Goldman Sach’s Jon Hatzius just published an interesting Brookings Paper on the inter-relationship between falling home prices, the credit crunch, and real GDP.
I found some interesting theories and arguments worth chewing over in the paper. (A link to the full paper and the abstract are below).
Here are the four main points I took away from his analysis:
1) The "best case scenario" during the the credit downturn would be a "couple of years of stagnation or mild recession in the broader economy;" and that’s only, according to Hatzius, if the GSE’s continue expanding their books of business (i.e., keep buying up mortgages).
2) On the other hand, if the "GSEs were to stop growing their book of business . . . it "would also raise the risk of substantial adverse feedback effects
between the real economy, the housing market, and the financial
Um, news flash: The feedback loop (in a negative direction) between housing, credit and the economy is not a risk, its a reality. That is precisely what we are in the early stages of experiencing. Its here, its now, and it looks to be getting worse.
3) Now’s where things get interesting: "The specter of such a feedback loop was likely an important reason for the Treasury’s decision to take the GSEs into conservatorship on September 7."
I would argue that the adverse loop was already visible to the Treasury (and the Fed), and their concern was a rapid expansion of this negative (duh) inter-relationship between credit, housing and the economy. Its the only half-decent economic explanation I have heard so far to justify the conservatorship.
4) "Macroeconomic policies may need to remain unusually expansionary during the adjustment of the financial system to the housing and credit market downturn."
Um, yeah. At this point, a tighgtening is off the table for the Tuesday Fed meeting. I expect by next Summer’s fishing trip, rates will be down to 1.5%.
A few charts and the ABSTRACT are after the jump . . .
Beyond Leveraged Losses: The Balance Sheet Effects of the Home Price Downturn
Brookings Papers, September 10, 2008
Foreclosure Starts Peak in Late 2008 if Home Prices Fall Another 10%
Mortgage Credit Loss Projections
Breakdown of Total Debt Outstanding (Q1 2008, Trillions of Dollars)
This paper aims to quantify the impact of the decline
in US home prices, the increase in mortgage credit losses, and the
associated reduction in credit supply on real GDP growth. Using a
state-level panel analysis, we first estimate the link between home
prices and foreclosures. We estimate that an additional 10% home price
decline from mid-2008 levels would be consistent with total residential
mortgage credit losses over the years 2007-2012 of $636 billion,
although the uncertainty is high. We then try to gauge the impact of
the credit losses on the supply of credit from banks, asset-backed
security markets, and the government-sponsored enterprises (GSEs), and
the knock-on effect on real GDP growth. In our central scenario, we
estimate that the crisis could lower real GDP growth in 2008 and 2009
by an average of 1.8 percentage points per year. This assumes that the
GSEs continue to expand their mortgage book of business aggressively,
an outcome that has become more likely following the measures announced
by the U.S. Treasury on September 7, 2008. If instead the GSEs stopped
expanding, the estimated GDP hit would rise to 3.2 points per year.