allowed the underwriting of loans that would never have been made had originators held ... Correspondingly in. CDOs, equity tranches offered the highest yields, and senior tranches the ... The assets that CDOs were investing in have also changed over time. The ..... but on everyone who lives in these neighbourhoods.
University of Pennsylvania Law School
ILE INSTITUTE FOR LAW AND ECONOMICS A Joint Research Center of the Law School, the Wharton School, and the Department of Economics in the School of Arts and Sciences at the University of Pennsylvania
RESEARCH PAPER NO. 08-35 Subprime Lending and Real Estate Markets
Susan Wachter UNIVERSITY OF PENNSYLVANIA
Andrey Pavlov UNIVERSITY OF PENNSYLVANIA
Zoltan Pozsar MOODY’S ECONOMY.COM
August 2008
This paper can be downloaded without charge from the Social Science Research Network Electronic Paper Collection:
http://ssrn.com/abstract=1319757
Electronic copy available at: http://ssrn.com/abstract=1319757
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Subprime Lending and Real Estate Markets Susan M. Wachter, Andrey D. Pavlov; Zoltan Pozsar
Wharton School, University of Pennsylvania; Moody’s Economy.com
The subprime disaster has led to falling housing prices and delinquencies and foreclosures at levels unprecedented since the Great Depression. Here we identify how financial and real-estate market forces drove the crisis. We show how financial engineering worked together with a collapse of lending standards to induce the housing bubble and its current unravelling. What started as a normal housing cycle became a credit-induced housing bubble. The resulting toxic mortgages have found their way into the bloodstream of the global financial system, leading to economic distress in the US and elsewhere. A critical factor in the bubble was the interaction of financial engineering and deteriorating lending standards in real-estate markets, which fed on each other to cause unsustainable price rises, and then collapse. Financialmarket expansion and innovation provided new funding sources and a demand for mortgages for securitisation. This required the easing of lending standards, which drove prices up. The soaring housing prices were both an effect and a cause of too much easing as the price rises supported the continued undermining of lending standards. This dynamic is the key to the crisis that we have today. When lenders encourage borrowers to overextend themselves through aggressive mortgage instruments, they generate excessive and unsustainable demand for housing, which results in inflated asset prices. This phenomenon occurs even if the aggressive instruments are correctly priced for the risk they contain. The effect is magnified if they are underpriced, as they were. We review the literature describing and documenting this phenomenon and provide empirical evidence in its support. Any discussion of the housing/subprime bubbles needs to address the 1
Electronic copy available at: http://ssrn.com/abstract=1319757
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global macroeconomic backdrop against which the bubble developed. Throughout the world during what was a global run-up in housing and other asset prices, interest rates were declining. In the US, massive volumes of imports – fuelled by rising housing wealth and home equity withdrawal – resulted in massive volumes of export revenues and central bank reserves in Asian economies. These reserves were invested in safe US Treasuries, depressing yields and forcing investors to look for yields elsewhere. This created an abundance of credit for mortgage borrowers, whose securitised obligations were perceived as virtually risk-free. When yields are depressed, the incentive to seek out riskier investments goes up. For example, insurance companies are faced with fixed-rate commitments. If they stay with low-return investments, they are likely to default on their commitments. If, on the other hand, they take higher-return investments, they have some chance of survival. Such investors were natural buyers of relatively high-yielding CDO (collateralised debt obligation) tranches, and had a keen interest in any innovative financial instrument that offered above-average yields. Demand from these and other investors who were similarly stretched for yield drove demand for innovation in structured finance. This innovation in turn drove demand for higher-yielding loans – subprime mortgages – that served as raw material for structured finance CDOs. On the lending side of the ledger, the housing boom began in 2003 following an easing campaign by the Fed to help the economy rebound from recession. Low interest rates strengthened housing activity and house prices. Rising prices attracted more and more buyers as well as investors, whose purchases pushed prices even further on the margin. Underwriting standards began to worsen along the way, and lenders started to attract borrowers from the periphery – the subprime boom began to take hold, and the contamination of the financial system with toxic mortgages began. As prices rose, demand for these aggressive and often subprime mortgages increased; many involved negative amortisation, which increased affordability. The expectation was that, as subprime borrowers remained current on their payments, their credit score would improve. As prices rose, these mortgages would then be refinanced at lower rates. This depended on everincreasing prices, driven by deteriorating underwriting standards and the layering on of risk to expand the market. With the US housing boom as the backdrop, exotic mortgages offered to borrowers with poor credit histories and investors stretched for yield created a perfect storm of supply of financing and demand for real estate. 2
Electronic copy available at: http://ssrn.com/abstract=1319757
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The interplay between global and US developments at the macro level, and between asset originators, asset packagers and asset managers on the micro level, evolved such that, at the height of the housing boom, broker-dealers’ order books for CDOs became the main source of demand for subprime loans driving the spectacular collapse in underwriting standards, and broker-dealers’ main profit source. The pooling and tranching of mortgages allowed the underwriting of loans that would never have been made had originators held them on their books. This process caused house prices to increase, postponing delinquencies and defaults, and enticing financial players into a false sense of security that risk had not increased. Defaults and foreclosures would not and did not increase as long as housing prices were increasing. CDOS’ ROLE IN FUELLING THE BOOM The disintermediation of traditional balance-sheet lending through the securitisation of credit and its transfer to investors through traded capital market instruments has been ongoing since the 1970s, when the first mortgagebacked securities were issued. These securities marked the advent of the originate-to-distribute model of banking. This disintermediation has accelerated during the current decade, as securitisation expanded to riskier loans and came in more complicated forms, such as structured-finance CDOs. Credit risk transfer instruments such as credit default swaps (CDSs) and CDOs were originally designed to manage banks’ capital requirements by way of reducing the risk profile of loan portfolios. This was done either by purchasing insurance against credit losses using CDSs (reducing the gross risk of a loan portfolio) or by removing the riskiest (first loss) portions of loans from a portfolio using CDOs. Initially, CDOs were applied to corporate loans. A bank would pool the corporate loans on its books (the assets of a CDO) and carve up the pool’s underlying cashflows into tranches with varying risk profiles (the liabilities of a CDO). Payouts from the pool were first paid to the least risky senior tranches, then the mezzanine tranches and lastly to the most risky equity tranches. Conversely, losses were first allocated to equity tranches, then to the mezzanines, and only lastly to senior tranches. Correspondingly in CDOs, equity tranches offered the highest yields, and senior tranches the lowest. This initial role of CDOs changed over time. They were no longer used solely to fine-tune the risk profile of a bank’s loan portfolios to manage capital requirements (so-called balance-sheet CDOs), but also to pool traded 3
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whole loans and corporate bonds, earning a spread between the yield offered on these assets and the payment made to various tranches (so-called arbitrage CDO). The assets that CDOs were investing in have also changed over time. The first generation of arbitrage CDOs was backed by investment-grade corporate loans and bonds. The widening of corporate credit spreads in the wake of the tech bubble and corporate bankruptcies made it easy to structure CDOs, as wide spreads provided sufficient spread income to compensate handsomely the CDOs’ originators, investors and managers. However, as the economy began to improve in 2003, corporate spreads narrowed, which made it harder to structure CDOs using investment grade credit as collateral (see Figure 15.1). In response, underwriters shifted to new collateral types, such as mortgage-backed securities (MBSs) backed by subprime mortgages, and other asset-backed securities (ABSs) backed by credit card receivables and auto loans. CDOs that invested in these new collateral types came to be known as ABS (or structured finance) CDOs. Through the use of riskier classes of debt, ABS CDOs offered fat spread incomes and hence filled the vacuum created by the narrowing of spreads on CDOs that invested in investment grade corporates. Before 2004, the market for ABS CDOs was small, and ABS CDOs had a
Figure ??.1 ABS CDOs drive demand for loans. Global cashflow/hybrid arbitrage CDO insurance breakdown, % Investment grade bonds
High-yield bonds
Structured finance (ABS)
Leveraged bonds
Emerging market and other debt 100 80 60 40 20 0 99 00 Source: Lehman Brothers
4
01
02
03
04
05
06
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well-diversified pool of assets across the ABS/MBS universe. Over the 2005–07 period, however, ABS CDOs underlying portfolios became increasingly concentrated in MBSs referencing subprime mortgage pools. The typical ABS CDO issued during this period invested nearly 70% of its portfolio into subprime MBSs.1 Growth in the volume of CDOs outstanding was especially strong during 2005 and 2006. The CDO market kept on growing as its tranches offered fatter yields than comparably rated sovereign or corporate securities, which was a sure sell to investors such as pension funds that were struggling to match their fixed obligations with low-yielding government and corporate bonds. Meanwhile, broker-dealers earned hefty fee incomes for originating and managing CDOs, and trading their tranches. The CDO market was so strong, in fact, that it ended up driving demand for underlying mortgages in and of themselves. Consequently, prices of MBSs and mortgage loans remained extremely buoyant, cheating investors into a false sense of security, as underwriting standards were collapsing. As the prices of underlying MBSs/mortgages rose and their yields fell correspondingly, some broker-dealers decided to purchase outright mortgage lenders so that they would have direct access to the loans and avoid paying fees to middlemen – this was one avenue through which the roles of banks, finance companies and broker-dealers as credit intermediaries converged over time. Shrinking yield dynamics were similar to those that occurred in 2003, which made the construction of CDOs from corporate loans less feasible and led to the increased used of ABSs to structure CDOs. The purchase of wholesale loan originators and finance companies by broker-dealers also meant that the origination standards of the loans that the CDOs were investing in became increasingly driven by dealmakers’ order books for CDOs, and less by the credit views of the firms (in-house or independent) that originated them. Underwriting standards deteriorated through risk-layering, as lenders offered risky borrowers nontraditional mortgages with extremely aggressive credit features, such as high combined loan-to-value ratios, reduced documentation and no down payment. Thus, over time, arbitrage CDOs became an integral part of the credit intermediation process, with their role changing from repackaging existing loans and bonds to facilitating the creation of new loans. Through the slicing and dicing of credit risk, CDOs enabled the underwriting of loans that would never have been underwritten had banks had to hold them as whole loans. Accordingly, CDOs also helped expand homeownership to those who should never have become homeowners in the first place. 5
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At the very top of the housing and securitisation boom, arbitrage CDOs’ role further morphed into one where they became a powerful source of demand for loans in and of themselves, de facto driving the spectacular collapse in underwriting standards. In this sense, CDOs morphed from being a tool to manage risk into a source of credit risk in and of themselves. CDOS AND ASSUMPTIONS GONE WRONG ABS CDOs have one crucial difference from CDOs investing in corporate bonds. Traditional CDOs invest in heterogeneous pools of corporate loans and bonds, spanning a range of names and industries, where diversification offers safety against company and industry idiosyncratic events, while systematic risk is controlled by having a mix of cyclical and countercyclical industries in the pool. ABS CDOs’ risk instead is driven by economy-wide factors such as interest rates, house prices and the job market. These risks are systematic and cannot be diversified away. However, such a “diversification” was assumed to be present, as ABS CDOs were pooled from loans originated in different states with separate local economies and, apart from the Great Depression, the US never experienced falling house prices/mortgage credit problems in multiple regions at the same time. Due to the “diversified” nature of these pools, ABS CDOs were expected to perform well in most circumstances, but could suffer steep losses during times of system-wide stress, exposing investors to a “heads you win, tails you lose” risk profile. This high-correlation tail event could be driven by everything, including collapsing house prices, payment shocks from ARM resets, and deteriorating underwriting standards. In fact, it is the combination of all of these factors that undid the low-correlation assumptions that were instrumental to the economics behind the structuring of ABS CDOs. WHO ENDED UP HOLDING THE BAG? CDOs were sold to a wide group of investors with various risk appetites. Equity tranches ended up primarily with hedge funds. Mezzanine tranches ended up with insurance companies, pension funds and asset managers, and also with broker-dealers who warehoused them until they were re-securitised into CDO-squared (CDO2). Finally, senior and super-senior tranches ended up primarily with banks. However, unlike equity and mezzanine investors, who each ended up with relatively small amounts of these tranches on their balance sheets, the senior and super-senior tranches ended 6
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up being a sizable exposure on the balance sheet of the banks who bought them, their demise posing a far greater risk to the system as a whole. The main benefits of CDOs are that, through tranching, they spread risk across thousands of investors worldwide, with no participant in the financial system ending up with an excessive exposure to risk. This enhances the overall stability of the global financial system, or so the argument goes. Indeed, the losses associated with mezzanine and equity tranches did end up being well diversified. A large number of financial institutions worldwide have disclosed manageable losses from mezzanine exposures, and, based on the dearth of headlines, equity investors, who do not typically break out CDO losses in their trading results, presumably managed to absorb or hedge these exposures without a material impact on their results. Senior exposures in contrast did not end up dispersed at all, as they stayed with a small group of banks and monoline insurers (see Figure 15.2). Banks’ subprime exposures were opaque, however, as their super-senior investments were predominantly parked in off-balance-sheet structuredinvestment vehicles (SIVs), avoiding the radar of regulators and even investors. SIVs were leveraged entities, typically borrowing US$15 for each US dollar of equity. Subprime mortgages were also held by conduits, which were also structured as off-balance-sheet vehicles, and were a part of banks’ securitisation pipelines. The principal difference between SIVs and conduits
Figure ??.2 Breakdown of CDO holdings by tranche %, as of the first half of 2007 Equity
Mezzanine
Senior
100 80 60 40 20 0 Banks
Insurance companies
Hedge funds
Asset managers
Source: Citigroup
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is that the former invested in structured credits (AAA-rated CDOs), while conduits were invested in un-securitised whole loans. HYPER-STRUCTURING, LEVERAGE AND EASY UNDERWRITING At the outset, we noted that CDOs allowed for the underwriting of loans that would never have been underwritten if banks had to hold them on their balance sheet. The same applies to pools of loans backing relatively simpler products, such as MBSs. Tranching does not reduce the overall amount of risk associated with a pool, it merely distributes it to the different tranches in different degrees: equities are overleveraged instruments, whereas senior tranches are underleveraged instruments. This mechanism, coupled with a benign credit environment and the strong market appetite for yield, allowed banks to sell the bottom part of the capital structure, while retaining senior tranches (the latter requiring a much lower amount of capital than for whole loans). Basel II requires a 35% risk weight on residential mortgages, a 20% risk weight on AAA-rated residential MBSs and a mere 7% risk weight on AAArated tranches of ABS CDOs that invest in residential MBSs. These risk weights seemed plausible, as individual mortgages are riskier than an MBS that invest in a pool of thousands of individual mortgages and the AAAs are protected by overcollateralisation and subordination. Similarly, CDOs involve an extra layer of overcollateralisation and subordination, albeit the reader should keep in mind the discussion of the previous section. Thus, CDO technology contributed to the easing of underwriting standards, and the proliferation of exotic mortgages and “Ninja”2 loans. When assumptions about delinquencies and house prices proved far too optimistic, credit structure and subordination fell short of protecting investors, even the ones who bought what were supposed to be credit-insensitive AAA. As liquidity vaporised, money markets withdrew funding from SIVs, leverage unfolded, and losses began to mount. IMPACT OF AGGRESSIVE LENDING ON THE REAL-ESTATE MARKET The hyper-structuring, leveraging and easy underwriting came about in stages and enabled the extension of credit to ever more marginal borrowers. Marginal borrowers, who could not get a loan previously, now could, and the positive impact on demand and prices was felt in real-estate markets throughout the country, especially in affordability-constrained markets. With the seizing-up of capital markets, negative effects were sudden and, with the sharp reversal, stunning in their impact. The impact to capital 8
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markets extended throughout the world from Switzerland to Japan; in the US, standalone mortgage companies imploded, investment banks’ losses mounted, and the banking system faced serious retrenchment. The tightening financial market’s major effects were on high street real estate, going far beyond subprime asset-backed borrowing. For example, as reported in the September 2, 2007, issue of the New York Times, Tammi and Charles Eggleston never took a subprime (or otherwise risky) mortgage, never missed a payment and never thought of selling their home. Yet, as nearly all front gardens in their Cleveland suburb received a colourful “Foreclosure Sale” sign, the Egglestons saw their home, their equity and attachment to the neighbourhood evaporate. Their eventual for sale listing induced no visits, let alone bids. While such examples are now common and widespread, the link between high-risk lending (such as subprime) and real-estate markets is not so obvious. In particular, little work has been done to demonstrate that the availability and wide use of aggressive lending instruments fuels real-estate price increases in the short run. Such price increases were the enablers of underpriced and poorly underwritten loans – in a phrase, bad lending. The price increases of course only temporarily led to higher prices: in fact, when the lending could ease no further and supply of loans could increase no more, house-price increases stalled out. The expectation of future price increases, often deemed inevitable in a supply-constrained market, reversed quickly, as expectations of price increases shifted to expectations of declines. The impact on the supply of lending itself was immediate. The declining availability of credit was then both a result and a cause of real-estate price declines, even in the absence of high default rates. Of course, once the initial declines reached certain levels, defaults naturally occurred and further contributed to the real estate price declines[AA1].3 In this section, we investigate the impact of aggressive lending instruments, subprime in particular, on the underlying risk of realestate markets, and how this risk might be measured. Aggressive lending instruments take many shapes and forms. Interestonly, negative-amortisation pay option, teaser rate, high loan-to-value ratio, limited-documentation and other high-risk mortgages all became increasingly popular starting in 2003. The unifying feature of all these instruments is that they allow borrowers to purchase homes they otherwise could not afford. This effect is particularly strong in markets that are less affordable to begin with. With enough supply and uptake of these mortgages, it is not hard to imagine that the overall demand for real estate is going to increase 9
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for no other reason than the availability of aggressive lending instruments. This price increase provides further comfort and sense of security to lenders, homeowners and regulators. Increasingly, aggressive instruments become popular, and risk layering of various risky features becomes common practice. For instance, most subprime mortgages are also adjustable-rate, interest-only or negative-amortisation, and low- or no-equity affairs. The increased availability of aggressive loans, and their heightened ability to make homeownership more affordable further pushes real-estate prices up. This cycle can continue for quite some time until, at some point, price increases fail to materialise, leaving the most recent entrants into the market highly exposed. Lenders suddenly lose their comfort in extending the aggressive lending instruments. Note that, if lenders begin to view real estate as risky, these instruments are impacted substantially more than traditional well-underwritten loans. Consequently, potential homeowners who otherwise could enter the market are unexpectedly excluded. Thus, even in the absence of defaults, the demand for real estate drops and prices begin to decline. Of course, defaults further magnify the problem because they increase the supply of housing at the same time. The above mechanism, modelled formally in Pavlov and Wachter (2008), is at work even if both aggressive and traditional mortgages are priced correctly and compensate lenders for the risks they are taking. However, if the aggressive instruments are mispriced, then the impact on the underlying real-estate markets is further magnified. If lenders respond to short-term incentives or mispriced availability of funding to them, then home prices increase further not only because borrowers of marginal ability to pay enter the market, but also because homeowners benefit from the underpriced financing at the expense of the lenders, and eventually the investors. Following a negative-demand shock, either exogenous or generated by the withdrawal of credit, all lending instruments, especially the aggressive mortgages, become vastly more expensive, if available at all. This, in turn, further depresses the real-estate market, as the new prices reflect not only the new, lower, demand, but also the lack of underpriced financing. In fact, lenders often overreact and make financing excessively expensive and difficult to qualify for.4 What makes the impact of aggressive lending instruments particularly influential is their high concentration in certain neighbourhoods. While there are very few places nowadays left unaffected by the subprime-generated mortgage crisis, certain neighbourhoods with high concentrations of subprime mortgages are experiencing unprecedented declines. As the 10
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Egglestons’ story suggests, this impacts not only on subprime borrowers, but on everyone who lives in these neighbourhoods. PRIOR WORK ON LENDING AND ASSET MARKETS Our studies mentioned above are not the first to investigate the link between lending and asset markets. Allen and Gale (1998 and 1999), Herring and Wachter (1999), and Pavlov and Wachter (2002, 2005) show that underpricing of default risk in bank lending leads to inflated asset prices in markets with fixed supply. Furthermore, Pavlov and Wachter (2002, 2005, 2006) show that underpricing of default risk exacerbates asset market crashes. A handful of empirical investigations directly study the impact of aggressive lending on real estate, whether these instruments are priced correctly or not. Hung and Tu (2006) examine the California experience through 2004 and find that the increase in the use of adjustable-rate mortgages in California is associated with an increase in median home prices. They report that the median home price in 2004 in California would have increased by 20.3% due to fundamental changes in demand and supply drivers alone; while the actual appreciation rate in that year was 21.3%. Thus, in their results, only a small, although statistically significant, portion of the increase through 2004 can be attributed to the use of adjustable-rate mortgages[AA2].5 Their finding of only a small impact may be because they miss the period of the great run-up or because by 2004 ARMs were not particularly aggressive loans. Similarly, the International Monetary Fund report (2004, Chapter II, p. 81) on world economic issues suggests that countries with higher use of adjustable-rate mortgages have more volatile housing markets. The report notes that house prices across industrial countries have increasingly tended to move in tandem to the “synchronization of monetary policy and financial liberalisation – in addition to general business cycle linkages”. More generally they find that countries with ARMs have higher house-price growth and volatility than other countries with fixed-rate mortgages. The mechanism they conjecture to explain this finding is that higher use of ARM-like instruments makes real-estate markets more sensitive to interest-rate changes. This report does not consider the fluctuation in availability of ARMs, and other aggressive lending instruments, through the real-estate market cycle.6 Coleman, LaCour-Little and Vandell (2007) provide an additional test for the role of mortgage instruments using data from the recent US experience. They regress price change on fundamentals and a variety of mortgage indicators with mixed findings. 11
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The timing of these studies matters. The empirical work of Pavlov and Wachter (2008) identifies the credit bubble of 2006 as critical to unsustainable price rises, which in fact reversed in 2007. Moreover, the primary mechanism behind the bubble was not dissimilar to other banking and real-estate bubbles, too much and underpriced credit, which drives and is correlated with unsustainable house-price increases. With the inevitable retreat comes the sharp reversal in credit availability, with greater impact in those markets most dependent on aggressive credit for increases; the signature of the credit bubble is the disparate regional impact of credit availability and of volatility of housing prices, both on the way up and on the way down. SUBPRIME LENDING AND REAL-ESTATE MARKETS To demonstrate the above-described link between lending and real-estate markets we use national data from the Federal Reserve Bank of New York7 and from OFHEO. Figures 15.3 and 15.4 show the percentage of subprime loans and the share of low- and no-documentation loans across the US as of April 2008. Figures 15.5 and 15.6 show the percentage increase in quality-controlled house-price indexes by state during the time frames 2002 Q4 to 2005 Q4 and 2007 Q1 to 2008 Q1. As the figures show, areas with high concentrations of subprime loans experienced a steeper price increase during the 2005–2006[AA3] time period, followed by a steeper decline during the recent year and a half. Florida, California, Arizona, Nevada and some specific areas in the midwest and northeast have the highest concentration of aggressive loans and are also experiencing the deepest price declines. Figure ??.3 Number of subprime loans (per 1000 housing units)
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The national experience demonstrates very clearly how a high concentration of aggressive lending instruments, such as subprime, and especially low- or no-documentation loans, fuels excessive price inflation during up markets and more severe price declines during down markets. CONCLUSIONS The recent credit crunch and liquidity deterioration in the mortgage market have led to falling house prices and foreclosure levels unprecedented since the Great Depression. Figure ??.4 Subprime loans (proportion of low & no documentation loans)
Figure ??.5 House price index (increase 2002 Q4–2005 Q4)
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Figure ??.6 House price index (decrease 2007 Q1–2008 Q1)
A critical factor in the post-2003 house-price bubble was the interaction of financial engineering and the deteriorating lending standards in real-estate markets, which fed into each other, and caused an unsustainable rise in prices, and then collapse. This was coincident with macroeconomic developments, both globally and in the US, which fuelled an insatiable demand for high-yielding structured products, and created the seeds for the perfect storm in US mortgages, and its repercussions in markets worldwide. In the initial phase of expansion, exotic mortgages, often offered to marginal borrowers with poor credit histories, added to the fire, generating unsustainable demand for housing as well as inflated prices, especially in affordability-constrained markets. When the tide turned, the reversal was both sudden and stunning in its impact. Empirical evidence points to the fact that, as access to credit, liquidity and availability of affordability loans dry up, the correction to real-estate prices is amplified, as the new levels need to reflect not only decreased demand, but also lack of underpriced financing. 1
2 3
4
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Because ABS CDOs underlying portfolios became concentrated in subprime MBSs, the chapter henceforth discusses the portfolios and performance of ABS CDOs as if they were entirely made up and driven by subprime mortgages. NINJA stands for no income, no job and no asset verification. Market-risk spreads did not respond to the threat of delinquencies. In fact, by March 2007, BBB and BBB– tranches were trading in a 70–80-cents-on-the-dollar range, and they were near par in January 2007, when delinquencies have already risen by 1.5 ppts since early 2006 nationally and 2 ppts in CA and FL between Q106 and Q107. For a detailed discussion and empirical evidence on underpriced financing see Pavlov and Wachter (2007).
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5
6 7
This study adopts methodology used previously in Abraham and Hendershott (1996), Malpezzi, Chun and Green (1998), Jud and Wrikler (2002) and Liang and McLemore (2004) to identify price increases based on supply-and-demand fundamentals. Another approach is that used by Himmelberg, Mayer and Sinai (2005) to identify bubbles based on rent-price ratios and the degree to which the trends in these ratios can be linked to fundamentals. Abraham, Pavlov and Wachter (2008) discusses the degree to which the US bubble departed from the price increases across other countries of the world in 2005 and 2006. See http://www.newyorkfed.org/mortgagemaps.
REFERENCES
Abraham, A. Pavlov and S. Wachter[AA4], 2008, Zell Laurie Real Estate Center working paper. Allen, F., and D. Gale, 1998, “Optimal Financial Crises”, Journal of Finance.[AA5]
Allen, F., and D. Gale, 1999, “Innovations in Financial Services, Relationships, and Risk Sharing”, Management Science.
Coleman, LaCour-Little and Vandell[AA6], 2007, “Subprime Lending and the Housing Bubble: Tail Wags Dog?”, working paper. Federal Reserve Bank of New York, 2008, “Dynamic Maps of Nonprime Mortgage Conditions in the United States”, April, URL: http://www.newyorkfed.org/mortgagemaps/.
Herring, R., and S. Wachter, 1999, “Real Estate Booms and Banking Busts – An International Perspective”, Group of Thirty, Washington, DC.
Hung, S., and C. Tu, 2006, “An examination of house price appreciation in California and the impact of aggressive mortgage products”, working paper.
International Monetary Fund, 2004, “World Economic Outlook: The Global Demographic Transition”, URL: http://www.imf.org/external/pubs/ft/weo/2004/02/. Office of Federal Housing Enterprise Oversight, “House Price Index”, URL: http://www.ofheo.gov/hpi_download.aspx[AA7].
Pavlov, A., and S. Wachter, 2002, “The Option Value of Non-Recourse Lending and Inflated Asset Prices”, Wharton Real Estate Working Paper Series.
Pavlov, A., and S. Wachter, 2005, “Real Estate Crashes and Bank Lending”, Wharton Real Estate Review.
Pavlov, A., and S. Wachter, 2006, “The Inevitability of Market-Wide Underpricing of Mortgage Default Risk”, Real Estate Economics[AA8].
Pavlov, A., and S. Wachter, 2007, “Underpriced Lending and Real Estate Markets”, working paper.
Pavlov, A., and S. Wachter, 2008, “Underpriced Lending and Real Estate Markets”, Journal of Real Estate, Economics, and Finance, forthcoming.
Schwartz, Nelson, 2007, “Can the Mortgage Crisis Swallow a Town?”, New York Times, September, URL: http://www.nytimes.com/2007/09/02/business/yourmoney/02village. html?pagewanted=all.
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[AA1] See endnote: ppts. Is this percentage points? Happy with this abbreviation? [AA2] None of the citations in the endnote here are in the refs. [AA3] This period isn’t actually shown. We get 2002–05 on one and 2007–08 on the other. Or am I missing something? [AA4] No initial for Abraham. [AA5] No other info? Same goes for others in this list, too. [AA6] No initials. [AA7] Year? [AA8] Month or other identifier? Or is it an annual publication?
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