Decline in House Prices Slows Down; District Still Faring Better than Nation
The Eighth Federal Reserve District is composed of four zones, each of which is centered around one of the four main cities: Little Rock, Louisville, Memphis and St. Louis.
How much have U.S. house prices fallen
Views expressed do not necessarily reflect official positions of the Federal Reserve System. House prices in the United States were 14.1 percent lower in the first quarter of 2008 than they were a year earlier, according to a widely cited measure of U.S. house prices, the SP it also showed a more rapid decline in house prices during 2007-08. The OFHEO index tracks the sales prices of houses financed with conforming, conventional mortgages purchased by Fannie Mae and Freddie Mac. In 2007, conforming loans were limited to a maximum of $417,000. Home purchases involving larger, “jumbo” mortgages, or unconventional mortgages— including many subprime mortgages—do not influence the OFHEO index. By contrast, the SP it includes data on houses financed by jumbo mortgages, subprime mortgages, and home purchases that do not involve a mortgage. The S&P/CS index is also value weighted: More expensive homes have relatively greater influence on the index, whereas the OFHEO index is unit weighted. Further more, the S&P/CS index assigns greater weight to census regions with greater total residential real estate value. The OFHEO index, by contrast, weights regions based on the number of residential units. Hence, regions with relatively higher average home prices have more influence on the S&P/CS index than on the OFHEO index.1 The S&P/CS index exhibited faster growth in house prices before 2006 because house prices rose more rapidly in the regions with more influence on that index. These regions also tended to have a higher percentage of transactions involving mortgages ineligible for purchase by Fannie Mae and Freddie Mac. The relatively rapid decline in house prices since 2006 in the West and East Coast regions, and the relatively greater weight given these regions in the S&P/CS index help explain why the S&P/CS index shows a more rapid decline in house prices for the United States as a whole.
Did prepayments sustain the subprime market
This paper demonstrates that the reason for widespread default of mortgages in the subprime market was a sudden reversal in the house price appreciation of the early 2000's. Using loan-level data on subprime mortgages, we observe that the majority of subprime loans were hybrid adjustable rate mortgages, designed to impose substantial financial burden on reset to the fully indexed rate. In a regime of rising house prices, a financially distressed borrower could avoid default by prepaying the loan and our results indicate that subprime mortgages originated between 1998 and 2005 had extremely high prepayment rates. Most important, prepayment rates on subprime mortgages were extremely high (i) not just for ARMs but FRMs as well, (ii) even before the reset dates on hybrid-ARMs and (iii) despite prepayment penalties on the contract. However, a sudden reversal in house price appreciation increased default in this market because it made this prepayment exit option cost-prohibitive. In short, prepayments sustained the subprime boom and the extremely high default rates on 2006-2007 vintages were largely due to the inability of these mortgages to prepay (an option that was available for mortgages of earlier vintages).