Lessons Learned from the Financial Crisis: Avoiding a Financial Collapse, but not the Great Recession

September 11, 2011

The actions of regulators and the federal government clearly ended the panic in the financial markets, but could not avoid what many now call the Great Recession. Julie Stackhouse outlines the problems that linger, including housing market weakness and the nation's high unemployment rate.

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Julie Stackhouse: So did it work? I hear nothing. (Laughter) Okay, yeah. Obviously, the actions taken, while often not well understood, while often a little bit frightening and concerning to those that were trying to understand them, clearly brought the panic out of financial markets.

There is a little blip up if you look towards June. Some of that reflects the situation in Europe as financial markets still try to understand and adjust. And clearly we're seeing some ramp up in more recent times about concern in Europe as well.

What we did not avoid though was something that many have called the Great Recession. And I think most of us would be glad that the worst did not happen. But inevitably the consequences of a recession that is that deep are not insignificant.

We also did not avoid a very significant collapse in home prices. This is the chart that I promised you, and it really is quite amazing. Las Vegas, prices off about 59 percent from where they were. Think about that. Patty Bloomeyer, if you sold a house to someone in Las Vegas—I know you're in St. Louis—and that house is now worth 60 percent less, how do you think that homeowner feels? Pretty broke, yeah. Add to that the fact that some of these homeowners lost jobs because of the recession and you've got two things going on. You've got both situations where people can no longer—they could pay their mortgage prior to the financial crisis, but they lost their job. And you've got people who feel very trapped in their home.

There are challenges that remain in the housing market. What this map shows are mortgages that are seriously delinquent that's 90 days or more, or in foreclosure. And the really hot spots, as you can see, are California, Florida, Nevada. There are certainly hot spots in the Chicago area. Everybody says what's going on in Maine? Interestingly, Maine is more associated with the type of foreclosure proceedings in that state. They're very favorable to the consumer. So foreclosures take a long, long, long time in Maine. That's the situation in Florida as well. Florida has both, obviously, lots of investment properties, so there were lots of losses, and its foreclosure laws extend the foreclosure period for quite a while.

Sometimes I'm asked, well, isn't that good for the consumer? And it may be, although quite honestly these seriously delinquent mortgages are often a year to two years seriously delinquent. They're not just a little bit delinquent. What it does do though is it doesn't allow property values in those areas to stabilize. When the foreclosure does occur, when the property comes on the market, then it has that impact that realtors don't like to see, which is it brings down values typically around the property if the property is sold at a lower rate.

So in most cases the ideal is to move the foreclosed properties through the pipeline at an appropriate, a fair rate, but to get the process through and done so housing markets can begin to recover.

This process was also slowed by a well-publicized review of companies that collect payments on mortgages called mortgage servicers. They underwent a very strong regulatory review about this, beginning this time last year. And frankly, although there weren't many improper foreclosures, there clearly were practices in place - poor record keeping, poor internal controls, and those had to be addressed and that slowed the process as well.

This is kind of interesting too, because it's one to think about when you're thinking about what does that colleague who lives in Las Vegas, how do they think and feel? What we did is we took a look at mortgages and we said if you have a mortgage, now only about two-thirds of homeowners have a mortgage, but if you have a mortgage, is your mortgage, is the amount of your mortgage loan exceed the current value of your property? And we call that an underwater mortgage. So in this case we said what percent of mortgages have negative equity or are underwater in each of these states? Now, remember, this is not every homeowner, because not every homeowner has a mortgage. But when you take a look at the percent of mortgages that are underwater, it's really pretty amazing. Again, take a look at Nevada. It really sticks out. Clearly the stress that homeowners in that state are feeling is significant. But other states as well with 40 or 50 percent individuals with their homes that have a mortgage that are underwater. And so, of course, that influences sometimes called the wealth effect of how those individuals think, act, how they spend as they make choices and carry that debt burden.

Now there has been, there's some real interesting dialogue out there of just maybe we should have a program that just sort of allows these homeowners to refinance even if they're current on their mortgage, because wouldn't it be great if they had a lower payment? Because that would give them some extra income. And that certainly is one side of the story.

There was a report issued by the Congressional Budget Office late last week though that provided the other side of the story. And it's a pretty complicated economic principle, but what it says is if you do that, then all these investors we talked about earlier, the ones that hold the mortgage securities, the value of the investment, the return they expect is going to be diminished. And that is a loss of wealth to those investors. And it's a sizeable loss of wealth. About 55 percent of Fannie Mae, the mortgage giant, mortgage securities are held by investors that are outside the governmental system. So that's the rub. It sounds good, but the question is how will that forever affect those markets and will those markets then be available to your children as they want to purchase homes? So it has to be carefully weighed, both the costs and the benefits. But clearly it is something that will be getting, or likely will be getting discussion in the near future.

Okay. And, of course, one of the consequences of the financial crisis was high unemployment. And it remains sticky. And for that reason, I know I see Chris Waller way in the back of the room. Chris is our director of Research. In November, he's going to be talking about this topic and I hope you can join us for that. It's a hard topic. When you talk about unemployment. When you talk about the reasons for it, the changes that have occurred in our economy, the types of jobs that have been lost, and the types of jobs that might be created in the future, it's not an easy transition. But I think understanding or having a better idea of what to expect is very helpful even if it may not totally be the story that you would like to hear.

There is some good news in all this. At least there are certainly some things that I think bode well for the future. And one of the things that has happened is that mortgage financing options have changed quickly. Now Patty Bloomeyer may say this is actually bad news, because she may find that some of her home buyers can no longer get a mortgage. But what we have seen is that standards for qualifying for a mortgage have moved back to historic levels. That, yes, it is more difficult to get a mortgage, but by and large those getting mortgages can afford to pay the mortgage. And that speaks well for the future of those mortgages that are now being introduced into the market.

The other thing that's also kind of, again, a good news, but in the short term it's a little bit tough, we as a country are starting to save some money. And for many, many years we didn't do that. We were out there spending. Again, the spending may have contributed or fueled some of the economic growth, but over the longer term our households need to be thinking about their balance sheets as we face some of the challenges that lie ahead with expensive government healthcare programs like Medicare and Medicaid, or even looking at some of the challenges facing Social Security. So ensuring that there is a process for which households begin to save is a good thing. And as a result of the financial crisis we have seen some renewed savings.

This popular lecture series addresses key issues and provides the opportunity to ask questions of Fed experts. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.

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