Julie Stackhouse
Senior Vice President
Federal Reserve Bank of St. Louis
May 22, 2009
The views expressed are those of Julie Stackhouse and may not represent the official
views of the Federal Reserve Bank of St. Louis or the Federal Reserve System.
Today’s Challenges are Tied to Overuse of
Debt in an Unsustainable Housing Market
 Large amounts of international capital flowed into our financial
markets resulting in low long-term interest rates.
 Low rates combined with excess liquidity led to a boom in the
credit markets.
 Much of this excess liquidity flowed into the housing market. With
so much liquidity, credit standards eased and subprime mortgages
grew. The “originate to distribute model” largely kept the assets off
the lenders’ balance sheets.
 These mortgages were transformed into complex structured
financial products that were underestimated or misunderstood by
investors and by credit ratings agencies.
 As house prices began to fall, losses ensued.
2
The Size and Growth of the NonPrime Mortgage Market
Billions of dollars
Mortgage Originations
4000
Prime Home-Equity
Lines/Loans
Alt A
3000
Subprime
2000
Prime Jumbo
Prime Conventional/
Conforming
1000
FHA/VA
0
2001
3
2002
2003
2004
2005
2006
xx
2007
Q2
Q3
Q4
2008
Q2
Quarterly figures for 2007 and 2008 expressed at an annual rate.
Source: Inside Mortgage Finance, Jan. 30, 2009.
Q3
Q4
The Size and Growth of the NonPrime Mortgage Market
Billions of dollars
Mortgage Originations
4000
Prime Home-Equity
Lines/Loans
Prime Jumbo
3000
Prime Conventional/
Conforming
2000
FHA/VA
Alt A
1000
Subprime
0
2001
2002
2003
2004
2005
2006
2007
Q2
Q3
Q4
2008
Q2
Quarterly figures for 2007 and 2008 expressed at an annual rate.
Source: Inside Mortgage Finance, Jan. 30, 2009.
4
Q3
Q4
The Elements of Risk Layering:
Adjustable Rates
Share of Mortgages with Adjustable Rates, Including
Hybrids
75
Percent
ARM share of subprime
mortgages issued (Loan
Performance)
50
25
ARM share of prime
mortgages outstanding
(MBA)
0
1998
1999
2000
Sources: Mortgage Bankers Association, Loan Performance Corp.
5
2001
2002
2003
2004
2005
2006
2007
The Elements of Risk Layering:
Reduced Documentation
Share of Subprime Mortgages Underwritten With Reduced
Documentation
50
Percent
40
30
20
2000
Source: Loan Performance Corp.
6
2001
2002
2003
2004
2005
2006
2007
The Elements of Risk Layering:
Nominal Equity at Risk
Combined Loan-To-Value Ratio For Subprime Mortgages
Includes all mortgage debt on property
100
CLTV ratio
in %
95
90
85
2000
Source: Loan Performance Corp.
7
2001
2002
2003
2004
2005
2006
2007
The Elements of Risk Layering:
Cash-Out Refinancing
Share of Subprime Mortgages That Were Cash-Out
Refinances
75
Percent of loans
Fraction of
subprime loans
that were cashout refinances
50
25
Fraction of
conforming
(prime) loans
that were cashout refinances
0
2000
2001
Source: Loan Performance Corp, Freddie Mac.
8
2002
2003
2004
2005
2006
2007
The Elements of Risk Layering:
3rd Party Originators
Share of Subprime Mortgages Originated Through Broker
or Wholesale Channel
90
Percent of loans
80
70
60
50
2000
Source: Loan Performance Corp.
9
2001
2002
2003
2004
2005
2006
2007
Cash Flows From Questionable Mortgages were
Transformed into Securities and Derivative
Products – often with AAA Ratings
Subprime MBS becomes part of many CDOs
Source: Federal
Reserve Bank of New
York, “A Primer on the
Mortgage Market: The
Primary Market”, by
Michael Holscher and
Jason Miu, April 20,
2007.
10
House Prices Appreciated Beyond
Sustainable Levels
US House-Price Appreciation: S&P/Case-Shiller Home-Price Index
Percent per year
80-Year Historical Annual Average: 5 Percent
Percent per year
20
20
15
15
10
10
5
5
0
0
-5
-5
-10
-10
-15
-15
-20
95
00
05
Sources: S&P, Fiserv, and MacroMarkets LLC, Haver Analytics
10
-20
Over Time, Consumers Forgot how to Save
% of disposable
income
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
-2.0
1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007
And then, House Prices Fell – Major Market
Prices Down 29%
S&P/CaseShiller
Composite-10
Metro-Area
House-Price
Index set equal
to 100 in May
2006
100
June 2006
90
Forward curve on Mar. 2,
2009, based on contracts
traded at the Chicago
Mercantile Exchange
Actual data
80
70
December 2008
60
50
40
2000
2002
2004
2006
2008
2010
2012
12
Mortgage Delinquency Rates Accelerated
14
The Financial System Faced a Crisis
3-Month LIBOR-OIS Interest Rate Spread
Per centage points
1-Month LIBOR-OIS Interest Rate Spread
Per centage points
4
4
3
3
2
2
1
1
0
0
07
Sour ce: Haver Analytics
08
14
The Fed’s Response to the Crisis
Financial Institution Facilities
Primary Credit
Secondary Credit
Seasonal Credit
Term Auction Facility
Lender
District Reserve Banks
District Reserve Banks
District Reserve Banks
District Reserve Banks
Current Rate
Federal Funds plus 25 basis points
Primary Credit rate plus 50 basis points
Published
Set at auction
Section 13(3) Facilities
JPMC/Bear Stearns
Primary Dealer Credit Facility
AIG
Lender
FRB New York
FRB New York
FRB New York
Date of Facility
March 16, 2008
March 17, 2008
September 16, 2008/November 10, 2008
AIG– Residential Mortgage-Backed
Securities Facility
FRB New York
November 10, 2008
AIG- Collateralized Debt Obligations
Facility
FRB New York
November 10, 2008
AMLF - Asset-Backed Commercial Paper
Money Market Mutual Fund Lending
Facility
FRB Boston
September 19, 2008
CPFF- Commercial Paper Funding
Facility
FRB New York
October 7, 2008
MMIFF – Money Market Investor Funding
Facility
FRB New York
October 21, 2008
TALF – Term Asset-Backed Securities
Loan Facility
FRB New York
November 25, 2008
18
Changes in the Fed’s Balance Sheet
Federal Reserve Assets
Billions of dollars
2400
Other Loans
Currency swaps and other assets
Commercial Paper Funding Facility (CPFF)
Money Market Mutual Fund Liquidity
Facility (AMLF)
Primary Dealer Credit Facility (PDCF)
Primary Credit
Term Auction Facility (TAF)
Repurchase Agreements
Term Securities Lending Facility (TSLF)
and Overnight Lending
2100
1800
1500
1200
900
600
Securities held outright
minus those lent
300
0
Oct
Dec
Feb
2007
2008
Apr
Jun
Aug
Oct
Dec
Feb
2009
Apr
19
Congressional Response to the Crisis: $700 Billion
TARP and the Financial Stability Plan
 Capital Purchase Program (CPP)
 Stress testing of the largest banking organizations and Capital






Assistance Program (CAP)
Public-Private Investment Program (P-PIP)
Consumer and Business Lending Initiative (Super TALF)
Targeted Investment Program (TIP)
Auto Industry/Auto Supplier Program
Systemically Significant Failing Institutions Program
Affordable Housing Support and Foreclosure Prevention (Making
Homes Affordable Program)
Source: www.financialstability.gov/roadtostability/programs.htm
18
Transaction Report as of May 13, 2009
May 13, 2009
Capital Purchase Program (CPP)
Capital Assistance Program (CAP)
Consumer and Business Lending Initiative (Super TALF)
Public-Private Investment Program (P-PIP)
$197.8 billion
$0
$20 billion in LLC
$0
Targeted Investment Program (TIP) – Citi, BoA
$40 billion
Asset Guarantee Program - Citi
$5 billion
Auto Industry/Auto Supplier Program – GM, GMAC, and Chrysler
$35.6 billion
Systemically Significant Failing Institutions - AIG
$69.8 billion
Affordable Housing Support and Foreclosure Prevention (Making
Homes Affordable Program)
Source: www.financialstability.gov
14 servicers
Incentive caps of $15.1
billion
19
More about the Capital Purchase Program and
Capital Assistance Program
 Capital Purchase Program (10/14/2008)
 579 institutions currently participating (as of 5/13/2009)
 Total purchases: $199 billion
 Total repayments: $1.3 billion
 Investments:
 Preferred Stock: Pays cumulative dividends of 5% per year (first 5 years); 9% per year
after 5 years


Warrants: Treasury can purchase common shares of stock with an aggregate market
price equal to 15% of the Preferred Stock amount on the date of investment.

20
May not be redeemed for three years except with the proceeds from a “Qualified Equity
Offering” (sale of Tier 1 qualifying perpetual preferred stock or common stock for cash)
Term: 10 years
More about the Capital Purchase Program and
Capital Assistance Program
 Capital Assistance Program (2/10/2009)
 “Big 19” were primary participants via stress tests. Other publicly traded
banks may apply (deadline: 6/9/2009)
 Investments:

Convertible Preferred Securities: Convertible to common equity at a 10 percent
discount to the prevailing price prior to February 9 (with regulator approval).





Warrants: Treasury receives warrants to purchase shares of common stock with an
aggregate market value equal to 20% of the Convertible Preferred amount on the
investment date.

21
Carry a 9% dividend yield
Automatically converts to common equity after 7 years
Recipients must submit a plan on how they intend to “preserve and strengthen their
lending capacity”. Banks must submit detailed monthly lending reports which will be
made public.
Includes restrictions on the payment of dividends (maximum of $0.01 per share per
quarter), repurchasing shares and pursuing cash acquisitions
Term: 10 years
Congressional Response to the Crisis:
Expanded FDIC Insurance Coverage and an
Economic Stimulus Bill
 Federal Deposit Insurance Coverage increased to $250,000 per owner
through December 31, 2009; banks also had option to fully cover all
non-interest bearing accounts
 Temporary government guarantee of participating money market
mutual funds until September 19, 2009
 $800 billion economic stimulus package
22
Economists Estimate that Stimulus Might Save
One-Third to Half a Year’s GDP
14500
SAAR, Bil.
Chn.2000$
14000
13500
13000
12500
12000
11500
11000
$ 11.6 Trillion
$ 7.1 Trillion
Is the Current Crisis as Bad as the Great
Depression?
Indexed Return.
Series = 1 at approximate start of Crisis
1.4
S&P 500
Great Depression versus 2008/2009 Recession
1.2
1
0.8
0.6
0.4
0.2
Great Depression total Stock Mkt Return: -52%
08/09 Recession Stock Mkt Return to date: -43%
1
4
7
10
13
16
19
22
25
28
31
34
37
40
43
46
49
52
55
58
61
64
67
70
73
76
79
82
85
88
91
94
97
100
103
106
109
112
115
118
121
124
127
130
133
136
139
142
145
0
24
Months into Crisis
Great Depression
Current Recession
Is the Current Crisis as Bad as the Great
Depression?
Inflation: Great Depression versus Current Recession
1.1
1
0.95
0.9
0.85
0.8
0.75
0.7
1
4
7
10
13
16
19
22
25
28
31
34
37
40
43
46
49
52
55
58
61
64
67
70
73
76
79
82
85
88
91
94
97
100
103
106
109
112
115
118
121
124
127
130
133
136
139
142
145
Indexed CPI Growth
1.05
Months into Crisis
25
Current Recession
Great Depression
Is the Current Crisis as Bad as the Great
Depression?
Industrial Production Still Stronger than Great Depression
Automotive Industry Could drag Industrial Production Further Down
Indexed Return
Index = 1 at approximate start of crisis
1.5
1.4
1.3
Industrial Production decline since 2007: -11.4%
Automotive Industrial Production decline since 2007: -37%
1.2
Industrial Production growth during Great Depression: 46%
1.1
1
0.9
0.8
0.7
0.6
0.5
1
2
3
4
5
6
7
8
9
10
11
12
Years into Crisis
26
The Great Depression
Current Recession
Current Recession -- Automotive Products
13
Is the Current Crisis as Bad as the Great
Depression?
House Prices In Current Recession Steeper than Great Depression
Nominal House Prices
1.05
Indexed Return
Index = 1 at approximate start of crisis
1
0.95
0.9
0.85
0.8
House price depreciation during The Great Depression: -16%
House Price depreciation, 2007 - present: -20%
0.75
0.7
1
2
3
4
5
6
7
8
9
Years Into Crisis
27
Current Recession
Great Depression
10
11
12
13
Impact for the Future: The Market for PrivateLabel Mortgage-Banked Securities is Gone
Net Lending Via Private-Label ABS
Billions of dollars
1,000
Consumer, trade credit,
other loans
800
600
Commercial mortgages
400
Multifamily mortgages
200
0
Residential mortgages
-200
-400
Treasury and agency
securities
-600
2000
28
2003
2006
2009
Source: Federal Reserve Flow of Funds Accounts, Third Quarter 2008.
Impact for the Future: The Cost to Banks and
Investors Has been Significant
Loans
Residential mortgage
Commercial mortgage
Consumer
Corporate
Municipal
Total for loans
Outstanding
Billions of $
Implied
Cumulative
Loss Rate
(Percent)
Implied
Losses
Billions of $
5,117
1,913
1,914
1,895
2,669
13,507
8.4
9.8
14.2
5.2
3
7.9
430
187
272
99
80
1067
6,940
640
677
4,790
13,047
14.3
34.8
14.2
7
12.6
992
223
96
335
1644
26,554
10.2
2709
Securities
Residential mortgage
Commercial mortgage
Consumer
Corporate
Total for securities
Total for loans and
securities
Source: International Monetary Fund
29
Impact Today and in the Future: The
Number of Bank Failures is Rising
Number of Failed and Assisted Banks and Thrifts
600
500
400
300
Assisted
Failed
200
100
0
The Size of Failed Banks has Dwarfed the
1980s
Assets in Failed and Assisted Banks and Thrifts
1,800,000,000
1,600,000,000
1,400,000,000
1,200,000,000
1,000,000,000
Assisted
800,000,000
600,000,000
400,000,000
200,000,000
0
Failed
Where Does the Economy Stand?
(based on the views of Blue Chip Forecasters)
Percent
7
5
Real GDP Growth
Top 10 Blue Chip Forecasts (As of 5/10)
Bottom 10 Blue Chip Forecasts (As of 5/10)
3
1
-1 2008
2009
2010
-3
-5
-7
32
Post-Recovery Implications
 The IMF is now expects that “the deleveraging process will be
slow and painful, with economic recovery likely to be
protracted.
 As predictable in a recession, credit standards have tightened
considerably, although some recent improvements have been
seen in the corporate debt markets for financially strong firms.
 Riskier and larger credits were often securitized or syndicated.
Those markets remain weak. The market for securitized
subprime mortgages may not return for a long time. This has
implications for recovery of the housing market.
 The positive effects of the recently passed economic stimulus
legislation will take time to work through the economy.
Excellent Resources
 Financial Crisis Timeline:
http://timeline.stlouisfed.org/
 A Word on the Economy for High School Students:
http://www.stlouisfed.org/education/AWordontheEconomy/player.html
 Credit Card and Mortgage Delinquency Maps:
http://data.newyorkfed.org/creditconditionsmap/
 Crisis and Liquidity Programs and the Federal Reserve’s Balance Sheet:
http://www.federalreserve.gov/monetarypolicy/bst.htm
 Emergency Economic Act Stabilization Updates:
http://www.treas.gov/initiatives/eesa/
34