REPORT: MORTGAGE MARKETS

Office of Federal Housing Enterprise Oversight (OFHEO), 2004:

The U.S. economy ended 2003 on a sound note, having fully emerged from the recession that started two years earlier. However, the unemployment rate improved slowly as the year progressed. Early concerns about the sustainability of the recovery caused the Federal Reserve to ease monetary policy further in the first half of the year. Mortgage interest rates continued to descend, falling to the lowest level since Freddie Mac began tracking those rates in 1971. Commitment rates on fixed-rate loans averaged 0.7 percentage points below their level in the previous year.

The decline in mortgage rates sustained and strengthened the wave of mortgage refinancings that began in 2001, sending mortgage originations to a new high for the third consecutive year. Originations of single-family mortgages reached $3.8 trillion. The housing market achieved record levels of activity and contributed significantly to the economic recovery. On January 22, 2003, Freddie Mac announced that the Enterprise would restate its financial results for prior years. The restatement resulted in a cumulative increase in retained earnings of $5.0 billion and in regulatory core capital of $5.2 billion. Investigations by the Enterprise and OFHEO revealed substantial weakness in internal controls and inappropriate management of earnings. Several of Freddie Mac’s most senior managers were replaced, and extensive resources were employed in the restatement, but the Enterprise was able to continue its business functions throughout the year.

Both Freddie Mac and Fannie Mae reported strong financial results in 2003.1 The record level of mortgage originations enabled the Enterprises to achieve all-time highs in mortgage purchases and issuance of mortgage securities. Each Enterprise reported strong earnings despite sharp changes in interest rates. The Enterprises’ combined net income totaled $12.7 billion, while their combined net interest income rose 14.8 percent to $23.1 billion. The combined core capital of the Enterprises rose by $10.3 billion, more than keeping pace with growth in their outstanding business volumes. In addition, each Enterprise showed marked improvement in their fair value net worth. Strong earnings and higher capital enabled both Fannie Mae and Freddie Mac to meet their statutory minimum and risk-basedcapital requirements throughout 2003.

Full Report

Fed Study: Are Home Prices the Next Bubble?

A close analysis of the U.S. housing market in recent years, however, finds little basis for such concerns. The marked upturn in home prices is largely attributable to strong market fundamentals: Home prices have essentially moved in line with increases in family income and declines in nominal mortgage interest rates.

Moreover, weaker economic conditions are unlikely to trigger a severe drop in home prices. Historically, aggregate real home prices have fallen only moderately in periods of recession and high nominal interest rates.

While such conditions could lead to lower home prices in states along the east and west coasts—areas where an inelastic supply of housing has made home prices particularly sensitive to changes in demand—regional price declines in the past have not had devastating effects on the broader economy.

Full Study

ACADEMIC: U.S. Household Debt Service

Karen Dynan, Kathleen Johnson, and Karen Pence, of the Board’s Division of Research and Statistics, prepared this article. David Brown provided researchassistance.

Changes in aggregate household debt in the United States may contain information about the current state of the economy and may influence its future path. When a large share of household income is devoted to debt repayment, households have fewer funds available to purchase goods and services. Households with high debt levels relative to income are also more likely to default on their obligations when they suffer an unanticipated misfortune such as job loss or illness. Thus, when household debt ratios are high and unemployment is rising, lenders may respond to the expected increase in defaults by limiting the availability of credit; this dynamic may further
weigh on spending.

MORE