# Presentation: 543058

## Implications of House Price Trends for Financial Institutions

- Lawrence J. White
- Stern School of Business
- New York University
- lwhite@stern.nyu.edu
- Presentation at the OFHEO Symposium on “House Prices in the U.S. Economy”
- March 10, 2003

## Overview

- House price increases in context
- What should we expect?
- Are the house price increases coastal?
- What is special about a coast?
- Exposure of depositories
- Mitigation of depositories’ exposure to credit risk
- The GSEs’ exposure
- Mitigation of the GSEs’ exposure to credit risk
- Conclusion

## House Price Increases in Context – Since 1980

- 					_Tot. inc._	_Ann. Inc._
- Housing			184.9%	    4.9%
- Nominal GDP		275.8	    6.2
- GDP deflator		  94.2	    3.1
- S&P 500			641.2	    9.5

## House Price Increases in Context – Since 1997

- 					_Tot. inc._	_Ann. Inc._
- Housing			  38.3%	    6.7%
- Nominal GDP		  26.3	    4.8
- GDP deflator		    8.6	    1.7
- S&P 500			   -9.3	   -1.8

## House Price Increases in Context – Since 2001

- 					_Ann. Inc_
- Housing			   6.9%
- Nominal GDP		   4.0
- GDP deflator		   0.8
- S&P 500			-23.4

## What Should We Expect?

- In a growing economy, house prices will probably rise faster than other things
- Implications of standard urban models and rent-distance functions
- OFHEO index may not capture house improvements
- But the recent house price increases do seem to be greater than “normal”

## Are the House Price Increases Coastal? (1)

- 23 of 51 (45%) of the states have ocean coasts; but
- Of the 15 states with the *highest* 1-year price increases, 13 states (87%) are coastal
- Of the 10 states with the *highest* 5-year price increases, 13 states (87%) are coastal
- Of the 10 states with the *highest* 22-year price increases, 12 states (80%) are coastal

## Are the House Price Increases Coastal? (2)

- 28 of 51 (55%) of the states do not have ocean coasts; but
- Of the 15 states with the *lowest* 1-year price increases, 10 states (67%) are not coastal
- Of the 10 states with the *lowest* 5-year price increases, 10 states (67%) are not coastal
- Of the 10 states with the *lowest* 22-year price increases, 11 states (73%) are not coastal

## What Is Special about a Coast?

- Geographic expansion of the supply of housing outward is more difficult
- Where housing can easily expand outward from the center of a city, there are long-run restraints on the extent of house price increases

## The Exposure of Depositories:1-4 Res. Mort. as a % of Assets

- 			Com.				Sav.
- 			_banks_	_S&Ls_	_banks_
- 1972		    8%	  85%	  67%
- 1982		    9		  68		  54
- 1992		  10		  47		  41
- 2002		  16		  48		   -
- 						 45%

## Mitigation of Depositories’ Exposure to Credit Risk

- Underwriting standards
- 4% capital requirements
- Maximum LTV ratio of 80%
- Mortgage insurance above 80%
- Hold MBS
- Explicit deposit insurance
- 1-4 residential mortgages have rarely been the cause of S&L failures

## The Fannie Mae’s & Freddie Mac’s’ Exposures (2001)

- About 85% of their total assets ($1.2T of $1.4T) are in 1-4 family residential mortgages (or MBS)
- Almost 100% of their total outstanding MBS ($1.5T) are in 1-4 family residential mortgages

## Mitigation of the GSEs’ Exposure to Credit Risk

- Underwriting standards
- Capital requirements
- Forward-looking stress tests
- Nation-wide portfolios
- Maximum LTV ratio of 80%
- Mortgage insurance above 80%
- Implicit government guarantee

## Conclusion

- Some housing price increases are to be expected
- Recent increases are notable; they seem to be largely coastal
- Depositories’ exposures are generally not serious and are mitigated
- GSEs’ exposures appear more serious, but are mitigated
- Better accounting information (market value accounting) would help regulators deal with risks