Richard W. Peach

Juvenile Delinquent Mortgages: Bad Credit or Bad Economy?

We study early default, defined as serious delinquency or foreclosure in the first year, among nonprime mortgages from the 2001 to 2007 vintages. After documenting a dramatic rise in such defaults and discussing their correlates, we examine two primary explanations: changes in underwriting standards that took place over this period and changes in the economic environment. We find that while credit standards were important in determining the probability of an early default, changes in the economy after 2004 - especially a sharp reversal in house price appreciation - were the more critical factor in the increase in default rates. A notable additional result is that despite our rich set of covariates, much of the increase remains unexplained, even in retrospect. Thus, the fact that the credit markets seemed surprised by the rate of early defaults in the 2006 and 2007 nonprime vintages becomes more understandable.

Implied Mortgage Refinancing Thresholds

The optimal prepayment model asserts that rational homeowners would refinance if they can reduce the current value of their liabilities by an amount greater than the refinancing threshold, defined as the cost of carrying the transaction plus the time value of the embedded call option. To compute the notional value of the refinancing threshold, researchs have traditionally relied on a discrete option-pricing model. Using a unique loan level dataset that links homeowner attributes with property and loan characteristics, this study proposes an alternative approach of estimating the implied value of the refinancing threshold. This empirical method enables us to measure the minimum interest rate differential needed to justify refinancing conditional on the borrowers creditworthiness, remaining maturity, and other observable characteristics.

The Supply Side of the Housing Boom and Bust of the 2000s

The boom and subsequent bust in housing construction and prices over the 2000s is widely regarded as a principal contributor to the Financial Panic of 2007 and the subsequent Great Recession. As of this writing, housing market activity remains at depressed levels as the economy slowly resolves the legacy of excess supply and sharply lower prices. Over 2.6 million foreclosures have been completed since 2008 and 1.9 million foreclosures are in process. Much has been written about the demand side of this pronounced housing cycle, in particular, the innovations in mortgage finance and the loosening of underwriting standards that greatly expanded the pool of potential homebuyers. In this paper, we take a closer look at developments on the supply side of the housing market. Following a short literature review, we begin with a descriptive review of housing production, sales, and prices at the national, regional, and state levels. We then look at developments in the homebuilding industry over this period. We also take a closer look at land markets using a quarterly price index for metropolitan statistical areas with both elastic and inelastic housing supplies across the United States. An important question is to what extent the supply side of the market contributed to the boom/bust dynamics. A second question is whether the significant changes in the industrial organization of the homebuilding industry exacerbated or ameliorated this supply impact.

The homeownership gap

After rising for a decade, the homeownership rate peaked at 69 percent in the third quarter of 2006. Over the next two and a half years, as home prices fell in many parts of the country and the unemployment rate rose sharply, the homeownership rate declined by 1.7 percentage points. An important question is how large the ultimate decline in the homeownership rate will be over this economic downturn? To address this question, we propose the concept of the “homeownership gap” as a gauge of the downward pressure on the homeownership rate. We define the homeownership gap is the difference between the “official” homeownership rate and a recomputed rate which excludes owners who are in a negative equity position, meaning that the value of their house is less than the outstanding mortgage balance. Our estimate of this gap suggests that the official homeownership rate will likely be under significant downward pressure in the coming years.

How Does Slack Influence Inflation

Economists have long studied the relationship between resource utilization and inflation. Theory suggests that when firms use labor and capital very intensively, production costs tend to rise and firms have more scope to pass those cost increases along in the form of higher product prices. In contrast, when that level of intensity is relatively low—that is, when the economy is operating with slack—production costs tend to rise more slowly (or even fall) and firms have less scope for raising prices. Empirical evidence, however, has varied concerning the exact nature of the relationship between resource utilization and inflation. In this study, the authors reexamine this relationship by evaluating the presence of “threshold effects.” They find that the level of intensity of resource utilization must be below or above certain critical values before it can help to forecast movements in inflation.

Is there a Bubble in the Housing Market now

Real home prices have been rising strongly since the mid-1990s, and have continued to do so even as the economy has weakened. This has sparked the concern as to whether there is a bubble in the housing market, the collapse of which could harm the overall economy. Taking into account fundamentals – including more appropriate price indices and interest rates – aggregate home prices are relatively high but not yet out of line. Home prices in some areas still may be set for a fall; however, prices in these areas typically have been volatile. Previous large home value declines in these areas have not had a sizable negative effect on the aggregate economy.

The Evolution of the Federal Budget and Fiscal Rules

Peach discusses the role of the fiscal rules introduced in the United States at the federal level from the mid-80s. He notes that the first generation of rules, which focused on numerical targets for the deficit, did not prove very effective. The second generation was more successful: it established ceilings on some expenditure items and modified budgetary procedures. In particular, changes in the tax code and in expenditure enacted in a session of the Congress were expected to be deficit neutral over a certain number of years. Peach argues that rules, although not always adhered to, substantially affected the policy debate in the United States. Rules were particularly effective when they were supported by the political will to avoid large deficits and debts. He notes that also simple rules can be instrumental in improving the fiscal balance. In particular, the requirement to formally raise the debt ceiling introduced in the US in 1917 contributed to the enactment of legislation aimed at avoiding debt expansion. He concludes that rules are particularly effective when the majority of voters are convinced that compliance with them is in their interest.

The Measurement of Rent Inflation

Providing for shelter represents a large portion of the typical household budget. Accordingly, rent, paid either to a landlord or to oneself as an owner-occupant, has a large weight in the CPI and in the personal consumption expenditures deflator, resulting in substantial scrutiny of how tenant rent and owners’ equivalent rent are measured in these price indexes. In this paper, we describe how the Bureau of Labor Statistics (BLS) estimates tenant rent and owners’ equivalent rent. We then estimate alternative inflation rates for tenant rent and owners’ equivalent rent based on American Housing Survey data, following BLS methodology as closely as possible. Our alternative tenant rent inflation series is generally consistent with the corresponding BLS series. However, our alternative owners’ equivalent rent inflation series is consistently lower than the corresponding BLS series by an amount large enough to have a significant effect on the overall inflation rate. This result is driven by the inverse relationship between rent inflation and the level of monthly housing cost evident in the American Housing Survey data.

Core CPI: Excluding Food, Energy...And Used Cars?

Although used car prices represent only a small portion of the consumer price index, their extreme volatility has had a major impact on the measured inflation rate. To explain this relationship, the authors describe how used cars are treated in the CPI and explore what might cause the wide swings in used car prices.