant for sale

Q3

0

1

2

3

4

5

6

0

1

2

3

4

5

6

Per

cent

of h

ousi

ng s

tock

19951995 19971995 1997 19991995 1997 1999 20011995 1997 1999 2001 20031995 1997 1999 2001 2003 20051995 1997 1999 2001 2003 2005 20071995 1997 1999 2001 2003 2005 2007 2009

Oversupply of Housing

Housing Market Fundamentals

Census Bureau, Housing Vacancy Survey.

10

Housing Market Fundamentals

Percent of mortgaged property underwater Loan to value ratio

California 35% 72%

Florida 45% 87%

Arizona 48% 91%

Nevada 65% 114%

Michigan 37% 84%

New York 6% 49%

Nation 23% 70%

First American Core Logic, “Negative Equity Report” (Q3 2009).

11

Housing Market Fundamentals

Price-to-Rent Ratio

0.8

0.9

1

1.1

1 .2

1 .3

1 .4

1 .5

1 .6

1 .7

1 .8

1 .9

2

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Composite-10 Composite-20

S&P/Case-Shiller 10 and 20-city composite indices & BLS.

12

Housing Market Fundamentals

“New and Existing Home Sales: The Distressing Gap,” Calculated Risk: Finance & Economics (October 28, 2009).

13

Revenues & Outlays in CBO’s Baseline, 1969-2019

Douglas W. Elmendorf, “The Budget and Economic Outlook.” Presentation to the National Economists Club (September 24, 2009).

14

Doug Elmendorf, “Federal Budget Challenges.” Economics Lecture at Harvard University (April 2009).

Federal Debt Held by the Public

15

Treasury Yield Curve

Treasury Yield Curve

0

1

2

3

4

5

1 mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 20 yr 30 yr

Treasury rates as of 12/11/2009

U.S. Department of the Treasury, Daily Treasury Yield Curve Rates (December 11, 2009).

16

Debt Maturity

U.S. Department of the Treasury, “Quarterly Refunding Charts” (11/30/09).

17

Federal Reserve Balance Sheet: Assets

Federal Reserve Board of Atlanta, “Financial Highlights” (Dec. 2, 2009).

18

Federal Reserve Balance Sheet: Liabilities

Federal Reserve Board of Atlanta, “Financial Highlights” (Dec. 2, 2009).

19

• WSJ Survey of Forecasters (12/11/09): Modest Recovery

• GDP growth = 3% through 2010

•Unemployment rate of 9.6% at end of next year.

The Path of Real GDP in Previous Business Cycles

100

105

110

115

-4 -2 0 2 4 6

1961q1

1970q4

1975q1

1982q4

1991q1

2001q4

2009q3

Rea

l GD

P (T

roug

h =

100)

Quarters from Trough

The Path of Real GDP in Previous Business Cycles

The Wall Street Journal, “Economic Forecasting Survey” (December 2009).