October 29, 2009 William R. Emmons Assistant Vice President and Economist

1. 2009 Kentucky Affordable Housing Conference The 2010 Housing Outlook For Kentucky and the Nation October 29, 2009 William R. Emmons Assistant Vice President and Economist Division of Banking Supervision and Regulation Federal Reserve Bank of St. Louis William.R.Emmons@stls.frb.org

2. The 2010 Housing Outlook For Kentucky and the Nation • The mortgage-foreclosure crisis is being driven by falling house prices and the resultant negative homeowners’ equity. • Foreclosure-prevention initiatives haven’t stemmed the tide because they rarely address negative equity. • Rising unemployment increases the stress on families with depleted equity. • The foreclosure crisis is likely to continue into 2010 and beyond, as house prices and homeowners’ equity aren’t likely to rise much.

3. Our Challenges in 2010 and Beyond Provide services and support for families losing their homes in foreclosure or short sales. Counsel at-risk families so they can avoid foreclosure; or emerge from foreclosure with hope for the future. Educate future home-owning families about the costs and risks of mortgages and homeownership.

4. Important Reminder • These comments do not necessarily reflect the views of the Federal Reserve Bank of St. Louis or of the Federal Reserve System.

5. U.S. Foreclosure Starts Have Surged Since 2006 2009: 3 mn.? 2008: 2.4 mn. Millions Source: Mortgage Bankers Association. Annual data through 2008.

7. Kentucky Foreclosures Rising, Albeit Not As Fast As Elsewhere 2009: 20,000? 2008: 18,000 Foreclosure starts Source: Mortgage Bankers Association. Annual data through 2008.

9. In Previous Downturns, Most Households Could Recover After Missing a Payment Percent Why are so many more households falling into serious delinquency and foreclosure this time? Early-stage delinquencies: Missed one or two payments Late stage: Missed three or more payments Source: Mortgage Bankers Association. Quarterly data through Q2.2009.

10. Why Are Foreclosures Exploding? • Three theories of mortgage default • Unaffordable mortgage: NO—You can sell the house if there is positive homeowners’ equity. • Ruthless default (walk away as soon as you go underwater): NO—it happens, but is unusual. • Dual triggers: YES • Adverse life event + Negative equity => Mortgage default. • Unemployment, illness, divorce most common adverse events. • With positive equity, you can sell/refinance to avoid default. • Risk characteristics of the borrower and the loan can increase sensitivity to trigger events. • High leverage (LTV ratio); High debt-service burden (DTI ratio); Poor financial habits (low FICO); Loan features not understood by the borrower (ARM, prepayment penalty). The key to the crisis Source: Testimony of Paul S. Willen before the U.S. Senate Committee on Banking, Housing , and Urban Affairs Hearing on “Preserving Homeownership: Progress Needed to Prevent Foreclosures,” July 16, 2009, www.bos.frb.org/news/testimony/willen071609.pdf.

11. Falling House Prices Wiped Out Homeowners‘ Equity, Triggering the Foreclosure Crisis House-price index (1990 level = 4) Serious-delinquency or foreclosure rate (%) Sources: Mortgage Bankers Association and Standard & Poor. Quarterly data through Q2.2009.

12. Kentucky House Prices Have Fallen Less Than National Average House-price index (1990 level = 4.36) Serious-delinquency or foreclosure rate (%) Sources: Mortgage Bankers Association, First American Core Logic, FHFA. Quarterly data through Q2.2009.

13. Underlying Cause—and Continuing Driver— of the Foreclosure Crisis: Negative Equity Candidates for 2010 foreclosures

14. How Well Are Federal Foreclosure-Prevention Efforts Working? (I) • From the Report of the Congressional TARP Oversight Panel, Oct. 9, 2009 (http://cop.senate.gov/press/releases/release-100909-foreclosure.cfm) • “Treasury's strategy is inadequate to address the coming wave of foreclosures.” • “For many homeowners, foreclosure will be delayed, not avoided.” • “It increasingly appears that HAMP (Home Affordable Modification Program) is targeted at the housing crisis as it existed six months ago, rather than as it exists right now.”

15. How Well Are Federal Foreclosure-Prevention Efforts Working? (II) • From the Report of the Congressional TARP Oversight Panel, Oct. 9, 2009 (http://cop.senate.gov/press/releases/release-100909-foreclosure.cfm) • “The program is limited to certain mortgage configurations. Many of the coming foreclosures are likely to be payment-option ARMs and interest-only loan resets, many of which exceed HAMP eligibility limits.” • “Treasury's strategy also makes no provision for foreclosures due to unemployment, which now appears to be one of the biggest drivers of foreclosure.”

16. How Well Are Federal Foreclosure-Prevention Efforts Working? (III) • From the Report of the Congressional TARP Oversight Panel, Oct. 9, 2009 (http://cop.senate.gov/press/releases/release-100909-foreclosure.cfm) • “Foreclosures continue every day as Treasury ramps up the program, with foreclosure starts outpacing new HAMP trial modifications at a rate of more than two to one…. Treasury's own projections indicate… fewer than half of the predicted foreclosures would be avoided.”

17. How Well Are Federal Foreclosure-Prevention Efforts Working? (IV) • From the Report of the Congressional TARP Oversight Panel, Oct. 9, 2009 (http://cop.senate.gov/press/releases/release-100909-foreclosure.cfm) • “HAMP modifications are often not permanent: For many homeowners, payments will rise after five years, and although the program is still in its early stages, only a very small proportion of trial modifications have converted into longer term modifications.”

18. How Well Are Federal Foreclosure-Prevention Efforts Working? (V) • From the Report of the Congressional TARP Oversight Panel, Oct. 9, 2009 (http://cop.senate.gov/press/releases/release-100909-foreclosure.cfm) • “The Panel is also concerned about homeowners who are ‘underwater’ (face negative equity)…. For many borrowers, HAMP modifications increase negative equity, a factor that appears to be associated with increased rates of re-default.”

19. Fed‘s Economic Forecast: Unemployment Will Remain Very High Through 2011 Q4.2009: 10.0% Percent Q4.2010: 9.7% Q4.2011: 8.6% FOMC projections as of July 2009

20. The 2010 Housing Outlook: Continuing Foreclosures and Immense Challenges • The “dual triggers” of foreclosure remain: • Flat house prices imply continued negative equity. • Unemployment will remain very high. • No silver bullet: Foreclosure-prevention initiatives usually don’t/can’t address negative equity—Not enough $$. • Challenges we must meet: • Support families losing their homes in foreclosure. • Counsel at-risk families to minimize preventable foreclosures. • Educate future home-owning families so we never go through this again.