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 Recap of the housing crisis, and review of a few subprime myths and facts  Quick look at the current state of the housing markets  Review the macroeconomic backdrop to housing  Primer on recent Federal Reserve actions

 The subprime population is too high risk, and should not get mortgages  Historical default rates for subprime about 2% in US  Subprime mortgages are “exotic”: Option-ARMs, Neg- Ams, IO, etc.—we should stay away from such predatory products  NO: In fact, VERY FEW of subprimes were this type of mortgage  Almost all were 2/28 or 3/27 ARMS  OK, but that’s why they defaulted—the ARM resets!  NO: Little or no evidence of any reset effect  (In fact, many reset to lower interest rates)  Securitization was a bad idea—Subprime MBS securities all lost huge amounts, and were a dumb idea  NO: In fact, losses on AAA “vanilla” MBS < 10%

Source: Mortgage Bankers Association, Haver Analytics Normal times: subprime rates are higher, but manageable Crisis times: Everyone is in a mess

No link between reset date and default Defaults increased in 2007/8—because house prices fell, unemployment rose Thus the rapid increase in prime defaults as well (not shown) Source: Foote and Willen (2012)

Losses less than 10% on AAA Why: Credit protection worked Losses much worse on CDOs Foote and Willen (2012) Private label RMBS

 Better—permits are rising, inventories are lean Source: Census Bureau, Haver Analytics

 Prices are flattening or turning up modestly Source: FHFA, Core Logic, Haver Analytics

 Vacancies have improved nationwide (less so in VT, NH)  Still a lot of REO/property held off the market Source: Census Bureau, Haver Analytics

Source: Bureau of Labor Statistics, Haver Analytics

Recession ends Source: Bureau of Labor Statistics, Haver Analytics

Recession ends Source: Bureau of Labor Statistics, Haver Analytics

Source: Bureau of Economic Analysis, Haver Analytics

 Consumer spending has been fair to middling, given overall strength  And you know about housing! Source: Bureau of Economic Analysis, Haver Analytics

Source: Census Bureau, Michigan Survey Research Center, Federal Reserve Board, Haver Analytics

 Household wealth has improved a bit (housing values, stock market)  The “fiscal cliff” matters less to households?  But it matters to businesses  The global slowdown affects export- dependent businesses, consumers less so

Source: Bureau of Economic Analysis, Haver Analytics

“Fiscal Cliff” risks CategoryMagnitude “Bush Tax Cuts” (income, estate, AMT) $221B Payroll Tax cut expiration$95B Sequestration spending cuts$65B Expiration of unemp. benefits$26B Other changes (war drawdown, discretionary spending cuts, deprec. allowance) $303B TOTAL$710B=4.6% of GDP Overall effect on GDP growth~2.5 pctg. points Source: Congressional Budget Office, author’s calculations Source: Wall Street Journal, Haver Analytics

Price stability (low and stable inflation) Maximum sustainable employment Congressionally-mandated goals (Dual Mandate) Federal Funds rate (overnight bank rate) Primary policy instrument QE “Forward Guidance” Alternative Policy Instruments X Long-term interest rates, stock prices, exchange rate

 We buy long- term assets  Removes them from circulation in private markets  But private agents still want them  So they’re willing to accept them for a lower yield  Bottom line: we’re trying to reduce long-term rates Fed’s Securities Private Markets’ Securities

 The recovery has been frustratingly slow  Our tools to address weakness are somewhat limited  But we are doing what we can  Recently, we have paid particular attention to employment shortfalls  Not because we don’t care about inflation  But because the gap between the goal for employment is so large