Making Sense of the

Housing and the Economy
John V. Duca
Vice President & Senior Policy Advisor
Federal Reserve Bank of Dallas*
* The views expressed are those of the author, and are not necessarily those of 
the Federal Reserve Bank of Dallas or of the Federal Reserve System.
 Some Links to Relevant Articles
John V. Duca, Federal Reserve Bank of Dallas
• Reopening America’s Financial Arteries: Addressing the Recent 
Financial Crisis (forthcoming, Dallas Fed Economic Letter, by 
DiMartino, Duca, & Renier) http://dallasfed.org/research/eclett/
• From Complacency to Crisis: Financial Risk‐Taking in the Early 21st
Century (Dec. 2007):
http://dallasfed.org/research/eclett/2007/el0712.pdf
• The Rise and Fall of Subprime Mortgages (Nov. 2007):
http://dallasfed.org/research/eclett/2007/el0711.pdf
• Making Sense of the U.S. Housing Slowdown (Nov. 2006):
http://dallasfed.org/research/eclett/2006/el0611.pdf
• The Housing Market, After the Boom (July 2007):
http://dallasfed.org/research/swe/2007/swe0703e.pdf
• Making Sense of Elevated Housing Prices (fall 2005):
http://www.dallasfed.org/research/swe/2005/swe0505b.pdf
• Early Signs of Home Overvaluation Emerging (spring 2004):
http://www.dallasfed.org/research/swe/2004/swe0402.pdf
 Housing Permits Point to Some
Further Home Construction Declines

Source: Bureau of Economic Analysis, U.S. Census and author’s calculations.
 Outline
• The housing slowdown
– First mortgage interest rates 
– Then credit standards (subprime crunch)
– And now the financial/credit crisis
• Some regional observations
• Conclusion
 Housing Booms and then Falls
Mortgage rates
start rising

Source: National Association of Realtors, U.S. Census and author’s calculations.
 Housing Booms and then Falls:
First Interest Rates
Mortgage rates
Mainly 
start rising
Mortgage‐
rate effects

Source: National Association of Realtors, U.S. Census and author’s calculations.
 Housing Booms and then Falls:
Then the Subprime Crunch
Mortgage rates
start rising

Subprime 
crunch hits

Source: National Association of Realtors, U.S. Census and author’s calculations.
 Subprime Mortgages
• Low credit scores, low downpayment, high debt 
burdens
• Around 13% of outstanding mortgages
• But strong growth large effect on housing boom:
– Subprime originations $120 B (‘00) to $620 B (‘06)
– 6% of new mortgages in 2000 to 24% in 2006
– 40% new mortgages in 2006 subprime or Alt A
• 5% to 6% of homes sold per year, big effect of nonprime 
mortgages on market prices of homes used for lending
 Subprime & “Alt A” Share of Mortgage 
Originations Jump (Goldman Sachs)

2.3

Source: Goldman Sachs, US Economics Analyst, Feb. 23, 2007, Andrew Tilton.
 Mortgage Financial Flows 1950s‐70s

Funding  Funding Uses
Sources

Prime Mortgage 
Savers/Investors
Borrowers

De
po
s it s
s
e age
Banks im g
P r o rt
M
 Mortgage Financial Flows 1980s‐90s

Funding  Funding Uses
Sources

Mortgage
Originators
Pr
Mo ime
rtg
ag
es

 M BSs
E
 GS
Buy
Prime Mortgage 
Savers/Investors
Borrowers

De
po
s it s
s
e age
Banks im g
P r o rt
M
 Mortgage Financial Flows 2000‐06
1st Innovation: 
Credit‐scoring

/ A lt.A Nonprime 
r ime ges
p
Sub ortga Mortgage
M Borrowers
Mortgage
Originators
Pr
Mo ime
rtg
ag
es

 M BSs
E
 GS
Buy

es .A
Prime Mortgage 

ag Alt
Savers/Investors

rtg e/
Borrowers

Mo bprim
Su
De
po
s it s
s
e age
Banks im g
P r o rt
M
 Mortgage Financial Flows 2000‐06
1st Innovation: 
Credit‐scoring

2nd Innovation:  / A lt.A Nonprime 

r ime ges
Structured Finance p
Sub ortga Mortgage
M Borrowers
Mortgage
Originators
uy  
 M BSs Pr
B ate
Priv Mo ime
rtg
ag
es

 M BSs
E
 GS
Buy

es .A
Prime Mortgage 

ag Alt
Savers/Investors

rtg e/
Borrowers

Mo bprim
Su
De
po
s it s
s
e age
Banks im g
P r o rt
M
 Structured Finance: Achilles Heel of
funding subprime securities
• Investors use new instruments to protect 
against default risk, but little history
• Make mortgage credit flows vulnerable to 
market reassessment of default risk
• Over‐optimism; mistakenly saw low 
unemployment => low subprime losses 
 Low‐Rated Tranches to Protect High Rated 
CDOs from Default Losses
Last Loss

Aaa

Pools of 

Loss Position
Subprime
Pools of  Aa
Mortgages
Subprime
Mortgages A
Baa
Ba
B
Equity
First Loss

Source: Author modified from Commercial Mortgage Securities Association
 Low‐Rated Tranches to Protect High Rated 
CDOs from Default Losses

Aaa

Pools of 
Subprime
Pools of  Aa
Mortgages
Subprime
Mortgages A
Baa
Ba
B
Equity

Pre‐2006 forecasts subprime defaults

Source: Author modified from Commercial Mortgage Securities Association
 Late Mortgages More Prevalent

Source: Mortgage Bankers Association.
 Structured Finance: Achilles Heel of
funding subprime securities
• Investors use new instruments to protect 
against default risk, but little history
• Make mortgage credit flows vulnerable to 
market reassessment of default risk
• Over‐optimism; mistakenly saw low 
unemployment => low subprime losses
• Over‐looked role of temporary surge in home 
prices and low interest rates
 Late Mortgages More Prevalent

Source: Mortgage Bankers Association.
 Late Mortgages More Prevalent

Source: Mortgage Bankers Association.
 Low‐Rated Tranches to Protect High Rated 
CDOs from Default Losses

Aaa

Pools of 
Subprime
Pools of  Aa
Mortgages
Subprime
Mortgages A
Baa
Ba
B
Equity

Pre‐2006 forecasts subprime defaults

Source: Author modified from Commercial Mortgage Securities Association
Unexpected Subprime Losses Pose Risk to High 
“Rated” CDO Tranches

Aaa

Pools of 
Subprime
Pools of  Aa
Mortgages
Subprime
Mortgages A
Baa
Ba
B
Equity

Much larger actual subprime defaults

Source: Author modified from Commercial Mortgage Securities Association
Unexpected Subprime Losses Pose Risk to High 
“Rated” CDO Tranches

Junk? Aaa

Pools of 
Subprime
Junk? Aa
Mortgages
Junk? A
Junk? Baa
Ba
B
Equity

Much larger actual subprime defaults

Source: Author modified from Commercial Mortgage Securities Association
 Subprime Mortgage Credit Crunch

/ A lt.A Nonprime 
r ime ges
p
Sub ortga Mortgage
Originators M Borrowers
of Securitized
uy  
 M BSs Mortgages Pr
B ate
Priv Mo ime
rtg
ag
es

 M BSs
E
 GS
Buy

es .A
Prime Mortgage 

ag Alt
Savers/Investors

rtg e/
Borrowers

Mo bprim
Su
De
po
s it s
s
e age
Banks im g
P r o rt
M
Effects from Mortgage & Other Losses on 
Financial Activity
• Mortgage losses lower capital cushions
• Mortgage losses and opaqueness of new 
financial products create uncertainty, hurts 
inter‐bank loans, “counter‐party risk”
• Banks severely tighten credit standards
 Banks Tighten Credit Standards on All 
Types of Loans
Net % tightening credit  April  Oct. Oct. Jan.
standards over 3 months on: 2007 2007 2008 2009

Prime mortgages 15% 41% 70% 47%

Real  Subprime mortgages 56% 56% 100% 56%
Estate
Commercial real estate 30% 50% 87% 79%

Business loans ‐4%  19%  84%  64%

Busi‐ (large/med firms)
ness Business loans 2% 10% 75% 69%
(small firms)
Consumer loans (noncred. card) 8% 26% 64% 58%
Cons‐
C&I
umer Willingness to make consumer +8% ‐6% ‐47% ‐16%
installment loans (back to 1967)
 Housing Booms and then Falls:
Now the Financial/Credit Crisis
Mortgage rates
start rising

General 
Financial/Credit 
Crisis hits

Source: National Association of Realtors, U.S. Census and author’s calculations.
 The Main Arteries Funding Home Mortgages

Banks
Ho
m
sits e M
po or
De tg
ag
es

Nondeposit Home Mortgages
Savers &  funded 
Borrowers
Investors Mortgage
Originators

Buy
Di GSE RMBS
re
ct 
i nv
e stm
en
t Securities 
Markets
Blockages Affecting the Funding of Home Mortgages

Banks
Ho
m
sits e M
po or
De tg
ag
Loan losses es
capital constraints

Nondeposit Home Mortgages
Savers &  funded 
Borrowers
Investors Mortgage
Originators

Liquidity of
Di MBSs
re
ct 
i nv
e stm
en
t Securities 
Markets
 Fed Actions Lower MBS Liquidity Risk Premiums,
Help Reopen Arteries Funding Home Mortgages
Banks
Ho
m
sits e M
po or
De tg
ag
es

Nondeposit Home Mortgages
Savers &  funded 
Borrowers
Investors Mortgage
GSE
Originators
RMBS
Bu
y t
re Fed &  Buy
a su Treasur
Di rie GSE RMBS
re s y
ct 
i nv
e stm
en
t Securities 
Markets
Mortgage Rates and Some Mortgage Spreads Have
Also Fallen After Fed Measures Were Announced

4.87 49bp
4.38

145bp

2.93
Home Prices: from Rapid Appreciation to
Declines

Source: National Association of Realtors, Freddie Mac and S&P/Case‐Shiller.
New Home Inventories At Record Highs,
Will Weigh On Home Prices

Source: U.S. Census Bureau
 Mortgage Foreclosures Jump,
Likely to Weigh on Home Prices
 Why Our Regional Economy Had 
Outperformed the Nation
• Better business climate & low cost of living
• Texas consumer spending less dependent on 
people spending home price gains
• Result: job growth outperforming the U.S.
• Although helping national economy, fallback 
in energy prices may slow TX
 Home Prices Had Risen Faster
in Coastal Regions

Source: Freddie Mac and author’s calculations.
 Home Prices Had Risen Faster
in Coastal Regions

Austin

Source: Freddie Mac and author’s calculations.
Housing affordability recovers some in coastal areas, but largely 
due to price declines
% Home Price
1999:q4 2006:q4 2008:q4 Change 07:3-08:3

U.S. 64% 42% 62% -6%

LA 43% 2% 27% -22%
New York 55% 5% 14% -5%
San Fran. 11% 8% 21% -9%
Miami 59% 10% 33% -19%
Atlanta 73% 68% 75% -2%
Dallas 64% 62% 68% +3%

Source: National Association of Home Builders and Wells Fargo, housing opportunity index and Freddie Mac repeat home price index
(data from mortgage refinancings included) for metro areas. Percent of homes sold that are affordable to families earning the 
median income of that area, putting 10% down, using a 30‐year conventional mortgage, and having mortgage payments no higher 
than 28% of income.
 Dallas Job Growth Outperforming the U.S. Again, But 
Slowing Ahead of Current Financial Crisis
Percent,
year/year

Tech
Wreck
Years

U.S.

Texas

Oil Bust Years

Source: Bureau of Labor Statistics and author’s calculations.
 Dallas Job Growth Outperforming the U.S. Again, But 
Slowing Ahead of Current Financial Crisis
Percent,
year/year

Tech
Wreck
Dallas Years

U.S.

Texas

Oil Bust Years

Source: Bureau of Labor Statistics and author’s calculations.
 Summary
• Credit boom‐bust behind the housing boom and bust
• Subprime/Alt A bust hurts housing unevenly across US
• General financial and credit crisis affecting all interest‐
rate and finance‐sensitive sectors
• Some success in reopening credit to prime borrowers
• Housing affordability and pro‐growth policies cushion 
housing and economic downturn in Texas
• 4 down‐legs to housing bust: (1) mortgage rate swing 
(since summer ’05), (2) subprime credit crunch (since 
early ’07), (3) falling house prices and weak job mkt
(since late ‘07), and (4) general financial/credit crisis
• Much depends on healing the financial system, 
stabilizing the economy, and jump‐starting a recovery
Exposure to Nonprime Mortgage Bust Varied Some: 
Subprime & Alt A Borrowers Big Share of Home 
Builder Revenues in 2006
Subprime Alternative Combined
share A share
U.S. 21% 21% 42%

California 25% 30% 55%

Florida 24% 23% 47%

Texas 22% 13% 35%

Source: Credit Suisse Report, “Mortgage Liquidity Du Jour: Underestimated No More,” March 13, 2007.

After Directly Raising GDP Growth, Housing 
Subtracts

Source: Bureau of Economic Analysis.