[Senate Hearing 109-1085]
[From the U.S. Government Publishing Office]


                                                       S. Hrg. 109-1085
 
        THE HOUSING BUBBLE AND ITS IMPLICATIONS FOR THE ECONOMY 

=======================================================================

                                HEARING

                               before the

               SUBCOMMITTEE ON HOUSING AND TRANSPORTATION

                                and the

                    SUBCOMMITTEE ON ECONOMIC POLICY

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                                   ON

 THE ISSUES SURROUNDING A HOUSING BUBBLE AND ITS POSSIBLE IMPLICATIONS 
                            FOR THE ECONOMY


                               __________

                     WEDNESDAY, SEPTEMBER 13, 2006

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html

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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire        DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina       ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida

             William D. Duhnke, Staff Director and Counsel
     Steven B. Harris, Democratic Staff Director and Chief Counsel
               Peggy R. Kuhn, Senior Financial Economist
           Mark A. Calabria, Senior Professional Staff Member
            Johnathan Miller, Democratic Professional Staff
   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
                       George E. Whittle, Editor
                                 ------                                

               Subcommittee on Housing and Transportation

                    WAYNE ALLARD, Colorado, Chairman
                JACK REED, Rhode Island, Ranking Member
RICK SANTORUM, Pennsylvania          DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina       ROBERT MENENDEZ, New Jersey
MICHAEL B. ENZI, Wyoming             CHRISTOPHER J. DODD, Connecticut
ROBERT F. BENNETT, Utah              THOMAS R. CARPER, Delaware
MEL MARTINEZ, Florida                CHARLES E. SCHUMER, New York
RICHARD C. SHELBY, Alabama

                    Tewana Wilkerson, Staff Director
                Didem Nisanci, Democratic Staff Director
                   Kara Stein, Legislative Assistant
                                 ------                                

                    Subcommittee on Economic Policy

                    JIM BUNNING, Kentucky, Chairman
              CHARLES E. SCHUMER, New York, Ranking Member
RICHARD C. SHELBY, Alabama

                   William Henderson, Staff Director
            Carmencita N. Whonder, Democratic Staff Director










                            C O N T E N T S

                              ----------                              

                     WEDNESDAY, SEPTEMBER 13, 2006

                                                                   Page

Opening statement of Chairman Allard.............................     1
Opening statement of Chairman Bunning............................     3

Opening statements, comments, or prepared statements of:
    Senator Schumer..............................................     2
    Senator Reed.................................................     4

                               WITNESSES

Patrick Lawler, Chief Economist, Office of Federal Housing 
  Enterprise Oversight...........................................     6
    Prepared Statement...........................................    30
Richard Brown, Chief Economist, Federal Deposit Insurance 
  Corporation....................................................     8
    Prepared Statement...........................................    35
Dave Seiders, Chief Economist, National Association of 
  Homebuilders...................................................     9
    Prepared Statement...........................................    47
Tom Stevens, President, National Association of REALTORS........    11
    Prepared Statement...........................................    52

              Additional Material Supplied for the Record

Letter from the Housing Policy Council of The Financial Services 
  Roundtable.....................................................    55
David A. Lereah, Senior Vice President and Chief Economist, 
  National Association of REALTORS..............................     *

* PowerPoint Presentation on Current and Future Real Estate Trends is 
retained in Committee files.


   HEARING ON THE HOUSING BUBBLE AND ITS IMPLICATIONS FOR THE ECONOMY

                              ----------                              


                     WEDNESDAY, SEPTEMBER 13, 2006

                               U.S. Senate,
         Subcommittee on Housing and Transportation
                    Subcommittee on Economic Policy
           Committee on Banking, Housing, and Urban Affairs
                                                    Washington, DC.
    The Subcommittees met at 10:02 a.m., in room SD-538, 
Dirksen Senate Office Building, Hon. Wayne Allard, and the Hon. 
Jim Bunning, Chairmen of the Subcommittees, presiding.

           OPENING STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. The Committee will come to order.
    Both Senator Bunning and myself like to start on time and 
we like to follow the rules of debate, so I would like to have 
you watch your time clocks. We have one here and then one on 
the table, and then we will proceed.
    I am pleased to convene a joint hearing of the Housing and 
Transportation Subcommittee and the Economic Policy 
Subcommittee. I have always enjoyed opportunities to work with 
my friend Senator Bunning.
    The possible housing slowdown has significant implications 
for both the housing markets and for the economy as a whole, so 
this topic is of great interest to both subcommittees. During 
recent years the country has seen dramatic escalations in home 
values. While this has been very beneficial for homeowners, it 
has definitely created challenges for home buyers.
    Over the last 5 years, home prices have increased 
nationwide by 56 percent. The inflation-adjusted increases are 
higher than at any point in 26 years since data has been 
tracked. The story is even more startling in selected markets. 
For example, home prices here in the District of Columbia have 
increased by a whopping 120 percent over the same 5 years.
    Part of the price run-up has been fueled by low interest 
rates, favorable tax treatment, and changes in the credit 
markets. However, there are questions as to whether 
fundamentals can fully explain the increases, particularly over 
the last several years as interest rates have risen. More 
recently we have seen signs that the market is cooling. 
Existing home sales are down 11.2 percent. On a year over year 
basis in July, new home sales fell 21.6 percent. Last year the 
Office of Federal Housing Enterprise Oversight, called OFHEO, 
also reported the largest housing price deceleration in three 
decades.
    We have gone through a period of housing expansion, in part 
because of the efforts of Congress to expand home ownership 
opportunities. Will there be a significant reduction in the 
rate of expansion is a question that would ask, and what are 
the implications of this possibility, is a follow-up question.
    While housing has received attention, the discussion has 
always been as a side issue at other hearings, such as the 
semiannual monetary policy hearing. However, these interactions 
have only offered a brief glimpse into a very complicated 
topic. Today's hearing is intended to offer members an 
opportunity to examine this issue in depth.
    Specifically, we are interested in learning more about the 
current state of the housing market, the degree to which, if 
any, the housing bubble might exist, key factors that 
contributed to the current status, projections for where the 
housing market will be in the short, intermediate, and long-
terms, how these projections will manifest in the economy, as 
well as for companies and for individual homeowners and home 
buyers.
    Today's hearing is designed as a learning opportunity 
rather than a policy discussion. Therefore, we have invited 
some of the leading housing researchers to testify.
    First we will hear from Patrick Lawler, chief economist at 
the Office of Federal Housing Enterprise Oversight. Just last 
week OFHEO released the updated housing price index, which 
showed the largest deceleration in three decades. This recent 
housing data, as well as OFHEO's extensive historical data will 
be very helpful in today's discussion, as well as projections 
for the future.
    Next, we will hear testimony from Rich Brown, chief 
economist for the Federal Deposit Insurance Corporation. The 
FDIC has done extensive analysis of market trends, including a 
specific analysis of whether and when booms are followed by a 
bust. This information will help us evaluate our current 
situation.
    Our third witness will be Dave Seiders, chief economist of 
the National Association of Homebuilders. As you might imagine, 
the Homebuilders collect extensive information on their 
industry, which provide important insight into the industry's 
future.
    Finally, we will turn to Tom Stevens of the National 
Association of Realtors. Just as the Homebuilders, the realtors 
are in a position to collect and track extensive industry data 
through its 1.3 million members.
    All four organizations are among the leading housing 
researchers and have compiled extensive data. No doubt this 
information will be extremely helpful as members try to better 
understand housing and its economic implications.
    I will now turn to my ranking member, Senator Reed.
    Senator Reed. Mr. Chairman, may I yield to Senator Schumer?
    Senator Allard. You may.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Well, thank you, Mr. Chairman. I 
apologize.
    First, I thank you and Senators Bunning and Reed for having 
this hearing and I am happy to join in. I apologize. I will 
only be here very briefly, and I would ask unanimous consent 
that my entire statement be put in the record.
    Senator Allard. Without objection, so ordered.
    Senator Schumer. I will just make a brief point. I guess, 
to paraphrase Shakespeare, is there a bubble or isn't there a 
bubble? That is the question. And we all know housing markets 
are not growing as vigorously and, in some places, declining a 
bit, but will there be a soft landing or will the bubble burst? 
That is a very important question for our economy for the next 
few years, and to learn what things we can do to decrease the 
likelihood of bubbles. And one of the things I am particularly 
concerned with is actually relates to our next hearing, which 
is on mortgage products and too many people pushing mortgages 
that people cannot really afford, the kinds of loss leaders and 
other kinds of things that are put in to the various types of 
reverse mortgages and other kinds of things around--not reverse 
mortgages, but no-interest mortgages, no principle mortgages, 
are really troubling.
    So, I look forward to reading everybody's testimony. It 
particularly affects my area of New York, where we have amazing 
growth in housing prices. We bought our coop in 1982, and you 
can add a zero to it. That is about the most important thing we 
own in New York, in terms of its value.
    I look forward to hearing the testimony of everyone. Again, 
I apologize for not being able to stay.
    Senator Bunning.

            OPENING STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Chairman Allard.
    I am glad to be co-chairing this series of hearings with 
you as we examine current issues in the housing market. Today's 
hearing is on the state of the housing market and what it means 
to the economy.
    Some people, especially in the media, suggest that there 
has been a housing bubble and it is about to burst. Others 
think we are in the middle of a normal economic cycle and that 
the market will take care of itself over time. I hope our 
witnesses can shed some light on these views today. Clearly, 
the housing market has been hot the last few years. It is also 
clear that the market is cooling now, although it is not as 
clear how fast or how long-lasting that cooling will be. It is 
important to point out that not all parts of the country have 
experienced the same price changes. The coasts have seen rapid 
home price increases, while, in the middle of the country, home 
prices have increased at a slower and more constant rate.
    For example, in my State of Kentucky home prices have 
increased about 25 percent over the last 5 years, while here in 
Washington, D.C., home prices have increased about 120 percent. 
So, while the bubble could be about to pop in some parts of the 
country, a nationwide collapse in home values, in my opinion, 
does not seem likely.
    Even though a nationwide housing bust may not happen, a 
rapid cooling in overheated markets could have implications for 
the entire economy. For example, consumer spending accounts for 
over two-thirds of the U.S. economic activity. Therefore, to 
the extent that consumer spending has been supported by 
increased home values, any stall or decline in home values 
appreciation could be very troublesome. A declining market has 
already hurt the profits of homebuilders and that could spread 
to related industries, as well.
    Furthermore, a wave of defaults could hurt the financial 
sector and the overall economy. That could happen if lenders 
loosen their credit standards in order to write more loans or 
if mortgage interest rates continue to climb thanks to the 
Federal Reserve interest rate hikes.
    At this point, it is hard to tell what the full impact of 
interest rates will be because of the large number of non-
traditional mortgages written lately. We will look more closely 
at that topic next week. We also have to look at how we got 
here. Housing prices began to climb in 1997 and picked up the 
pace in 2003. It was not until this year that nationwide 
averages have begun to seriously slow. The tech burst in 2000 
left people looking for somewhere other than the stock market 
to put their investment money, and a lot of that money went 
into housing.
    The Federal Reserve began cutting interest rates in early 
2001, eventually taking the overnight Fed rate to 1 percent in 
2003. Former Chairman Greenspan kept rates at this historically 
low level for a year before beginning the 2-year string of 
increases that just ended last month. That period of extreme 
low interest rates makes the beginning of the most rapid 
acceleration of the housing boom and caused part of it. I think 
it is clear that the Feds actions contributed to the housing 
boom and that more recent actions will turn out to be a key 
factor in the slowdown.
    Many other factors must be examined, as well. Americans' 
appetite for bigger and nicer homes has no doubt pushed up the 
prices. The growing population and the increased wealth of the 
Baby Boom generation has contributed to increased housing 
demand. Congress made home ownership more beneficial starting 
in 1997 when most homeowners no longer had to pay tax on the 
proceeds of the sale of their primary residence.
    There is no doubt many other factors that have contributed 
to the current state of the housing market. We do not need to 
be concerned with factors that contributed to normal market 
forces, but if the market has moved because of unsustainable or 
artificial forces, we may be in for a rough ride.
    I want to thank all of the witnesses for coming today. I 
will look forward to hearing from them and to exploring this 
important topic.
    Senator Allard. Thank you.
    Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Thank you very much, Mr. Chairman, and 
Chairman Bunning, for holding this very timely hearing on the 
housing bubble and its implications for the economy.
    For the past several years, a booming housing market has 
been one of the few sources of strength in our economy. That 
strength has come not only from homebuilding activity itself, 
but also from the household spending supported by rising home 
values and increased home equity wealth.
    What we are seeing now, however, are clear signs that the 
housing boom is cooling off. What we would like to explore in 
this hearing is how this process is likely to play out. Will 
there be a smooth economic adjustment to a housing market with 
a slower pace of home building and house price appreciation or 
will the popping of the housing bubble be accompanied by 
serious economic disruptions and flat or even falling housing 
prices?
    A wide range of recent data points to a distinct cooling in 
the housing market. Residential investment peaked in the third 
quarter of last year and has declined since, directly lowering 
economic growth. In the second quarter of this year residential 
investment at a 9.8 percent annual rate, the largest quarterly 
decline in more than a decade, and directly shaved .6 
percentage points off the economy's overall growth rate for the 
quarter.
    Current indicators of homebuilding also point at the 
possibility of further declines. The number of housing units 
started in July was 13.3 percent lower than it was a year 
earlier. The number of authorizations for new housing 
construction was down 20.1 percent, the largest drop since the 
recession of 1990. Sales of single family homes in July were 
13.2 percent below their level a year earlier.
    Moreover, the supply of new single family homes available 
for sale rose to equal six-and-a-half months of supply at the 
current sales rate, the highest ratio of houses available to 
sales in more than a decade. So far we have not seen the 
collapse of housing prices, although the rate of increase has 
slowed dramatically. After rising 12.9 percent in 2005, the 
median price of existing homes published Mr. Stevens group, the 
National Association of Realtors, rose a scant .9 percent over 
the 12 months ending in July.
    Mr. Lawler's office, OFHEO, has a price index that is 
constructed differently, but tells a similar story of sharply 
decelerating home prices over the past four quarters. A 
striking feature of the housing boom and its recent slowing is 
its regional character. Prices went up dramatically in some 
States in 2001 to 2005, but much less so in others. Now that 
prices are coming down, the most pronounced slowing has 
occurred in those areas that experienced the greatest 
increases, while areas that never had a boom do not seem to be 
experiencing a bust either.
    What happens to the housing sector and home prices is of 
enormous concern to ordinary Americans, for whom their house 
is, by far, their most important source of wealth. It is also a 
concern for the people in the construction, real estate, and 
mortgage lending businesses, whose livelihood depends upon a 
very healthy housing sector. And it is a concern for the 
overall economy. I hope the economy can make a smooth 
transition to a more sustainable pace of housing activity and 
house price increases without going through the turmoil that is 
often associated with the bursting of an economic bubble.
    But I worry that the economy may be headed for a bumpy 
landing. As long as the Bush Administration refuses to take any 
serious action to address other challenges in the economy, 
especially our fiscal and trade imbalances, we cannot count on 
strong business investment or an improving trade balance to 
offset the loss of housing-based spending.
    I look forward to the testimony of our witnesses today to 
help us understand this situation as we approach it over the 
next several months.
    Thank you, Mr. Chairman.
    Senator Allard. OK, the Committee plan at this point is 
that we will go ahead and start with the testimony from the 
experts at the panel and then I will turn the gavel over to 
Senator Bunning to be in charge the rest of the meeting.
    Mr. Lawler.

STATEMENT OF PATRICK LAWLER, CHIEF ECONOMIST, OFFICE OF FEDERAL 
                  HOUSING ENTERPRISE OVERSIGHT

    Mr. Lawler. Thank you very much Chairman Allard, Chairman 
Bunning, Ranking Member Reed.
    I am pleased to be here, where I enjoyed working as a 
Committee staff member some years ago, to testify on housing 
market developments and prospects. OFHEO has a strong interest 
in housing markets and particularly in house prices because 
they have a powerful effect on the credit quality of mortgage 
loans owned or guaranteed by Fannie Mae and Freddie Mac, the 
enterprises we regulate.
    Over the past 5 years we have witnessed an extraordinary 
change in the relative price of houses. The general level of 
house prices soared 56 percent from the spring of 2001 to this 
spring. And the prices of other goods and services rose much 
less, so that inflation-adjusted house prices are now 38 
percent higher than 5 years ago. That exceeds the inflation-
adjusted increase in house prices from the previous 26 years, 
going back to the beginning of our data in 1975.
    A number of factors have contributed to these price gains. 
Long-term mortgage interest rates fell from about 8 percent in 
mid-2000 to less than 6 percent from early 2003 to mid-2005. 
Short-term rates declined by more, and borrowers took advantage 
as more of them took out adjustable rate loans. Interest only 
and negative amortization loans provided even lower monthly 
payments. The spread of these products helped stimulate demand 
as did the rapid growth of sub-prime lending.
    Demographics have also been favorable. Aging Boomers are 
reaching their peak earning and investing years, with many 
interested in second homes for vacations or future retirement. 
Immigration has accelerated household formation. Supply 
constraints have made it difficult to meet the increased 
demand, lengthening the time necessary for builders to bring 
new houses on the market and raising the premiums paid for 
prime house locations.
    Finally, there is some evidence of speculation, including a 
higher share of loans made to investors and anecdotes of 
property flipping. Certainly the poor performance of the stock 
market early in this decade was in obvious contrast with the 
investment performance of houses, and that may have encouraged 
some shift in investor focus.
    House price increases have been uneven across the nation, 
though. While homeowners in Indiana, Ohio, and Michigan have 
seen their house values over the past 5 years in constant 
dollars roughly stay the same, residents in Florida, 
California, and here in the District of Columbia have watched 
prices virtually double, even after adjusting for inflation.
    Over the past year, the pace of house price inflation over 
most of the country has moderated dramatically. The sharpest 
decelerations have come in some of the most superheated markets 
of a year ago. Nationally, prices rose in the second quarter of 
this year by less than the inflation rate of other goods and 
services in the economy.
    Other market indicators confirm the general chilling of 
housing markets across the nation. Particularly noteworthy is 
the swelling inventory of unsold houses on the market, which 
has risen from less than 3 million houses to about 4.5 million 
in, roughly, the last year-and-a-half. The sales rates have 
fallen at the same time, so inventories relative to sales are 
now the highest since the early 1990s.
    Historical patterns of price behavior in housing markets 
may provide some guidance about potential future developments. 
OFHEO's national house price index has never fallen over a 
period of a year or more, but it has come close, and inflation-
adjusted prices have fallen significantly, by 11 percent in the 
early 1980s and by 9 percent in the early 1990s.
    In the first instance it took nearly 8 years for inflation-
adjusted prices to regain their past peak, and in the second 
case almost 10 years. Certainly a similar event is quite 
possible now. Cycles in inflation-adjusted home prices have 
occurred in a much more pronounced way in some cities, such as 
Boston and Los Angeles. The cycles stem from the effects of 
local business cycles, the delays in the response of supply to 
increased prices, and, to some extent, from speculation.
    Over much of the country fundamental factors have pushed up 
demand and accounted for at least a large portion of the price 
increases of recent years. However, increasing supply, higher 
interest rates, and a turn in market psychology may cause 
prices in some markets to fall. In the past, significant 
nominal price declines have generally been associated with 
local or regional economic recession, but the exceptional size 
of some of the recent increases could make them vulnerable 
without a recession.
    In the long run, I expect housing markets to perform well, 
especially if immigration continues at recent rates. An 
important caveat, though, is that healthy housing markets could 
soften seriously from an unexpected disruption in the ability 
of Fannie Mae and Freddie Mac to function effectively in 
secondary markets.
    OFHEO is currently focused on correcting the significant 
accounting, internal control, management, and corporate 
governance weaknesses identified at both companies through 
OFHEO examinations. While both companies have made progress, 
much more needs to be done. It is apparent that, in order to 
insure the long run safety of these two GSEs, the regulatory 
framework must also be strengthened.
    OFHEO supports the enactment this year of legislation that 
will create a new regulator with adequate funding, bank-like 
regulatory and enforcement authorities, and encompassing not 
only safety and soundness, but also mission regulation.
    Thank you. I will be happy to answer any of your questions.
    Senator Bunning. Mr. Brown, go right ahead.

 STATEMENT OF RICHARD BROWN, CHIEF ECONOMIST, FEDERAL DEPOSIT 
                     INSURANCE CORPORATION

    Mr. Brown. Thank you. Chairman Allard, Chairman Bunning, 
and Senator Reed, I appreciate the opportunity to testify on 
behalf of the Federal Deposit Insurance Corporation concerning 
housing market trends and their implications for the economy. 
Like the other panelists testifying today, the FDIC closely 
monitors current conditions in U.S. housing markets.
    I would like to focus my oral statement on recent FDIC 
research into housing boom and bust cycles in U.S. metropolitan 
areas over the past 30 years. I believe these results may 
provide useful context on the topic of today's hearing.
    The FDIC monitors trends in U.S. home prices and mortgage 
lending practices as part of its risk analysis process. FDIC-
insured institutions are extremely active in just about every 
aspect of housing finance. These activities have helped the 
industry to post record earnings for five consecutive years.
    Credit losses for the industry remain low by historical 
standards, while capital levels remain high. No FDIC-insured 
institution has failed in over 2 years. However, our experience 
in the late 1980's and early 1990's showed that banks and 
thrifts are subject to potentially large credit losses arising 
from boom and bust cycles in real estate. This experience was 
the motivation for our recent studies of metropolitan area home 
price trends.
    In this research, FDIC analysts asked three simple 
questions. Where have booms occurred? Where have busts 
occurred? Does boom necessarily lead to bust?
    Using the OFHEO house price index series, our analysts 
attributed a housing boom to any metropolitan area that 
experienced at least a 30 percent price increase, adjusted for 
inflation, during a given 3 year period. A housing bust is 
defined as a 15 percent decline in nominal terms over a five 
year period.
    We use a 15 percent price decline to define a bust because 
it would be enough to wipe out the equity of recent homebuyers 
who made only a 10 percent down payment and would seriously 
impair the equity of those who put 20 percent down. Given that 
about two out of five first time homebuyers last year 
effectively received 100 percent financing, a 15 percent price 
decline could be expected to have significant adverse credit 
implications for mortgage lenders and investors.
    Applying these standard definitions for booms and busts 
over the period from 1978 through 1998, we observe that 
movements in home prices tend to be long-term trends that play 
out over years. We also see that true housing busts are 
relatively rare events, with only 21 such episodes recorded 
since 1978.
    But of the 54 individual housing booms recorded during this 
period, only 9 resulted in a subsequent housing bust, according 
to our definitions. Housing booms have typically been followed 
by an extended period of stagnation where prices may, in fact, 
fall, but usually not by enough to meet the FDIC's definition 
of a bust. Where housing busts did occur they were usually 
associated with episodes of severe local economic distress, 
such as the energy sector problems experienced in Houston in 
the mid-1980's.
    While these findings are somewhat reassuring from a risk 
management perspective, we need to keep in mind that the 
periods of stagnation that typically follow booms can be 
painful for homeowners, investors, and real estate 
professionals. Measures of housing market activity, such as 
home sales and construction, tend to suffer larger declines 
than home prices themselves.
    The fact that current homeowners are very reluctant to sell 
at distressed prices during these episodes unless they are 
forced to helps to explain why home prices tend to be what 
economists call ``sticky downward.'' Our analysis also points 
to two important trends that distinguish the current situation 
from our historical experience. First is an increase in the 
number of boom markets to unprecedented levels, from a then 
record high 40 markets in 2003 to 89 individual markets in 
2005. Second is the sweeping change that is taking place in the 
structure of mortgage loans. Since 2003, we have seen borrowers 
migrate toward adjustable rate, interest only, and payment 
option structures where monthly payments may start out low, but 
can increase substantially if interest rates rise, or as low 
introductory interest rates expire. By some estimates, interest 
only and payment option loans made up between 40 and 50 percent 
of mortgage originations during 2004 and 2005.
    In conclusion, FDIC's studies find that housing price booms 
do not inevitably lead to housing price busts, and that severe 
local economic downturns continue to pose the greatest downside 
risk to local home prices. While mortgage credit performance at 
FDIC-insured institutions remains excellent at present, we will 
continue to monitor these portfolios as this decade's great 
housing boom inevitably subsides.
    This concludes my testimony, I will be happy to respond to 
any questions the Subcommittees might have.
    Senator Bunning. Thank you very much.
    Mr. Seiders.

     STATEMENT OF DAVE SEIDERS, CHIEF ECONOMIST, NATIONAL 
                  ASSOCIATION OF HOMEBUILDERS

    Mr. Seiders. Thank you, Chairman Bunning, Chairman Allard, 
Senator Reed.
    My full statement outlines my view of the basic causes of 
the 2004-2005 housing boom and the current housing downswing. 
It also estimates the depth and duration of the downswing and 
discusses the likely economic impacts of the downswing in 
housing market activity, as well as from some secondary housing 
effects, like the weakening of the housing wealth effect that 
has already been mentioned.
    I think the first thing you will recognize is that the 
housing boom of 2004-2005 and the current housing downswing 
have some really unique features that make these episodes 
different from previous housing market swings. Three big 
differences that I see are, first, unusually stimulative 
financial market conditions before and during the boom. Second, 
record breaking increases in inflation-adjusted, or real, house 
prices. And third, an outsized presence of investors or 
speculators in both the single-family and the condo markets.
    To put things in perspective, the current contraction, in 
my view, amounts to an inevitable mid-cycle adjustment or 
transition from unsustainable levels of home sales, housing 
production and house price appreciation, to levels that are 
supportable by underlying market fundamentals, that is, 
primarily by demographics and household income trends.
    With respect to timing, the previous boom involved more 
than 2 years of unsustainable housing market activity. And we 
are likely to experience a below trend performance of home 
sales and housing starts of roughly similar duration. We expect 
the downswing to bottom out around the middle of next year 
before transitioning to a gradual recovery that will raise 
housing market activity back up toward sustainable trend by the 
latter part of 2008.
    Regarding house prices, national average price appreciation 
is likely to be quite limited in the near term as the housing 
market weakens. Indeed, some decline is a distinct possibility 
in coming quarters. The rate of price appreciation should 
remain below long-term trend for some time into the future in 
nominal terms. Real house prices, adjusted for general 
inflation, are likely to fall to some degree on a national 
average basis following the unprecedented surge of recent 
years.
    In terms of economic impact, the downswing and home sales 
and housing production will continue to detract from overall 
economic growth through mid-2007. However, much of this 
negative impact should be offset by strengthening activity in 
other sectors of the U.S. economy, keeping GDP growth 
reasonably close to a sustainable trend-like performance. These 
sectors include non-residential fixed investment, including 
non-residential structures, as well as our trade balance.
    There are bound to be some adverse secondary impacts of the 
ongoing housing contraction. These effects include, first, less 
support to consumer spending from the housing wealth effect. 
Second, the impacts of payment shock on homeowners facing 
upward adjustments to monthly payments on various exotic or 
non-traditional types of adjustable rate mortgages.
    At this point, my judgment is that the size and timing of 
these two effects are not likely to seriously threaten the 
economic expansion in the next few years. My bottom line is 
that the evolving housing cycle will definitely exert a serious 
drag on the economy through several channels, but that the U.S. 
economy should avoid outright recession during the 2006-2008 
period.
    I should point out that there are significant downside 
risks to this outcome, and I have outlined a number of these 
risks in my full statement. To mention a few, there is always 
the possibility of spikes in interest rates or energy prices. I 
have got both of these factors behaving rather quietly in my 
baseline forecast. Another major risk is that there could be 
wholesale resales of housing units back on to the market by 
those investors or speculators that purchased them in the last 
couple of years. On the exotic ARM and the payment shock issue, 
there clearly are major uncertainties about the dimensions of 
that. I am glad to hear you are having another hearing on that 
shortly. I will also say that there are major uncertainties 
about the actual accurate size of the inventory of the new 
homes for sale on the market.
    That concludes my oral remarks. I will be happy to take any 
questions. Thank you.
    Senator Allard. Mr. Stevens, please.

 STATEMENT OF TOM STEVENS, PRESIDENT, NATIONAL ASSOCIATION OF 
                            REALTORS

    Mr. Stevens. Thank you Chairman Allard, Chairman Bunning, 
Senator Reed, and Senator Carper. I appreciate the opportunity 
to be here and represent our 1.3 million members of the 
National Association of Realtors.
    For the past 5 years the housing market has been a 
steadfast leader in the U.S. economy. In 2005, mortgage rates 
remain near 45 year lows, and the nation's economy generated 2 
million new jobs. Existing home sales and new single family 
housing starts also set new high marks in 2005. Overall, the 
housing sector directly contributed more than $2 trillion to 
the national economy in 2005, accounting for 16.2 percent of 
economic activity.
    After 5 years of outstanding growth and being the driving 
force of the U.S. economy, the housing market is undergoing a 
period of adjustment. Existing home sales in July have fallen 
11.2 percent from a year ago. New home sales are down 22 
percent from a year ago. What is especially striking is that 
the inventory of unsold homes on the market is at an all time 
high at 3.9 million, which is a 40 percent rise from just a 
year ago.
    Given the falling demand and increased supply, home prices 
have seen less than 1 percent appreciation from a year ago, 
compared to double digit rate of appreciation in 2005. While 
recent market changes raise concerns, it is important to 
remember that the housing market varies significantly across 
the country. One-third of the country is still seeing rising 
home sales. These places include Alaska, Vermont, New Mexico, 
and States in the South, with the exception of Florida. The 
remaining two-thirds of the Nation are experiencing lower 
sales, with some States feeling acute adjustment pains. Sales 
are down significantly in Florida, California, Arizona, Nevada, 
Virginia, and Maryland.
    These regions experienced the greatest rise in home prices 
in recent years. Affordability has become a major issue for 
homebuyers in these markets, as well. The decline in sales has 
resulted in higher housing inventories or tripling and 
quadrupling in some cases. These areas are the ones most 
vulnerable to outright price declines, particularly if interest 
rates continue to increase.
    Contrary to many reports, there is not a national housing 
bubble. All real estate is local. For example, the housing 
market in California is extremely different from the housing 
market in Oklahoma. Home priced income ratio, home priced to 
rent ration and, more importantly, mortgage debt servicing cost 
to income ratio have greatly increased in some housing markets 
to unhealthy levels. Markets in Florida, California, Arizona, 
Nevada, Virginia, and Maryland have exhibited trends far above 
the local historical norm.
    Because of these exceptional trends, it would not be 
surprising for these markets to experience a price adjustment, 
and we are starting to see that in some of the areas. However, 
these States have solid job growth. Price declines are likely 
to be short lived in a period of solid job growth as new job 
holders enter the housing market.
    If mortgage rates were to rise measurably to, say, 7.5 
percent or 8 percent from the current 6.5 percent for whatever 
reasons, then the housing market would certainly come under 
more pressure, and many markets would likely undergo price 
declines. Rising mortgage rates are the most influential factor 
in the housing market coming under more pressure.
    Many home buyers in coastal markets have resorted to more 
exotic mortgages as the only way to enter the housing market. 
For some buyers this has meant financing their home through 
interest only, adjustable rate, or option ARMs. These buyers 
are at their financial capacity. With raising interest rates, 
homebuyers have become exhausted financially, which explains 
why sales have tumbled in high priced regions of the nation.
    This is where we are in the housing market to date and how 
we arrived to this point. The national forecast for the coming 
year, based on stabilizing mortgage rates and a modestly 
expanding economy through 2007 predicts that existing home 
sales will fall 8 percent in 2006, followed by another 2 
percent decline in the following year 2007.
    New home sales will fall by an even greater amount of 16 
percent in 2006, and then 7 percent in 2007. Home price growth 
will be minimal or less than 3 percent in 2006 and 2007. 
However, some markets will have higher or lower rates of 
appreciation as compared to the national forecast. All real 
estate is local and based on local economic conditions. Also, 
it is important to understand that any significant shift in 
mortgage rates and the change in the economy will change the 
forecast.
    We also expect that spending on residential construction as 
part of the economy will drop 3.4 percent in 2006, and 8.5 
percent in 2007. In other words, our nation's economy will lose 
$21 billion from the GDP this year, and another $49 billion in 
2007. This is a sharp contrast to the near $50 billion in added 
economic power during the housing market boom of the last 5 
years.
    The housing market also supports consumer spending for 
items such as furniture to cars, travel, education. All of 
these spending items have been supported by increases in 
housing equity over the past several years. The housing sector 
also directly employs real estate agents, mortgage lenders, 
construction workers, and is responsible for the expansion of 
home improvement retail stores such as Home Depot and Loews.
    In the past 5 years, a typical homeowner gained $72,300 in 
housing equity, including over $20,000 in the past year. Nearly 
all economists would agree that consumer spending has been far 
more robust than can be explained by income growth, job gains, 
and stock market gains. GDP growth would have been 1.5 
percentage points lower had the housing market not provided the 
wealth accumulation in recent years.
    As the nation's leading advocate for home ownership, 
affordable housing, and private property rights, realtors 
understand that the housing sector could not maintain the 
record-setting pace indefinitely.
    We believe that a soft landing is possible and, under the 
right circumstances, likely. But a soft landing is dependent 
upon policies that support a transition to a more normalized 
market and work to mitigate changes in local markets so that 
affordable mortgage financing is available to home buyers.
    And we stand ready to assist the Congress in any way to 
help continue the dream of American homeownership.
    And I would, Mr. Chairman, like to support for the record--
our chief economist could not be here, but he has a PowerPoint 
presentation----
    Senator Bunning. Without Objection.
    So ordered.
    Mr. Seiders. Thank you.
    Senator Allard. Thank you, Chairman Bunning.
    Mr. Brown, you talked about some of the differences between 
the current growth and value of homes and where we begin to see 
that drop down--actually rate of growth decrease in many areas. 
You compared that to previous experiences and talked about the 
market devaluation increases as a difference, and also you 
mentioned mortgage instruments changed considerably as a 
difference.
    And perhaps Mr. Seiders would also like to comment on this. 
But we have also, it seems to me, experienced a pretty good 
jump in raw material, right now. The cost of raw materials that 
are going into a home--I think the last couple of years, at 
least in my State of Colorado it has increased 10 percent, and 
you did not mention that. I am wondering what other factors 
that you, perhaps, did not mention that you would like to 
elaborate on, and I am particularly interested in the raw 
materials issue.
    Mr. Brown. And that is in terms, Mr. Chairman, of the 
difference between today's situation and previous booms?
    Senator Allard. Yes. You use the terms boom and bust and 
define those----
    Senator Bunning. Please bring your mic up just a little bit 
so that we can hear better.
    Senator Allard [continuing]. And you were talking about 
today's housing issues as compared to previous boom and bust 
periods.
    Mr. Brown. That is right.
    Well, Mr. Chairman, the historical cycles that we are 
looking at never replay themselves in exactly the same policy 
environment or the same economic environment. Clearly, the 
commodity price increases that you are speaking of are 
important in today's environment. And the structure of mortgage 
lending is another important factor. I would emphasize that 
with the big changes we have seen as mortgage lending 
technologies and instruments have evolved over time, you have a 
vastly different institutional environment today than you had 
in the booms in the 1970's and the 1980's.
    I do think that there are three reasons to believe that our 
experience going forward may be similar to what we have seen in 
previous booms. First is the consistency of the results that we 
have seen over time. Second is the behavioral rationale for the 
fact that prices are ``sticky downwards'' or they tend to go 
down slowly, with homeowners very reluctant to sell at 
disstressed prices. And the third reason is that these episodes 
of severe local economic distress, such as Houston in the mid-
1980's, have proven to be relatively rare and especially so 
since the rolling regional recession of the 1980's.
    Senator Allard. Mr. Seiders.
    Mr. Seiders. Yes, Mr. Chairman. That gives the opportunity 
to mention a few things.
    I consider the virtual explosion of house prices in both 
nominal and real terms in 2004 and 2005, even in 2003, to be 
primarily a demand-driven phenomenon. Having said that, one of 
the factors that exacerbated the upward price movements was, 
and still is, pretty serious supply constraints in a lot of the 
markets where we have seen the biggest price increases to date, 
meaning land use controls, difficulty for the builder to bring 
more supply on to meet the surge in demand.
    In terms of the costs of production, there is a long-run 
relationship between what I will call the replacement cost for 
housing and all house values, both new or existing. They sort 
of have to gravitate together over the long-term. We have seen 
large increases in the prices of the bundle of building 
materials that is used in homebuilding. There is a producer 
price index, subcomponent for that package of materials that's 
running at pretty rapid rates even at this time, for very 
different reasons for different parts of the commodities 
markets. But again, mainly a demand-driven phenomenon 
exacerbated by supply constraints in a bunch of places.
    If the cost increases should continue to run this high or 
even run higher, over the long-term we may see more upward 
pressure on house values than I have in the forecast.
    Senator Allard. Now, we have seen some dramatic increases 
in home prices and mortgage costs. In fact, thinking back on my 
investment, I think my home investment has probably been better 
than any stock market investment I have ever made. I was 
fortunate enough to be in a home at the time.
    How are credit and lending standards influencing these 
scenarios where we see increases in both home prices and 
mortgage costs outstripping income growth?
    Mr. Brown. Well, we certainly saw an intensification in the 
home price increases in 2004 and 2005. In 2005, we saw U.S. 
prices, on average, rise three times faster than disposable 
income. That is a disparity that we have not seen before. Also, 
the expansion in the scope of the boom was unprecedented. And 
certainly the prevalence of some of the non-traditional 
mortgages, the interest only and payment option loans, was 
greater in the boom markets than it was in other parts of the 
country.
    One of the rationales is that people have been using these 
instruments to qualify for homes in high-priced markets. It is 
a way for them to stretch what they can afford.
    Mr. Lawler. Certainly, the availability of mortgage credit 
has never been greater. Sub-prime lending, I think is part of 
that, as well, taking 20 percent of the market in the last 
couple of years, which is a big change from just a few years 
ago.
    Senator Allard. I did not realize it was 20 percent of the 
market. Significant.
    Any other panel comments? My time is expiring here.
    Mr. Stevens. I would just comment that the housing 
affordability, which is key, has shifted and started to turn. 
We were just under 70 percent of all Americans owning a home up 
until this turn in the housing market started a year, a year-
and-a-half ago.
    So, the two things that have affected that are the raise in 
rates and the appreciation and home values, the vast 
appreciation. So, the affordability index has turned.
    Senator Allard. Thank you, Mr. Chairman.
    Senator Bunning. Senator Reed.
    Senator Reed. Thank you, Mr. Chairman.
    Thank you, gentlemen, for your testimony.
    Most economic forecasts suggest as you have that there will 
be a decline, in terms of economic housing activity over the 
next year. Goldman Sachs economists are forecasting a housing 
slowdown, which would shave about 75 basis points off the 
overall growth in 2007. I think that is consistent with your 
comments.
    And they have also suggested the OFHEO price index would 
likely decline about 3 percent.
    So, Mr. Lawler, do you think it would decline by about 3 
percent, your price index?
    Mr. Lawler. That our index will decrease 3 percent----
    Senator Reed. Yes.
    Mr. Lawler [continuing]. Over the next year?
    We have not made any specific point forecasts. We are more 
concerned with what is the worst that can happen. Certainly 
something like that could happen. It is a matter of concern for 
us. We have never seen anything like that in the past, but we 
recognize there are aspects of the run up that we have seen in 
the last few years that are unprecedented.
    Senator Reed. So it is a possibility that you have not yet 
concluded, then?
    Mr. Stevens, in that vein, you talked about the regional 
characteristics of the housing market, prices appreciating and 
depreciating, but could you see a national decrease in housing 
prices on the order of 3 percent or less, but a national 
housing decrease in prices.
    Mr. Stevens. Well, I think, overall, you take all of the 
different pockets across the country and you are going to have 
an average amount. So, yes, you are probably going to see some 
kind of a percentage decrease. I think what is critical to 
whether we are talking bubble burst or not is the rate 
increases. I think that we are sitting right on a fence where 
the Fed has stopped raising rates. I do not think that could 
have come any later. We are hoping that it came in time, and it 
is our feeling, and our chief economist, David Lereah, who, 
unfortunately, could not be here, is that if those rates start 
to rise again that will dictate whether we slide off that fence 
into a challenging recession, bubble burst-type situation.
    Senator Reed. Thank you.
    Mr. Seiders, again, thank you for your testimony. You 
talked about, in the longer term, beyond 2007, of compensating 
economic factors that would make up for this slowing market you 
suggested, trade balance and non-residential structures. Would 
you care to comment on that?
    Mr. Seiders. Yes. This is a puzzle, obviously. This is one 
of these mid-cycle rotation processes that I am counting on. 
Actually it applies to 2006 and 2007, primarily, and maybe into 
2008. We do definitely expect, this year, all of it, and at 
least half of next year, for the housing production component 
of GDP to be in retreat, stabilizing, hopefully, around the 
middle of the year.
    I am counting on business spending on capital equipment and 
software, as well as non-residential structures to be in 
stronger growth phases than they had earlier. I am also 
expecting our trade balance to be improving. Now, I realize 
that we have recently gotten some troublesome numbers on both 
of those fronts. So, it is hard to be exactly sure it is going 
on out there. And that is, obviously, one of the downside risks 
that I would list to the forecast that I have.
    Senator Reed. So, if the compensating factors of the 
improved trade balance and business investment do not 
materialize, then this housing will pull down GDP even further?
    Mr. Seiders. There is no doubt about that. That would be a 
much more serious economic picture than I have penciled in or, 
I would say, the Blue Chip panel in general.
    Senator Reed. Let me ask a question, both to you, Mr. 
Seiders, and Mr. Brown, about foreclosures. Data that was 
released today has seen an increase in foreclosures, 
particularly in the hot markets like Nevada.
    How do you factor in foreclosures in terms of your views?
    Mr. Seiders. Well, I try to factor in, as I mentioned very 
briefly in my statement, the impact of payment shock on 
consumers that have these mortgages that are going to come home 
to roost. They are coming home to roost now and will later. 
There are not only strains on household budgets in store, but 
also prospective defaults on loans and so forth.
    In my forecast, I had that being a manageable factor. I do 
not expect that those default rates are going to move up all 
that much, but it is another very gray area. And the thing that 
really bothers me about this is, we can tell, roughly, how many 
loans were originated with payment-option features, with 
negative amortization or interest-only loans or things like 
that. What we cannot tell is how various features were layered 
on top of each other. You could have a payment-option mortgage 
allowing for negative amortization. You could have, on top of 
it, a piggyback second written who knows how. It could be a no-
documentation loan--so forth and so on.
    So, again, in my forecast, I have got minimal negative 
economic impacts from this phenomenon, but it is another area 
of substantial uncertainty.
    Senator Reed. Thank you, Mr. Chairman.
    Will we have a second round?
    Senator Bunning. I hope so.
    I am going to take my 5 minutes now.
    Mr. Lawler and Mr. Brown. Clearly interest rates play an 
important role in affordable housing. The lower the interest 
rate on mortgage, the more house a buyer can get for their 
monthly payment. I think it is clear that rate cuts by the Fed 
are what helped drive the housing boom.
    What role do you think lower interest rates enabled by the 
Fed rate cuts played in heating the housing market and driving 
up prices? And, specifically, do you think Fed rate cuts from 
2001 to 2003, especially the decision to leave rates at 1 
percent for a full year, are the most significant factor in 
driving up house or home prices?
    Mr. Lawler. I think they are the most significant factor 
during that period. Not only did they help lower long-term 
interest rates, but they increased the use of adjustable rate 
mortgages focusing on extremely low short-term interest rates 
and stimulated some of the investor psychology, which added on 
top of that. It also encouraged some of the increased use of 
other mortgage types, option ARMS, interest only loans, that 
really make investment especially easy.
    So, I think they were the most important contributor.
    Senator Bunning. Mr. Brown.
    Mr. Brown. Mr. Chairman, I would certainly agree that 
interest rates are a very important component to housing 
affordability. It is not just the short-term interest rates, 
which were at generational lows during the early part of this 
decade, but also long-term interest rates, which also were at 
generational lows, and still remain lower than what we have 
seen at similar parts of previous business cycles.
    This has been attributed in some quarters to heavy 
investment by the foreign sector of U.S. Treasury and mortgage 
instruments. That has helped keep long-term mortgage rates down 
and also has helped to boost housing activity from where it 
otherwise would have been.
    Senator Bunning. Now, this is the second part of the 
question I just asked the regulators, for Mr. Stevens and Mr. 
Seiders.
    Just as the Fed rate cuts helped drive the housing boom, 
the 17 straight rate increases from June 2004 to 2006 
contributed to the recent slowdown. However, home prices 
continued to climb and even accelerated while the Fed was 
increasing interest rates. That suggests that there is a lag 
between their action and their impact on the market.
    What impact have the Fed rates increases from 2004 to this 
year had on the housing market? And do you think that the full 
effect of those increases has been felt yet?
    Mr. Seiders. Well, first of all, the string of rate 
increases until early this year was basically getting back to 
or toward monetary neutrality. It had to be done.
    During most of that period, the long-term rates still 
remained stubbornly low, I think to the Fed's chagrin, at 
times, largely because of the international financial market 
picture. The Fed is now into the restrictive zone on monetary 
policy. There are definitely fairly long lags in the impacts of 
monetary policy on the interest-sensitive sectors, including 
housing.
    That is why we have been strenuously encouraging the Fed, 
since before the August 8th meeting, to please stop. We will 
see how this evolves going forward. In my forecast, my next 
change in Fed policy is rates moving downward, but that is not 
until toward the middle of next year.
    So, it is very important how the Fed manages monetary 
policy as we go forward. They know very well that they have a 
lot in the pipeline with a lot of lag to have to worry about.
    Senator Bunning. Mr. Stevens.
    Mr. Stevens. I echo what Mr. Seiders said and I am in 
agreement. It does have a direct effect.
    To answer the lag question, I truly do think, based on 
history and past economics, that we will see a continued 
decline in house values. We certainly have not bottomed out, 
yet. There is a lag there in the raising of the rates. That lag 
will follow, and prices will continue to decline.
    Senator Bunning. Last, do you think if the Fed resumes 
their increases, that they are going to go over the top and 
send our economy the other way rather than flattening out, 
sending it on a cycle down?
    Mr. Seiders. If I had to pencil into my forecast Fed 
tightening from here forward, I would have to definitely lower 
both the housing and the economic outlook.
    Mr. Stevens. And I already said the same thing.
    Senator Bunning. OK.
    Senator Carper.
    Senator Carper. Thanks very much. Going back to the reason 
there was such a spike in housing prices in, you said, 2003, 
2004, 2005, and a moderation today, was part of that driven--
you may have said this and I missed it--was part of that driven 
by a flight from equities, as people on the heels of Enron and 
other financial disasters we know a lot about in this Committee 
drove a lot of people out of equities? And they are looking for 
a place to put their money. They put it, in some cases, 
improvements in their own homes. In other cases, they put it in 
second homes.
    Mr. Lawler. I definitely think that that is a contributing 
factor. The performance of the stock market earlier in this 
decade was weak. And, as Boomers were reaching their prime 
earning and investing years, more turned toward housing, 
thinking about retirement homes and vacation homes as a way to 
combine two things at one time, investment and something to be 
used. And that fed on itself as the house increases made 
housing look like a really good investment in comparison.
    So, I think the psychology was favorable to housing for a 
while. And it has continued for quite some time. It is probably 
changing now.
    Mr. Seiders. If I might add on that, yields on fixed-income 
investments were obviously at very rock bottom, both short and 
long-term.
    Senator Carper. Mr. Stevens.
    Mr. Stevens. I echo both comments by the two gentlemen 
prior to me. I think there was a flight from the financial 
markets.
    And then, also, I think wealth accumulation. You had 40 
percent of the properties sold in 2005 were investment 
properties, second homes and investments, vacation homes. So, 
there was a lot of wealth accumulation and people saw the value 
and appreciation in real estate and moved to that market.
    Senator Carper. What are the implications for second homes, 
for vacation homes, going forward for the next year or two or 
three?
    Mr. Stevens. Well, I think that housing--I will jump in--
that market is still very strong and robust. There is still a 
lot of Baby Boomers looking to invest in that property. The 
challenge that I think you have today is the coastal areas 
where most of them, percentage-wise, want to be near water. You 
have got flood insurance challenges. They cannot get insurance.
    And, as I stated in my testimony, you cannot get a mortgage 
if you do not have insurance. So, they are looking to these 
sub-prime-type lending products and that starts another 
challenge in the marketplace.
    Senator Carper. All right.
    Mr. Seiders.
    Mr. Seiders. I am worried to some degree about the bona 
fide vacation, resort area issue, although it is worth 
remembering that the Baby Boom generation, which now is in its 
stage where they have a lot of the wealth of the country, are 
still going to want those kinds of units.
    What I worry most about, on the investment side, is that we 
know a lot of the investors were, in fact, speculators. They 
had no intention to be using the units even as vacation 
properties, or even as rental properties. My builder surveys 
are telling me that we are seeing a good number of sales 
contracts to those kinds of buyers canceled before closing. And 
now we are seeing some resales of units bought by investors for 
short-term speculative purposes being resold back on to the 
markets.
    I think, from a market perspective, that is one of the big 
risks that I have in the back of my mind.
    Senator Carper. OK. Thank you.
    Mr. Lawler. We are seeing in a number of areas in Florida, 
for example, huge increases in inventory sales ratios in 
vacation areas.
    Mr. Brown. I would emphasize that the long-term 
demographics appear to be quite positive. Again, with the 
maturing of the baby-boom generation and the desire for second 
homes, housing is coming to be viewed more as a luxury good, 
prompting more investment in such housing.
    In addition, many of these boom economies have boomed 
before. These are places where people want to be, that are 
adding jobs, and that have fairly vibrant economies.
    Senator Carper. Thank you all.
    My other question, and I would like to start with you, Mr. 
Stevens, and then just go to each of the other panelists if we 
could. We have grappled with the issue of GSE reform, trying to 
make sure our GSEs--Fannie Mae, Freddie Mac, the Home Loan 
Banks--have strong regulators. One of the few times in my 5, 6 
years on this Committee I have seen us actually break apart 
along partisan lines has been on this particular issue. The 
House has passed--they have come together overwhelmingly around 
a measure over there that I think most folks on our side can 
support. We are falling apart in two areas, and Senator Reed 
has done a lot of work on the affordable housing fund. My sense 
is that we could probably put something together there, but the 
bigger issue is the portfolio, restrictions on the portfolio 
and composition of the portfolios.
    If you could each just briefly share with us some comments, 
some guidance, some counsel on how we might bridge our 
differences with respect to particularly the portfolio issues 
on GSE reform, I would appreciate that.
    Mr. Stevens. Well, certainly the Association is in favor of 
oversight and--you know, regulatory oversight. I think the 
difference in the portfolio, I think it becomes restrictive. 
You know, our position has been that we do not think that 
should be there. There should be portfolio restriction, but it 
should be left up to the regulator. If you are going to put 
someone in charge with guidance and restrictive capabilities, 
then that should be left up to that regulator. It should not be 
an artificially imposed number.
    Senator Carper. Good.
    Mr. Seiders.
    Mr. Seiders. From my economist's point of view, my concern 
on the GSE front would be what the reform package could do to 
the spread between the home mortgage rate and, say, a 
comparable maturity Treasury like the 10-year Treasury yield. 
In my forecast, I have got that spread dead-steady about where 
it is right now, about 155, 160 basis points.
    I just would encourage the Congress to avoid doing anything 
that would disrupt the markets to the degree that the mortgage 
rate would move up out of alignment from Treasury yields, and 
it is possible that rather draconian limits on the GSE's 
portfolios, or even requiring some liquidation, could affect 
that spread. That is my key concern.
    Senator Carper. Good. Thank you, sir.
    Mr. Brown.
    Mr. Brown. I do not think we have anything to add on that.
    Senator Carper. Mr. Lawler, any comment?
    Mr. Lawler. Yes. OFHEO strongly supports legislation and 
hopes that a compromise will be achieved. We believe that the 
portfolios are larger than they need to be and that guidance 
from Congress would be very desirable. The Senate language in 
the Senate bill appears very restrictive in some areas and may 
not--it could be interpreted to restrict the ability of the 
enterprises to function in a crisis situation, for example, or 
to have all of the appropriate--to be able to invest in all of 
the kinds of affordable housing loans that are appropriate for 
their mission.
    Senator Carper. My thanks to each of you for those 
responses. Thank you.
    Thank you, Mr. Chairman.
    Senator Bunning. Senator Sarbanes.
    Senator Sarbanes. Well, thank you very much, Senator 
Bunning.
    I want to commend Senator Bunning and Senator Allard for 
joining the two subcommittees together in order to hold these 
hearings. I think it is a very constructive approach, and I 
know we will be doing a second hearing next week on some of 
these exotic mortgage products. I actually wanted to anticipate 
that a little bit.
    Mr. Brown, in his testimony--actually, in a footnote to his 
testimony--cites data saying that 43 percent of first-time 
homebuyers in 2005 obtained 100 percent financing. In other 
words, they had no down payment, almost half of all homebuyers. 
He cites as his source actually a National Association of 
Realtors profile of homebuyers and sellers.
    My first question is: Are these homes concentrated in areas 
where prices appreciated the most?
    Mr. Brown. I do not believe that we have that information, 
but I will say that the extent of 100 percent financing really 
speaks to the second mortgage situation. Typically, most first 
mortgages are still for 80 percent or 90 percent financing. But 
whereas a borrower would have had mortgage insurance before, 
now they may have a second mortgage that stands in place of the 
down payment.
    That is a change in mortgage practices that has helped to 
bring in new homebuyers. It is something that at the margin has 
helped to keep demand going during the latter stages of the 
housing boom.
    Senator Sarbanes. Well, if this is more concentrated in 
areas that are likely to experience house price decreases, what 
outcome would we then expect for these homeowners? Are we 
facing the potential of sort of a major crisis of defaults and 
foreclosures?
    Mr. Brown. Well, once again, I do not have specific 
information that it is more prevalent in those markets than in 
other markets around the country. Certainly incomes tend to be 
higher in some of the boom markets with more vibrant economies, 
so it is not clear at the outset that that is the case.
    However, the research that the FDIC did looking at the 
prevalence of large declines in home prices speaks to exactly 
the issue that you are bringing up: How likely is it that a 
large downward home price decline will wipe out a significant 
portion of equity or all of the equity for a substantial 
portion of homebuyers? That is a credit event with regard to 
lenders and certainly for FDIC-insured institutions, affecting 
not only mortgage portfolios but also construction portfolios. 
In the problems of the 1980's and early 1990's that the FDIC 
experienced, those sorts of busts certainly did have big credit 
problems associated with them.
    Senator Sarbanes. Does anyone else want to add to that?
    Mr. Stevens. The National Association of Realtors, we do 
not have those numbers where those first-time buyers 
specifically are buying. But, anecdotally, we have found that a 
lot of it is concentrated in those resort areas, which you have 
a big resort area in Maryland, Ocean City, et cetera. But that 
is basically it.
    Those products are phenomenal products to get first-time 
buyers into homes. The challenge is you have to make sure they 
are applied and administered properly. That is where you end up 
with your default rates raising and foreclosure rates.
    Senator Sarbanes. Right. Mr. Seiders.
    Mr. Seiders. Well, just to add, that in what had been the 
hottest markets, obviously the price appreciation was very, 
very rapid. It obviously depends on when the person got the 
loan. There might be a lot of equity already under their belt 
and they could absorb, or most of them absorb, at least a 
modest decline in house values before they would be thinking of 
default.
    We also know that there seems to be a fairly strong 
correlation between the prevalence of that kind of exotic 
financing structure and the prevalence of investor buying. I am 
thinking now of the kinds of investors that are not in it for 
the long haul but for the short haul, for price appreciation.
    If that is the case, I would expect those investors to be 
hanging on or getting out without serious damage to themselves 
as consumers. So we will see how it winds out. I mentioned 
earlier it is one of the downside risks to my forecast as to 
how this will all pan out.
    Senator Sarbanes. Yes. Of course, I have a concern, you 
know, we are not facing a modest decline. I know that OFHEO put 
out a release showing that the housing price index shows the 
largest deceleration in three decades. It is still going up, 
but just in the last quarter, hardly at all, as I understand 
it.
    I gather that some economists are predicting, actually, 
that there is going to be a decline in nominal house values. 
So, you know, we may be facing and approaching a crisis 
situation, and it underscores, to me at least, what I regard as 
the--well, I do not want to use the word ``fragility'' of the 
housing finance system, but it is a sensitive structure. It has 
worked very well. We have put a lot of people into 
homeownership. In many respects it is very complicated.
    You all are very much involved in making it work, but there 
are two things on the agenda that concern me greatly. One is 
this increase in interest rates, which Senator Bunning was 
referring to. I have been for some time now urging the Fed to 
stop this process, which they have now done, although they had 
some dissent on that within the Open Market Committee--at least 
one open dissent--actually, the head of my regional Fed Board, 
who continues to run around making speeches about this. But the 
impact of that can be quite severe.
    The other we touched on, as Senator Carper, on the question 
of GSEs. Actually, there is no difference within this Committee 
about setting up a strong regulator. Both proposals, both from 
the majority and the minority, had put significant powers into 
the regulator, comparable to what the bank regulators have. We 
differed--well, there is not an affordable housing provision 
there, and that is a concern, and then the portfolio 
restrictions.
    We have heard from the low-income tax credit people, the 
mortgage revenue bond people, the multifamily housing people, 
all of whom try to provide affordable housing, that those 
portfolio restrictions would, in effect, put them out of 
business. They are fearful that that would be the case. And, 
you know, I am happy to give the regulators safety and 
soundness authorities over the portfolio, but I am quite 
concerned about going beyond that because I think it could 
upset this financing mechanism that we have established. So I 
think we need to be extremely careful about that.
    I wanted to just close--I see my time has expired--by 
asking Mr. Seiders for the homebuilders and Mr. Stevens for the 
realtors: Do you feel that your voice is heard at the Fed on 
some of these complicated issues, that you have a reasonable 
opportunity to present your concerns and to have them listened 
to? And how does that take place? And what could be done to 
strengthen it? And then, more broadly, I would say to all that 
the Managing Director for Real Estate Finance at Moody's say, 
and I quote him, ``The soft landing is sort of like the white 
whale--much rumored, rarely seen.'' And I am sort of interested 
in what the members of the panel see in terms of the 
possibilities of achieving a soft landing. If you could address 
those two very quickly, I would appreciate it.
    Thank you, Mr. Chairman.
    Mr. Seiders. On the second question first, in terms of the 
soft landing possibilities, I think there are some precedents 
in history for a housing setback that did not go really deep. 
The one that comes immediately to mind is the 1994-1995 period. 
The Fed was tightening aggressively during 1994, into early 
2005. Housing really did start to lose ground rapidly. In fact, 
Chairman Greenspan came and spoke to our board of directors 
that January, kind of into the lion's den, but the Fed then 
subsequently eased off later in 1995. The whole thing, after a 
downshift went ahead fine.
    It is a different environment this time in terms of what 
has caused this boom-bust and so forth, and my forecast does 
have--I guess you would call it a relatively soft landing, 
although I've got housing starts down about 11 percent in both 
2006 and then again in 2007. So it is a real downslide for 
sure. If you want to call that soft, that is in the eye of the 
beholder. To me it is a bit alarming.
    In terms of our communication with the Federal Reserve, I 
think it has been good over the years. We routinely have 
meetings with the Fed Chairman or maybe even other members of 
the Federal Reserve Board. Sometimes our own officers will take 
in the CEO's of the very big building companies. We also take 
in CEOs from the big suppliers to our industry that come and 
supply the materials and so forth.
    We actually have, since some time back with Chairman 
Greenspan, done some special surveying of builders that we 
share with the Fed, and we share all of our ongoing survey 
information with them, even if it is confidential for other 
reasons. And Chairman Bernanke seems very, very receptive to 
receiving our information and discussing it with us. We had a 
meeting with Chairman Bernanke about 10 days ago, I guess, 
within the last 2 weeks, and we expect to be able to do that 
periodically.
    Senator Sarbanes. Do you talk to the members of the Open 
Market Committee? They meet as a committee and they vote, you 
know. Do you have a chance to make these presentations to the 
broader membership?
    Mr. Seiders. The last meeting that we had with the Federal 
Reserve, there were five Federal Reserve Board Governors 
present. That is a fairly good sized piece of the FOMC.
    There is some contact with some of the Federal Reserve Bank 
presidents who are on the FOMC about what is happening in the 
housing sector. That I think could definitely be strengthened.
    Senator Sarbanes. Yes.
    Mr. Stevens, do you want to add to that?
    Mr. Stevens. Very similar. We have pretty much been granted 
an open door. We have a meeting with the Fed Chair and the 
presidents twice a year.
    Senator Sarbanes. The presidents of the regional banks?
    Mr. Stevens. Yes. And the Fed Chair has--we send our 
reports and our studies to him on a regular basis for their 
analysis and use as they see fit. So we feel like there has 
been an open-door policy. And we would have liked them to have 
listened a little sooner on the increase in the rates. As I 
said earlier, we think it is real temperamental right now. You 
know, our chief economist's studies show that if they were to 
raise rates another half percent, you know, all appreciation 
disappears. It stops. If we go another percent, then we are in 
about a 2.5 to 3 percent reverse in appreciation. House values 
decline.
    So we are still sitting there on the fence to see if it was 
stopped in time or not. I think by the end of the year will 
tell.
    Senator Sarbanes. Thank you, Mr. Chairman. Can I just close 
with this observation? You know, these members of the Open 
Market Committee, they all have a vote, each one of them, and 
it seems to me that--I appreciate your suggestion that you 
should maybe deal with them directly and not necessarily put 
the Chairman of the Fed in the position of having to transmit 
it through and be the persuading agent instead of them hearing 
very directly from those that are actually in the field and 
having the experience as to what the problems are.
    Mr. Lawler. I wonder if I could respond briefly to the 
Senator's second----
    Senator Bunning. Well, he has gone, let us see, about 10 
minutes over, so I am going to cut him off. And I just want to 
say that Chairman Bernanke has made it very clear that he would 
like to diffuse the influence of the Fed Chair and have the 
regional bank presidents have more to say about Fed policy.
    Now, that is what he said. Let's see what he does.
    Senator Sarbanes. Well, if that happens, even more under--
--
    Senator Bunning. Even more.
    Senator Sarbanes [continuing]. What we were just 
discussing.
    Senator Bunning. All right. Senator Allard.
    Senator Allard. Thank you, Chairman Bunning.
    I want to explore a little bit these local markets. You 
know, I think a couple of you mentioned the impact of local 
markets, and it is difficult to look at it from a national 
perspective when you look at housing bust and boom cycles, as 
Mr. Brown referred to, because so many times it depends on, if 
you have a one-company town, how well that company is doing, or 
maybe there are other factors in there that are driving these 
local markets.
    I think Alan Greenspan in some testimony we had before the 
Committee at one time, you know, because of local markets 
bubbling up and down, he called it a ``froth'' nationwide. And 
his kind of approach was that it had more local significance 
sometimes than it does national significance.
    The Wall Street Journal in 2005 tried to kind of 
nationalize the argument a little bit by saying that 22 of the 
metro areas with the fastest-growing price growth had more than 
35 percent of the Nation's housing wealth. I guess the thought 
that came to my mind--and I would like to hear a comment on 
this, and I do not know as I have seen studies of this, but I 
suspect that probably family income in urban areas rose much 
faster in urban areas than it did in rural areas also.
    But I guess the fundamental question here is: Do these 
possible local issues actually have some national implications? 
I will open that up for discussion from the entire panel.
    Mr. Brown. Senator, let me start on that. Yes, certainly, 
the scope of the housing boom with 89 markets, including some 
very big markets such as San Francisco, Los Angeles, 
Washington, D.C., and New York, containing a large proportion 
of the value of U.S. real estate, leads to some concerns about 
what happens if they slow at nearly the same time and what 
effect is that going to have on construction and household 
wealth. So I do think that the scope does cause some concerns. 
It is unprecedented. It is one of the wild cards in this 
situation compared to our previous experience.
    Senator Allard. Any other comments on that?
    Mr. Seiders. I certainly agree with your premise. We talk 
about housing markets being localized largely because you 
cannot move inventory around, you know, either in or out. But 
people can move in and out, and, you know, very bad economic or 
housing market conditions in major metro areas do have their 
way of making their way around a bit. And if you do add up the 
areas that were clearly overheated, at least in price terms, 
you have got a big chunk of the national market.
    Mr. Lawler. I think that while it is true that there have 
been very different rates of growth in different parts of the 
country, the changes in growth rates have been somewhat across 
the board. Recently, the deceleration that we have seen has 
occurred everywhere. The biggest drops in growth rates have 
been in the areas that have been growing the fastest, but areas 
with actual decreases that we saw in the second quarter were 
areas that had been growing very slowly, prices had been 
increasing very slowly before, and where the economies are not 
as strong as some other areas.
    Senator Allard. OK. Let me pursue the cost of owning homes 
compared to renting a home nationwide. How does this compare on 
a nationwide basis, particularly in those markets experiencing 
the most significant housing price increases? And, also, maybe 
comment a little bit on how this compares to historical trends.
    Mr. Lawler. Well, we have seen prices greatly outpace rent 
growth over the past 5 years, and that has started to change, 
especially in the condo areas. The rapid growth of prices for 
single-family houses resulted in a lot of switches from rental 
units to condos, brought on a lot of new supply, to the point 
where those markets have looked suddenly among the very 
weakest. But taking those out of the rental markets stimulates 
rent a little bit, and these things tend to equalize over time.
    Mr. Seiders. The tremendous surge in buying activity drove 
the Nation's homeownership rate and the rental vacancy rate to 
record highs at the same time in the early part of 2004. And 
the cost of owning in terms of monthly payment compared to rent 
was climbing dramatically during that period.
    One reason it could continue with momentum on the home-
buying side was that, in terms of what people consider the cost 
of owning a home to be, it includes expected price 
appreciation, and all the price appreciation going on fostered 
expectations of further price appreciation. So it felt like a 
really good deal, even cost of living-wise in a sense, to be 
buying rather than renting.
    We have really seen that swing now, and in the multifamily 
housing sector, there now is a rather significant downslide in 
the condo component. You know, that is going down. There is now 
upward pressure on rents and renewed interest in building for 
the rental market. Actually, in my forecast I have the 
production of rental housing moving up to some degree later 
this year and in 2007 as the homeownership side comes down, 
including the condo component.
    Senator Allard. Interesting.
    Thank you, Mr. Chairman.
    Senator Bunning. Senator Reed.
    Senator Reed. Thank you, Mr. Chairman.
    Mr. Brown, following up the line of questioning I concluded 
with Mr. Seiders, the suggestion I think that Mr. Seiders had 
is that it is hard to sometimes realize what types of mortgage 
instrument a borrower has out there. It could be a no-interest 
loan. It could be--you know, I do not even understand all the 
different products out there.
    But, going to the FDIC, do you have a notion of how many 
people are having these exotic loans? And are there multiple 
exotic loans? And do you feel confident that you understand 
actually the situation? I do not say that, you know, 
critically, just factually. Do you have a sense you understand 
what is going on?
    Mr. Brown. Yes, our analysts make use of state-of-the-art 
data from companies like Loan Performance and obviously from 
the Mortgage Bankers Association and other good sources. Some 
of the studies that these groups have put together, for 
example, one study by First American Mortgage Solutions, which 
is now affiliated with Loan Performance, estimates that about 
22 percent of all outstanding U.S. mortgages are adjustable 
rate mortgages that were made in 2004 and 2005.
    If you couple that with the estimates made using the Loan 
Performance database by both Loan Performance and by our 
analysts, perhaps 40 to 50 percent of those adjustable rate 
loans during 2004 and 2005 were the interest-only and payment 
option variety. So you are really talking in the neighborhood 
of 10 percent of the U.S. mortgage book. Of that 10 percent, 
then, some are taken out by high-net-worth individuals that 
have irregular incomes and want to use it for wealth 
management. Perhaps other households avail themselves of those 
loans as affordability products to try to afford high-priced 
homes in some of these boom markets.
    This gives us an order of magnitude in terms of the scope 
of those markets. Yes, they have really proliferated in recent 
years. That is a new thing. And it is uncertain as to how they 
will perform as interest rates rise and as the low introductory 
rates expire. But I think we have an overall viewpoint as to 
the order of magnitude of those loans.
    Senator Reed. So your sense is that this potential for 
significant foreclosures because of these types of lending 
arrangements is not decisive?
    Mr. Brown. Well, here is the situation. I think that we 
certainly could see some increases in credit problems among 
those borrowers who use those affordability products and who, 
when the introductory rates expire, will have problems repaying 
those loans. I think you are going to see credit distress among 
those households. There is no question.
    At the same time, we have to recognize that those loans 
have been largely securitized in private asset-backed 
securities and sold to investors around the world. I think the 
consensus of mortgage professionals and economists is that 
those risks have been spread around in a fairly efficient 
manner. But certainly I think the impact on those individuals 
who are caught in that situation, if they really cannot afford 
the payments as they go up, will be serious.
    Senator Reed. Absolutely.
    Mr. Lawler, you might want to comment now. You had a 
comment previously for Senator Sarbanes. But you might also 
touch upon this issue of the data that you are seeing, does it 
give you confidence that you have a reasonable grasp of what 
the situation would be with particularly these exotic products?
    Mr. Lawler. OK. I wanted to say, with respect to the effect 
of legislation on the markets, that it is important to keep in 
mind that only about 30 percent of the assets in the 
enterprises' retained portfolios help meet their affordable 
housing goals. Those are important assets, and I think what is 
key in legislation is for Congress to give some direction to 
the regulator about what assets really are the most important 
for the enterprises to hold and what are of less importance, 
what can reasonably be cut back and what might have damaging 
consequences for affordable housing if it were cut back, so the 
regulator would have some guidance in that area.
    On these exotic loans, I think one of the concerns is that 
a lot of the loans were made to people who can afford the 
higher rates. They were underwritten appropriately and the 
borrowers can afford them, in many cases as investors who found 
this a very convenient and inexpensive way to maximize the 
leverage that they were getting on new properties.
    But the risk there is that when rates that they are 
actually having to pay go up monthly and start to exceed the 
income that is coming in, if they are renting them out, they 
may be reluctant to hold onto them and may be more willing to 
try and sell them, which could put downward pressure on prices.
    Senator Reed. Any other comments? Mr. Stevens, please.
    Mr. Stevens. Just in the package that I submitted for the 
record, there are some charts in there showing the markets that 
carry higher risk due to the adjustable rate mortgages and 
things.
    Senator Reed. Thank you very much.
    Mr. Seiders. Maybe one final comment. One of the things 
that I am counting on with a lot of these strange mortgages 
coming home to roost in terms of big payment adjustments is the 
ability of the homeowner to refinance into something else. And 
my understanding is that most of these do not have hefty 
prepayment penalties in them. Some of the people in the 
mortgage finance industry are looking for a mini-refi boom as a 
lot of these mortgages approach their first payment reset. Some 
of that is already happening.
    Senator Reed. Thank you.
    Thank you, Mr. Chairman.
    Senator Bunning. A couple more. This question is for anyone 
who would like to--it is a toss-up. Do you think that price 
increases and sales volumes in the last 3 years were driven by 
normal market conditions? Or was it something unsustainable? 
Was there an unsustainable factor in the housing boom?
    Mr. Brown. I would like to start with that. I do believe 
that booms historically are situations where prices do get out 
ahead of the fundamentals. To that extent, the booms have never 
proven to last forever, and by definition, they are 
unsustainable.
    What really matters, I think, is the aftermath. In two-
thirds of the cases, after we have seen these booms, the prices 
fell in at least 1 year of the next 5. We only found, however, 
nine cases where they fell as far as 15 percent over the next 5 
years. So I think this period of stagnation, which can be 
fairly painful for homeowners and homebuilders, is the most 
common outcome. And if that is the definition of unsustainable, 
yes, I think booms are inherently unsustainable.
    Mr. Lawler. I agree that there are some unsustainable 
features. One of them clearly were the rates of increase in 
prices that were far outstripping growth in incomes. That could 
not be maintained indefinitely.
    And in the past, at least on an inflation-adjusted basis, 
we have seen cycles in many, many cities across the country, 
and also even in the national data. As real changes in demand 
occur, it is difficult for supply to keep pace, especially in 
some areas with more supply restrictions than others, more 
congestion, or more restrictions on zoning, for example. And so 
that can create cyclical behavior, and we have seen it on an 
inflation-adjusted basis for the country as a whole several 
times now.
    Senator Bunning. This question would be for Mr. Brown and 
Mr. Lawler. What, if any, impact has the housing boom had on 
consumer spending? In particular, is there reliable evidence 
that consumers have tapped wealth from home value increases to 
spend on home improvements, durable goods, or other things?
    Mr. Lawler. Well, I think definitely we are seeing 
substantial volumes of refinancing over the past year--even as 
interest rates have increased by a full percentage point--long-
term interest rates over a full percentage points over the last 
year, and short-term rates more than that.
    The main reason for this refinancing is to take cash out. 
We have seen some increases in spending on renovations, but 
most of it is going elsewhere, either to pay off debt or to buy 
consumption items.
    Mr. Brown. Adding cash-out refinancings and the increase in 
home equity lines of credit outstanding, totals approximately 
$450 billion in 2005. That is around 4 percent of disposable 
income. That is a pretty big number in terms of spendable cash.
    Now, some of that money is going back into homes. It is not 
purely consumption outside the home. And, again, this is in 
many cases part of an overall wealth management strategy by 
households that may have other assets offsetting their mortgage 
debt. The extent to which households decide to do extra 
spending based on the fact that they can borrow against their 
home, is not necessarily shown by the volume of cash-out 
refinancing and home equity lines.
    Mr. Seiders. Chairman Bunning, I was going to say on that, 
there is little doubt that, the housing wealth effect had a 
strong impact supporting consumer spending in the last couple 
of years. It really is a factor that has allowed the personal 
saving rate to go negative, for as long as it has.
    Also, in my view, it is really the housing wealth effect 
that matters the most, not how it is, in a sense, accessed. It 
does not have to be accessed through mortgage borrowing. You 
can spend all of your income. You can use financial assets. You 
can use other kinds of borrowing and so forth.
    So it is one of these big things in the economy that is 
definitely in the process of weakening in terms of support to 
the consumer sector.
    Senator Bunning. Well, if you all have good memories, 
Chairman Greenspan popped the bubble in 2001 and 2002 on the 
tech rally, and he always complained about the wealth 
component, and he took care of that in about a year and a half. 
[Laughter.]
    Senator Bunning. So I hope that is not the case for the 
housing situation.
    We are going to leave the record open for 10 days so anyone 
on the Subcommittee can submit a question, if they would like, 
to anyone here on the panel.
    I want to thank everyone for attending the joint hearing of 
the Housing and Transportation Subcommittee and the Economic 
Policy Subcommittee, and the hearing is adjourned. Thank you.
    [Whereupon, at 11:37 a.m., the hearing was adjourned.]
    [Prepared statements and additional material supplied for 
the record follow:]
                  PREPARED STATEMENT OF PATRICK LAWLER
    Chief Economist, Office of Federal Housing Enterprise Oversight
                           September 13, 2006
    I am pleased to be here, where I worked as a Committee staff member 
some years ago, to testify on housing market developments and 
prospects. The Office of Federal Housing Enterprise Oversight, OFHEO, 
has a strong interest in housing markets and particularly in house 
prices because they have a powerful effect on the credit quality of 
mortgage loans owned or guaranteed by Fannie Mae and Freddie Mac, the 
Enterprises we regulate.
    Over the past five years, we have witnessed an extraordinary change 
in the relative price of houses. The general level of house prices 
soared 56 percent from the spring of 2001 to the spring of 2006. The 
prices of other goods and services rose much less, so that inflation-
adjusted house prices are now 38 percent higher than 5 years ago. That 
exceeds the inflation-adjusted increase in the previous 26 years, going 
back to the beginning of OFHEO's data.
    A number of factors have contributed to these price gains. Long-
term mortgage interest rates fell from about 8 percent in mid-2000 to 
generally less than 6 percent in the period from early 2003 to mid-
2005. Short-term rates declined by more, and borrowers took advantage, 
as more of them took out adjustable-rate loans. Interest-only and 
negative amortization loans provided even lower monthly payments. The 
spread of these products helped stimulate demand, as did the rapid 
growth of subprime lending. In 2001, less than 10 percent of new 
mortgage securities were backed by subprime loans. In each of the past 
two years, subprime lending has amounted to more than 20 percent of 
that market.
    Demographics have also been favorable. Aging boomers are reaching 
their peak earning and investing years, with many interested in second 
homes for vacations or future retirement, and immigration has 
accelerated household formation. Supply constraints have made it 
difficult to meet the increased demand. Land use restrictions, 
environmental and economic impact studies, natural barriers, and 
existing high densities in some areas have lengthened the time 
necessary for builders to bring new houses on the market and raised the 
premiums paid for prime house locations.
    Finally, there is some evidence of speculation, as the share of 
loans made to investors has risen and turnover rates have been high, 
with anecdotes of property flipping becoming common. Certainly, the 
poor performance of the stock market early in this decade made an 
obvious contrast with the investment performance of houses, and that 
may have encouraged some to shift their investment focus.
    House price increases have been uneven across the nation, though. 
While homeowners in Indiana, Ohio, and Michigan have seen their house 
values over the past 5 years hardly budge in constant dollars, 
residents of Florida, California, and here in the District of Columbia 
have watched prices virtually double, even after adjusting for 
inflation. The coastal areas have generally had more vibrant economies, 
more in-migration, and more supply constraints.
    Over the past year, the pace of house price inflation over most of 
the country has moderated dramatically. The sharpest decelerations have 
come in some of the most superheated markets of a year ago, including 
Arizona, Nevada, California, and Hawaii in the West and DC, Delaware, 
Maryland, and Virginia in this area. Nationally, prices rose roughly 
1.2 percent in the second quarter of this year, a rate that only 
slightly exceeds the inflation rate for other goods and services in the 
economy. For comparison, the appreciation rate in the second quarter of 
last year was approximately 3.6 percent.
    Housing markets in New England and the Midwest are showing some of 
the most significant regional weakness. The relatively anemic New 
England market has been cooling for the last two years. While 
Massachusetts, New Hampshire, and Maine saw some of the largest gains 
in the nation in the late 1990s and early 2000s, rates of price 
increase have dropped sharply since. Our latest data suggest that 
prices in those states were virtually unchanged in the second quarter 
of this year.
    Although appreciation rates in the Midwest were only slightly above 
baseline inflation levels throughout the latest boom, the rates have 
declined somewhat. Price performance in Indiana, Ohio, and Michigan, in 
particular, appears weak. Appreciation over the last year was less than 
three percent in all three states, and, in the latest quarter, prices 
actually declined.
    We are seeing continued price strength in select areas of the 
country. The areas affected by Hurricane Katrina, for example, have 
shown strong increases, presumably a result of the loss of housing 
stock. Prices in Louisiana, for example, rose nearly 12.5 percent 
between the second quarter of 2005 and the second quarter of 2006. 
Price appreciation in the second quarter of this year was more than 
double the national rate in that state. Over the past year, gains in 
several Katrina-affected cities, including Gulfport-Biloxi and Mobile, 
were between 15 and 18 percent, the largest one-year increases we have 
ever recorded for these cities.
    Select areas in Texas, as well as parts of the Pacific Northwest, 
also seem to have fared relatively well. At more than 3.6 percent, 
quarterly appreciation rates in Oregon, Idaho, and Washington state 
were more than three times the national average. Appreciation in oil-
rich Texas areas like Odessa and Midland also appears to have been 
strong.
    Other market indicators confirm the general chilling of housing 
markets across the nation. Particularly noteworthy is the swelling 
inventory of unsold houses on the market, which has risen to 4.5 
million from levels generally below 3 million in 2003 and 2004. As 
sales rates have fallen at the same time, inventories are now more than 
7 times monthly sales, the highest since the early 1990s.
    Historical patterns of price behavior in housing markets may 
provide some guidance about potential future developments. OFHEO's 
national House Price Index has never fallen over a period of a year or 
more, but it has come very close, and inflation-adjusted prices have 
fallen significantly, by 11 percent in the early 1980s and by 9 percent 
in the early 1990s. In the first instance, it took nearly 8 years for 
inflation-adjusted prices to regain the past peak and in the second 
case, almost 10 years. Certainly, a similar event is quite possible 
now.
    Cycles in inflation-adjusted home prices have occurred in a much 
more pronounced way in some cities, such as Boston and Los Angeles. The 
cycles stem from the effects of local business cycles, the delays in 
the response of supply to increased prices, and to some extent from 
speculation. Over much of the country, fundamental factors have pushed 
up demand and accounted for at least a large portion of the price 
increases in recent years. However, increasing supply, higher interest 
rates, and a turn in investor-market psychology may cause prices in 
some markets to fall. In the past, significant nominal price declines 
generally have been associated with local or regional economic 
recession, but the exceptional size of some of the recent increases 
could make them vulnerable without a recession, especially if interest 
rates continue to rise.
    In the long run, I expect housing markets to perform well, 
especially if immigration continues at recent rates. An important 
caveat, though, is that healthy housing markets could soften seriously 
from an unexpected disruption in the ability of Fannie Mae and Freddie 
Mac to function effectively in secondary mortgage markets. OFHEO is 
currently focused on correcting the significant accounting, internal 
control, management, and corporate governance weaknesses identified at 
both companies through OFHEO examinations. While both companies have 
made progress, much more needs to be done. It is apparent that in order 
to ensure the long-run safety of these two GSEs, the regulatory 
framework must also be strengthened. OFHEO supports the enactment this 
year of legislation, currently before the full Committee, that will 
create a new regulator with adequate funding, bank-like regulatory and 
enforcement authorities and encompassing not only safety and soundness, 
but also mission regulation.
Research and OFHEO's House Price Index
    I now would like to talk briefly about some of OFHEO's research 
activities related to measuring home price trends. OFHEO's work has 
been focused on our House Price Index (HPI), which we publish 
quarterly. We estimate quarterly price changes for single-family houses 
at the national level and for census divisions, states, and 
metropolitan statistical areas. We use data obtained from Fannie Mae 
and Freddie Mac on values of houses in repeat mortgage transactions.
    OFHEO is working hard to ensure that our house price index remains 
an accurate and reliable indicator for both internal and external use. 
Precise measurement of historical price movements is extremely 
important in measuring the credit exposure at Fannie Mae and Freddie 
Mac, a critical part of OFHEO's regulatory duty. It is also important 
because mismeasurement may obscure indications of any accelerations or 
reversals in the housing cycle. Such information is valuable not just 
to OFHEO, but also to the other disparate entities and individuals that 
use our data. Government and private policy analysts, risk modelers at 
Wall Street firms, and even individual homeowners interested in 
tracking their home values all employ our data. Our historical index 
data, as well as related market commentary, are all available on 
OFHEO's website.
    Accurately measuring house price movements is quite challenging. 
One of the fundamental difficulties stems from the fact that houses do 
not sell frequently. At best, sporadic measurements of home values are 
usually available. Also, homes obviously differ substantially in their 
size and quality. This heterogeneity means that the average sales price 
of properties reflects not only trends in house prices, but also 
changes in the mix of houses transacting.
    A final challenge is that home valuation measures are not always 
perfect indicators of true home values. For example, much of OFHEO's 
home value information is derived from appraisals produced in the home 
refinancing process. Such appraisals, for a variety of reasons, may not 
always accurately reflect true home values.
    OFHEO in fact is actively researching the issue of appraisal bias. 
The underlying research question to be addressed is: ``How can 
appraisal bias be stripped from the OFHEO index without having to 
remove all appraisal data from OFHEO's calculations?'' Although home 
price appraisals may systematically differ from purchase price 
information, their inclusion can provide valuable information about 
price trends, particularly for small cities where the availability of 
price data is at a premium. More fundamentally, to the extent that 
refinanced homes may have different attributes than other homes, the 
inclusion of refinance-related appraisals provides our models with a 
potentially broader sampling of appreciation patterns.
    Preliminary research suggests that a refined methodology that aims 
to remove appraisal bias from the HPI may reflect long-run historical 
price patterns that are quite similar to what has been observed in the 
usual HPI. Despite the similarity, however, OFHEO may pursue such a 
refinement because changes in the mix of refinance and purchase 
valuations can affect measured short-term price change patterns.
    Another issue of broad research and policy significance is the 
effect of home improvements on measured price trends. Some observers 
have wondered whether a significant share of the dramatic appreciation 
reflected in the OFHEO HPI has been caused by home remodeling activity 
as opposed to fundamental price increases. The concern has been 
motivated in part by a divergence between appreciation shown in the 
OFHEO index and house price growth reflected in a ``constant-quality'' 
index produced by the Census Bureau.
    Although the OFHEO index is generically classified as a constant-
quality index, some recent appreciation may indeed reflect net quality 
improvements in the housing stock. Outside research coupled with as-yet 
unpublished internal OFHEO work nevertheless suggests that, even under 
generous assumptions concerning the impact of remodeling on home 
valuations, a relatively modest amount of appreciation is accounted for 
by what might be described as ``quality drift.'' In short, the recent 
price run-ups are not mere illusions caused by the fact that Americans 
are buying bigger and better homes.
    While OFHEO does not publish home price forecasts, it maintains a 
strong interest in available information concerning future 
expectations. One potentially useful development in this area is the 
introduction of real estate futures exchanges. Such exchanges, at least 
in theory, may one day provide a meaningful summary of the market's 
best guess for the future price trends. Unfortunately, trading volumes 
on these nascent futures exchanges are relatively low. Thus, although 
some futures markets currently point to small home price declines 
through the Spring of 2007, the implied price trajectories may not 
reliably reflect aggregate expectations concerning future prices.
Conclusion
    Although the future direction of home prices is the subject of 
great speculation, there is little doubt that several factors may 
constrain appreciation rates in the near future. First and most 
fundamentally, home prices are at historically high levels and have 
already started to stretch past many traditional affordability 
boundaries. Home affordability is at very low levels in places like 
California and the New England states, for example. Barring very 
significant increases in average incomes or interest rate declines, 
these price levels will weigh heavily against major price increases in 
the near term.
    The second constraint on appreciation rates is rising housing 
inventories. The number of homes available for sale has increased 
substantially over the last year, giving homebuyers much more 
bargaining power than they have had in recent periods. Such bargaining 
power can lead sellers to reduce prices.
    The third and final factor involves market psychology. Although it 
has been difficult to accurately quantify the effect of speculative 
activity on recent appreciation patterns, anecdotal evidence suggests 
that its effect may have been material in select markets in California, 
Nevada, Arizona, and other states. To the extent that the recent 
slowdown in appreciation rates may sour some potential investors on 
real estate investments, home demand may decline somewhat.
    Despite the presence of various factors that may act to constrain 
price appreciation in the near term, I would like to stress that 
housing markets and price appreciation are affected by some very basic 
economic and demographic patterns. For example, migration patterns 
(both domestic and international) affect the demand for housing and 
thus influence price movements. Also, the extent to which retiring baby 
boomers opt to increase or decrease their demand for second homes may 
also play a role in determining the direction of prices in the future. 
Finally, the cost of constructing new homes clearly can play a role in 
affecting supply and thus home prices. As is the case in other markets, 
the future trajectory of prices will be determined through a netting 
out of these factors, in addition to the short-term demand and supply 
determinants that have already been discussed. Thank you, and I'd be 
happy to answer any questions.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                     House Price Appreciation Slows

  ofheo house price index shows largest deceleration in three decades
    Washington, D.C.--U.S. home prices continued to rise in the second 
quarter of this year but the rate of increase fell sharply. Home prices 
were 10.06 percent higher in the second quarter of 2006 than they were 
one year earlier. Appreciation for the most recent quarter was 1.17 
percent, or an annualized rate of 4.68 percent. The quarterly rate 
reflects a sharp decline of more than one percentage point from the 
previous quarter and is the lowest rate of appreciation since the 
fourth quarter of 1999. The decline in the quarterly rate over the past 
year is the sharpest since the beginning of OFHEO's House Price Index 
(HPI) in 1975. The figures were released today by OFHEO Director James 
B. Lockhart, as part of the HPI, a quarterly report analyzing housing 
price appreciation trends.
    ``These data are a strong indication that the housing market is 
cooling in a very significant way,'' said Lockhart. ``Indeed, the 
deceleration appears in almost every region of the country.''
    Possible causes of the decrease in appreciation rates include 
higher interest rates, a drop in speculative activity, and rising 
inventories of homes. ``The very high appreciation rates we've seen in 
recent years spurred increased construction,'' said OFHEO Chief 
Economist Patrick Lawler. ``That coupled with slower sales has led to 
higher inventories and these inventories will continue to constrain 
future appreciation rates,'' Lawler said.
    House prices grew faster over the past year than did prices of non-
housing goods and services reflected in the Consumer Price Index. While 
house prices rose 10.06 percent, prices of other goods and services 
rose only 4.41 percent. The pace of house price appreciation in the 
most recent quarter more closely resembles the non-housing inflation 
rate.
    Significant findings in the HPI:

          1.  All states show four-quarter appreciation, but five 
        Midwestern and New England states had small price decreases in 
        the second quarter.
          2.  Price appreciation remains relatively robust in the two 
        states hardest hit by Hurricane Katrina one year ago--Louisiana 
        and Mississippi. Four-quarter appreciation rates were well 
        above the national average in several cities in the area 
        including: New Orleans-Metairie-Kenner, Gulfport-Biloxi, Baton 
        Rouge, and Pascagoula. Gulfport-Biloxi and Pascagoula in fact 
        logged their highest appreciation rates since the beginning of 
        OFHEO's Index.
          3.  The South Atlantic Census Division including Florida, 
        Delaware, the District of Columbia, Virginia and Maryland 
        experienced its most significant price deceleration since at 
        least the early 1980s. Its four-quarter appreciation rate fell 
        from 17.43 percent to 13.74 percent.
          4.  New England's four-quarter appreciation rate fell from 
        8.71 percent to 5.68 percent. While appreciation rates in 
        Massachusetts were consistently amid the 10 highest between 
        mid-1997 and mid-2003, its four-quarter appreciation rate now 
        ranks 48th among the states and the District of Columbia.
          5.  Despite a nine percentage point decline in its four-
        quarter appreciation rate, Arizona's housing market still 
        exhibits the highest appreciation rate among the 50 states. 
        Prices were up roughly 24 percent compared to the second 
        quarter of 2005 but grew only 2.94 percent in the most recent 
        quarter.
          6.  While the 20 Metropolitan Statistical Areas (MSAs) with 
        the highest appreciation included nine cities in Florida, the 
        representation of other states continues to increase. MSAs in 
        North Carolina, South Carolina, and Washington State have now 
        entered the list of fastest appreciating markets.
          7.  Michigan had the greatest numbers of price decreases 
        among ranked MSAs. Thirteen of Michigan's 16 ranked 
        metropolitan areas exhibited quarterly price decreases.

    One of the more striking elements of the new HPI data is that four-
quarter appreciation rates fell sharply in four of the five states that 
had fastest appreciation in last quarter's HPI release. This subject is 
discussed in greater detail in the Highlights section of this report on 
page 8.
    Changes in the mix of data from refinancings and house purchase 
transactions can affect HPI results. An index using only purchase price 
data indicates somewhat less price appreciation for U.S. houses between 
the second quarter of 2005 and the second quarter of 2006. That index 
increased 8.27 percent, compared with 10.06 percent for the HPI.
    OFHEO's House Price Index is published on a quarterly basis and 
tracks average house price changes in repeat sales or refinancings of 
the same single-family properties. OFHEO's index is based on analysis 
of data obtained from Fannie Mae and Freddie Mac from more than 31 
million repeat transactions over the past 31 years. OFHEO analyzes the 
combined mortgage records of Fannie Mae and Freddie Mac, which form the 
nation's largest database of conventional, conforming mortgage 
transactions. The conforming loan limit for mortgages purchased in 2006 
is $417,000.
    This HPI report contains four tables: 1) A ranking of the 50 States 
and Washington, D.C. by House Price Appreciation; 2) Percentage Changes 
in House Price Appreciation by Census Division; 3) A ranking of 275 
Metropolitan Statistical Areas (MSAs) and Metropolitan Divisions by 
House Price Appreciation; and 4) A list of one-year and five-year House 
Price Appreciation rates for MSAs not ranked.
    OFHEO's HPI report in PDF form is accessible at www.ofheo.gov. 
Also, be sure to visit www.ofheo.gov to use the OFHEO House Price 
calculator. The next HPI report will be posted December 1, 2006. Please 
e-mail [email protected] for a printed copy of the report.

                        HOUSE PRICE APPRECIATION BY STATE--PERCENT CHANGE IN HOUSE PRICES
                                          [Period ended June 30, 2006]
----------------------------------------------------------------------------------------------------------------
                                                                                                          Since
                             State                               Rank *     1-Yr.     Qtr.      5-Yr.     1980
----------------------------------------------------------------------------------------------------------------
Arizona, (AZ).................................................         1     24.05      2.94     96.71    323.30
Florida, (FL).................................................         2     21.28      2.51    112.59    377.53
Idaho, (ID)...................................................         3     20.14      3.78     55.27    229.24
Oregon, (OR)..................................................         4     19.47      3.99     63.79    333.68
Hawaii, (HI)..................................................         5     18.09      0.43    111.21    427.63
Washington, (WA)..............................................         6     17.39      3.67     60.21    363.59
Maryland, (MD)................................................         7     16.21      2.31    102.68    422.09
District of Columbia, (DC)....................................         8     15.86      1.28    119.97    534.93
New Mexico, (NM)..............................................         9     15.54      4.22     50.30    215.40
Utah, (UT)....................................................        10     15.17      3.75     33.39    229.32
California, (CA)..............................................        11     14.35      1.25    111.93    543.28
Virginia, (VA)................................................        12     14.24      2.01     83.38    360.29
Wyoming, (WY).................................................        13     13.97      2.94     55.61    149.60
Alaska, (AK)..................................................        14     12.90      2.82     53.01    169.33
Montana, (MT).................................................        15     12.66      3.12     55.84    254.28
Louisiana, (LA)...............................................        16     12.48      2.71     37.92    134.09
New Jersey, (NJ)..............................................        17     12.43      1.85     84.98    475.25
Delaware, (DE)................................................        18     11.78      0.63     70.75    392.00
Nevada, (NV)..................................................        19     11.44      0.26    104.77    312.02
Vermont, (VT).................................................        20     11.28      2.45     65.97    350.98
Pennsylvania, (PA)............................................        21     10.69      1.61     55.57    299.17
United States **..............................................  ........     10.06      1.17     56.49    298.85
New York, (NY)................................................        22      9.89      0.90     72.76    554.65
Mississippi, (MS).............................................        23      9.59      2.85     27.62    138.56
North Carolina, (NC)..........................................        24      9.32      1.93     28.41    221.47
South Carolina, (SC)..........................................        25      8.93      1.67     31.48    205.02
Alabama, (AL).................................................        26      8.91      1.88     30.18    174.32
North Dakota, (ND)............................................        27      8.88      3.00     39.64    140.99
Connecticut, (CT).............................................        28      8.46      0.83     62.98    376.96
Tennessee, (TN)...............................................        29      8.10      1.96     28.06    191.09
Arkansas, (AR)................................................        30      8.01      1.98     32.31    153.66
Illinois, (IL)................................................        31      7.82      1.12     42.76    270.57
Rhode Island, (RI)............................................        32      7.43      1.18     94.00    513.89
West Virginia, (WV)...........................................        33      7.40      0.15     34.73    127.04
Oklahoma, (OK)................................................        34      6.50      1.78     26.75     97.79
Texas, (TX)...................................................        35      6.45      1.93     22.64    111.87
Maine, (ME)...................................................        36      6.25     -0.20     61.74    405.84
Georgia, (GA).................................................        37      6.14      1.05     28.02    230.46
New Hampshire, (NH)...........................................        38      5.97      0.04     61.03    404.18
South Dakota, (SD)............................................        39      5.96      2.05     31.18    175.99
Missouri, (MO)................................................        40      5.77      0.45     33.29    196.36
Wisconsin, (WI)...............................................        41      5.58      0.31     36.00    226.57
Kentucky, (KY)................................................        42      5.27      1.21     24.94    183.51
Minnesota, (MN)...............................................        43      4.94      0.28     46.61    271.41
Iowa, (IA)....................................................        44      4.30      1.26     23.61    146.78
Colorado, (CO)................................................        45      4.20      0.96     23.68    263.10
Kansas, (KS)..................................................        46      4.15      1.04     24.10    138.93
Nebraska, (NE)................................................        47      3.63      0.95     21.57    155.27
Massachusetts, (MA)...........................................        48      3.40     -0.44     56.98    631.67
Indiana, (IN).................................................        49      2.76     -0.04     17.00    154.65
Ohio, (OH)....................................................        50      2.14     -0.05     18.40    172.34
Michigan, (MI)................................................        51      1.01     -0.72     18.95   222.11
----------------------------------------------------------------------------------------------------------------
* Note: Ranking based on one-year appreciation.
** Note: United States figures based on weighted Census Division average.

                                 ______
                                 
                  PREPARED STATEMENT OF RICHARD BROWN
         Chief Economist, Federal Deposit Insurance Corporation
                           September 13, 2006
    Chairman Allard, Chairman Bunning, Senator Reed and Senator 
Schumer, I appreciate the opportunity to testify on behalf of the 
Federal Deposit Insurance Corporation concerning housing markets and 
their implications for the economy. Like the other panelists testifying 
today, the FDIC closely monitors the current conditions in U.S. housing 
markets.
    Rather than restating the housing data available for economic 
analysis, my testimony will summarize some recent analysis performed by 
FDIC staff economists on historical boom and bust cycles in the U.S. 
housing markets. This analysis of almost 30 years of boom and bust 
cycles should complement the presentations of my fellow panelists and 
provide the Subcommittees with perspective on the credit risks of these 
cycles to banks and thrift institutions.
    My testimony will address four main topics: 1) the condition of the 
banking industry and its role in housing finance; 2) the historical 
performance of real estate loan portfolios at banks and thrifts; 3) the 
FDIC's recent analysis of housing boom and bust cycles; and 4) the 
implications for the future path of U.S. home prices.
Banking Industry Condition and Role in Housing Finance
    At the outset of my testimony, I would like to emphasize that FDIC-
insured banks and thrift institutions continue to exhibit strong 
earnings, low credit losses and historically high levels of capital. 
The industry as a whole has posted five consecutive annual earnings 
records and two consecutive quarterly earnings records. As of June 30, 
noncurrent loans measured just 0.70 percent of total loans, the lowest 
such ratio in the 22 years these data have been collected.\1\ At that 
same date, the industry's Tier 1 Risk Based Capital Ratio was 10.72%, 
near a historic high for this ratio. In addition, no FDIC-insured 
institution has failed in over two years--the longest such period in 
the FDIC's history.
---------------------------------------------------------------------------
    \1\ Noncurrent loans are defined as loans 90 days or more past due 
or in nonaccrual status.
---------------------------------------------------------------------------
    FDIC-insured institutions are extremely active in virtually every 
aspect of housing finance. These institutions act as lenders for home 
construction and the permanent financing of both single family and 
multifamily homes, as loan servicers and as issuers and investors in 
mortgage-backed securities. These lines of business have been very 
important in recent years to the ability of depository institutions to 
generate both loan growth and fee income, and have helped support the 
recent high levels of earnings. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Table 1 (attached) shows that housing-related assets held by FDIC-
insured institutions generally grew faster than commercial and 
industrial loans in the early stages of this economic expansion. In the 
most recent reporting period, year-over-year growth in holdings of 
single-family mortgages slowed slightly to 10.5 percent, but holdings 
of construction and development loans (which include both residential 
and nonresidential properties) are currently growing at an annual rate 
of over 30 percent.
Historical Performance of Real Estate Loan Portfolios at Banks and 
        Thrifts 

        [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Across the historical period for which loan performance data are 
available, mortgage lending has generally proven to be a relatively low 
risk line of business accompanied by comparatively low returns. Charts 
1 and 2 show that both the average return on assets and the average 
loan chargeoff rate for institutions specializing in mortgage lending 
have generally remained below the average for all FDIC-insured 
institutions over the past 15 years. This performance is not surprising 
because mortgage loans have traditionally been collateralized, subject 
to industry-standard underwriting practices and tradable in a fairly 
deep and liquid secondary market.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    In contrast, the credit performance of construction and development 
(C&D) loans has tended to be more variable over the long-term. 
Specifically, Charts 3 and 4 show that C&D loans performed poorly on 
average during the banking and thrift crises of the late 1980s and 
early 1990s. During that period, speculative construction loans, both 
for residential and nonresidential properties, played a significant 
role in the failure of institutions insured by the FDIC and the 
FSLIC.\2\ By contrast, the average overall performance of home mortgage 
loans remained comparatively strong during the early 1990s and has 
remained so up to the present time.
---------------------------------------------------------------------------
    \2\ See FDIC, History of the Eighties-Lessons for the Future, 
Chapter 3: ``Commercial Real Estate and the Banking Crises of the 1980s 
and early 1990s,'' 1997.
---------------------------------------------------------------------------
    It also is important to note that recent ratios of both problem 
loans and net chargeoffs have been very low by historical standards in 
every loan category related to housing finance. This performance can be 
attributed in large part to the low interest rates of recent years, as 
well as the large home price increases that have been seen in many 
parts of the nation.
    Notwithstanding the lower losses generally associated with mortgage 
loans over time, mortgage credit distress has been observed 
historically in certain metropolitan areas where severe local economic 
distress was accompanied by steep declines in home prices. A prime 
example was Houston, Texas between 1984 and 1987. As documented in the 
FDIC's history of the period, the shifting fortunes of the oil 
industry--from boom in the early 1980s to bust after 1985--was the 
primary force behind both a real estate bust in the latter half of that 
decade and the failure of hundreds of federally-insured depository 
institutions in the region. This boom-bust cycle represented the most 
serious of the regional banking crises experienced around the nation 
during that era.
Recent FDIC Analysis of Housing Boom and Bust Cycles
    Given its historical experience, the FDIC has in recent years 
continuously monitored trends in U.S. home prices and mortgage lending 
practices as part of its risk analysis activities. FDIC analysts issued 
two companion studies in our FYI series in February and May 2005 that 
examined housing boom and bust cycles. These studies, which are 
summarized in my testimony and available on the FDIC's website\3\, 
concluded that housing booms do not necessarily lead to housing busts. 
Instead, the analysis found that housing busts were usually associated 
with episodes of local economic distress.
---------------------------------------------------------------------------
    \3\ C. Angell and N. Williams, ``U.S. Home Prices: Does Bust Always 
Follow Boom?,'' FDIC, FYI, February 10, 2005, http://www.fdic.gov/bank/
analytical/fyi/2005/021005fyi.html, and Angell and Williams, ``FYI 
Revisited--U.S. Home Prices: Does Bust Always Follow Boom?,'' FDIC, 
FYI, May 2, 2005, http://www.fdic.gov/bank/analytical/fyi/2005/
050205fyi.html.
---------------------------------------------------------------------------
Analytical Approach
    The FDIC studies make use of the OFHEO House Price Index (HPI) 
series, which tracks average house prices for many U.S. metropolitan 
areas as far back as 1977. Based on ``matched sale'' observations of 
sale prices, and appraisals on refinancings, for the same properties 
over time, these data are thought to be a reliable indicator of home 
price trends that is relatively unaffected by changes in the 
composition of the housing stock.
    Measuring annual changes in HPI for all metropolitan areas for 
which it is available, the FDIC analysts asked three simple questions:

           Where have housing booms been located?
           Where have housing busts been located?
           Does boom necessarily lead to bust in U.S. housing 
        markets?

    In order to answer these questions, the analysts first had to 
develop definitions of boom and bust in terms of observed price 
changes.
    The definition of a housing boom used in the studies includes any 
metropolitan area that experienced at least a 30 percent increase in 
its HPI--adjusted for inflation--during a given three-year period. This 
definition serves not only to identify cities that have experienced 
large cumulative upward price changes in a relatively short period, but 
the inflation adjustment also helps to create a standard yardstick that 
can be used to compare price changes during periods of relatively high 
inflation (the late 1970s) with periods of relatively low inflation 
(since the early 1990s).
    The analysts also created a standard definition for a metropolitan-
area housing bust, namely any metropolitan area that experienced at 
least a 15 percent decline in HPI, in nominal terms, during a given 
five-year period. Nominal, as opposed to inflation-adjusted, price 
changes were used in the definition of a bust because it is nominal 
price declines that can potentially erode the equity of homeowners and 
reduce the incentive to repay the loan as well as the proceeds that can 
be obtained from the underlying collateral in the event of foreclosure. 
A nominal price decline of 15 percent was chosen because this 
represents a serious erosion of value. Such a decline would eliminate 
any equity of homebuyers who made only a 10 percent down payment and 
would seriously impair the equity of those who made a 20 percent down 
payment. Given the increase in high loan-to-value mortgage lending 
during the recent housing boom, a decline of this magnitude could cause 
concern.\4\
---------------------------------------------------------------------------
    \4\ In 2005, 43 percent of first-time buyers obtained 100 percent 
financing. Source: ``2005 National Association of Realtors Profile of 
Home Buyers and Sellers,'' NAR, January 2006.
---------------------------------------------------------------------------
    Finally, a five-year period was chosen in the definition of bust 
because of the observation that price declines tend to be long, drawn-
out affairs rather than brief, precipitous declines. What this means is 
that home prices tend to be--in economist jargon--``sticky downward,'' 
with consequences described below.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Historical Results
    Applying these standard definitions for booms and busts over the 
period from 1978 through 1998, FDIC analysts generated the list of 
cities that appears in Table 2. Based on these results, a few 
straightforward observations may be made.

        1.   Housing booms and housing busts, as well as other price 
        trends that do not quite meet the FDIC's definitions, tend to 
        be long-term trends that play out over years.
        2.   Despite the fact that the definition of a bust is somewhat 
        less stringent than that of a boom, busts are observed to be 
        relatively rare events. Prior to 2000, only 21 busts were 
        observed compared with 54 housing booms.
        3.   Of the 21 metropolitan-area housing busts, only nine (43 
        percent) were preceded within five years by a housing boom.
        4.   Conversely, of the 54 observed metropolitan-area housing 
        booms, only nine (17 percent) led to a housing bust within five 
        years.
        5.   Housing booms do not last forever. Most commonly, they are 
        followed by an extended period of ``stagnation'' where prices 
        may fall, but usually not by enough to meet the FDIC's 
        definition of a bust.

    Based on these results, FDIC analysts could not conclude that boom 
necessarily leads to bust. Instead, they found that housing busts were 
usually associated with episodes of local economic distress, such as 
the energy-sector problems that beset Houston in the mid-1980s.
    Other metropolitan areas where housing busts were at least in part 
attributable to problems in the energy sector included Anchorage, AK; 
Casper, WY; Grand Junction, CO; Lafayette, LA; Oklahoma City, OK; and 
five metropolitan areas in Texas. The study also attributed early 1990s 
housing busts in parts of New England and Southern California to a 
combination of defense industry cutbacks, a slowdown in commercial real 
estate construction, and the effects of the 1990-91 recession. Finally, 
the busts recorded in Peoria, IL from 1984 through 1988 and Honolulu, 
HI from 1996 through 2001 were largely attributed to the effects of 
distress in the U.S. farm sector and the Japanese economy, 
respectively, and were both interpreted in the study as arising from 
outside the local housing sector itself.
    The finding that housing booms do not necessarily lead to busts is 
somewhat reassuring from a risk management perspective. The periods of 
price stagnation that typically follow booms have not necessarily been 
associated with high mortgage credit losses to the degree that have 
sometimes been seen in bust markets. Rather housing stagnation tends to 
be characterized by steep declines in common measures of housing market 
activity, including new home sales, existing home sales, and housing 
starts. Home price stagnation can also be marked by declines in home 
prices that do not meet the FDIC's criteria for a bust.
    The FDIC's analysis shows that average home prices fell in at least 
one year of the five years following a housing boom in 35 of the 54 
booms that were identified. In 28 cases, the cumulative five-year 
change in home prices following the boom was negative, although only 
nine of these cases met the ``15 percent'' criteria for a bust.
    These periods of stagnation can be painful for homeowners, real 
estate investors, and others who make their living in real estate. In 
places like metropolitan New York, where prices fell by nine percent 
between 1988 and 1991, or Washington, D.C., where home prices remained 
essentially unchanged on average between 1990 and 1995, many can still 
recall the difficulties and disappointments they experienced trying to 
sell properties during the early 1990s. While often difficult in an 
individual situation, the credit implications of such periods of 
stagnation are much less severe, at least for mortgage loans, than 
situations where home prices decline sharply.
Current Boom Markets
    Somewhat less reassuring, however, are the results derived by 
applying the studies' framework to the U.S. housing boom that developed 
during the first half of this decade and that now appears to be near an 
end.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Chart 5 tracks the number of boom markets from 1978 through 2005. 
It shows that the number of boom markets has grown rapidly all through 
this decade--accelerating after 2002 as the number of markets exceeded 
its previous 1988 peak and nearly tripling to 89 metropolitan areas. A 
listing of all recent boom markets and 3-year cumulative percent 
changes in average real home prices in these markets is provided in 
Table 3.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    As in previous housing booms, recent boom markets have continued to 
be concentrated in the Northeast, the Middle Atlantic States, 
California, the Northwest, and areas of the Mountain West States. The 
state of Florida, which had never experienced a boom market according 
to the FDIC's criteria between 1977 and 2002, was home to 21 boom 
markets as of 2005.
    Factors shared by many boom markets--particularly those that had 
recurrent booms across time--include a combination of vibrant economies 
that are generating jobs and drawing in new residents, or a scarcity of 
available land on which to build new homes to meet demand, or both. By 
contrast, metropolitan areas in the middle of the country that depend 
more heavily on agriculture and manufacturing, and where land is 
readily available, have generally had much lower rates of home price 
appreciation in this decade.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    However, the intensification of the home price boom sinc 2002 has 
been unprecedented in scale as well as in scope. Chart 6 tracks annual 
changes at the national level in both the OFHEO home price index and 
disposable personal incomes, both measured in nominal terms. It shows 
that while disposable incomes have grown slightly faster than average 
home prices during most years, home prices began to grow faster than 
incomes beginning in 2001 much the same as they had during previous 
boom periods in 1978-79 and 1986-87. What stands out in Chart 6 is the 
acceleration of average U.S. home price growth to double-digit rates in 
2004 adn 2005. Average U.S. home prices grew more than three times 
faster than disposable incomes in 2005.
    However, the intensification of the home price boom since 2002 has 
been unprecedented in scale as well as in scope. Chart 6 tracks annual 
changes at the national level in both the OFHEO home price index and 
disposable personal incomes, both measured in nominal terms. It shows 
that while disposable incomes have grown slightly faster than average 
home prices during most years, home prices began to grow faster than 
incomes beginning in 2001 much the same as they had during previous 
boom periods in 1978-79 and 1986-87. What stands out in Chart 6 is the 
acceleration of average U.S. home price growth to double-digit rates in 
2004 and 2005. Average U.S. home prices grew more than three times 
faster than disposable incomes in 2005.
Recent Changes in Mortgage Markets
    In seeking to explain the recent acceleration in home price growth, 
the FDIC analysts in their May 2005 FYI study pointed to important 
changes in the mortgage lending business in 2004 and 2005 that may be 
related to the acceleration of home price growth. Certainly, low short-
term and long-term interest rates are factors that have helped to 
support home price growth in recent years. However, in 2004, just as 
short-term interest rates were beginning to rise, borrowers began to 
migrate toward adjustable-rate mortgages (ARMs) that are commonly 
indexed to short-term interest rates.
    According to the Federal Housing Finance Board, over 30 percent of 
all conventional mortgages closed in 2004 and 2005 were ARMs. The ARM 
share moderated to 25 percent by the second quarter of 2006. The 
percentage of ARMs among subprime mortgages is higher. Within subprime 
mortgage backed securities, the share of ARMs was far higher, close to 
80 percent.\5\ The prevalence of subprime loans among all mortgage 
originations doubled from 9 percent in 2003 to 19 percent in 2004.\6\
---------------------------------------------------------------------------
    \5\ See ``ARMs Power the Subprime MBS Market in Early 2006,'' 
Inside B&C Lending, July 21, 2006. Subprime mortgages are higher-
interest mortgages that involve elevated credit risk. For more on 
subprime mortgages, see C. Angell, ``Breaking New Ground in U.S. 
Mortgage Lending,'' FDIC Outlook, Summer 2006. http://www.fdic.gov/
bank/analytical/regional/ro20062q/na/2006_summer04.html.
    \6\ See ``Mortgage Originations by Product,'' Inside Mortgage 
Finance, February 25, 2005.
---------------------------------------------------------------------------
    One possible explanation for the shift toward ARMs and subprime 
loans is that prime borrowers with a preference for fixed-rate 
mortgages refinanced in record numbers as long-term interest rates fell 
to the lowest rates in a generation in 2003. This refinancing boom may 
have tended to skew the composition of mortgage loans in 2004 and 2005 
more toward subprime and ARM borrowers. Another explanation might be 
that new homebuyers were increasingly using the lower monthly payments 
associated with ARMs to cope with rapidly rising home prices.
    Adjustable-rate mortgage borrowers also increasingly turned to 
interest-only and payment option loan structures in 2004 and 2005.\7\ 
These mortgages are specifically designed to minimize initial mortgage 
payments by eliminating or relaxing the requirement to repay principal 
during the early years of the loan. Although it is difficult to measure 
the use of these mortgage structures across all mortgage originations, 
they appear to have made up as much as 40 to 50 percent of all loans 
securitized by private issuers of mortgage-backed securities during 
2004 and 2005.
---------------------------------------------------------------------------
    \7\ In an interest-only (IO) mortgage, the borrower is required to 
pay only the interest due on the loan for the first few years, during 
which time the rate may be fixed or fluctuate. After the IO period, the 
rate may be fixed or fluctuate based on the prescribed index; payments 
consist of both principal and interest. In a payment option ARM, the 
borrower may choose from a number of payment options that may include 
options that allow for negative amortization--an increase in the 
principal balance of the loan. For more on these loan types, see C. 
Angell, ``Breaking New Ground in U.S. Mortgage Lending,'' FDIC Outlook, 
Summer 2006. http://www.fdic.gov/bank/analytical/regional/ro20062q/na/
2006_summer04.html.
---------------------------------------------------------------------------
    Finally, there is evidence that a significant proportion of 
mortgage loans were made to real estate investors in 2004 and 2005. The 
National Association of Realtors found that 28 percent of all homes 
purchased in 2005 were for investment rather than occupancy by the 
buyers, up from 25 percent in 2004.\8\ This high share signals an 
increase in speculative purchases of residential properties, 
particularly condominiums. While speculative buying is a fairly common 
feature of housing booms, this activity deserves particular mention 
when home price increases have been so large and when use of 
nontraditional mortgages has increased as much as in the past two 
years.
---------------------------------------------------------------------------
    \8\ ``Second Home Sales Hit Another Record in 2005; Market Share 
Rises,'' NAR, April 5, 2006, http://www.realtor.org/
PublicAffairsWeb.nsf/Pages/SecondHomeSales05?OpenDocument. Loan data 
compiled by LoanPerformance Corporation from its loan-service companies 
found that 9.5 percent of home-purchase mortgages in 2005 were for 
investors, up from 8.6 percent in 2004. The discrepancy between the two 
reports may lie in differences in data collection and reporting. 
LoanPerformance does not capture data on homes purchased without a 
loan, and some investors may not identify themselves as such to lenders 
in order to avoid higher rates typically charged to investors. 
``Investment Homes To Get Less Focus, Realtors Predict,'' The Wall 
Street Journal, April 6, 2006.
---------------------------------------------------------------------------
Implications for the Future Path of U.S. Home Prices
    After undergoing a boom of historic proportions in recent years, a 
variety of recent indicators show that housing market activity is 
waning in most areas of the nation. Sales of new homes in July 2006 
were 22 percent lower than a year ago, while sales of existing homes 
were down 11 percent. Home price increases in most markets appear to be 
tapering off to single-digit rates, while small price declines have 
been seen in a number of markets located in the upper Midwest states.
    The FDIC's analysis of metropolitan-area boom and bust cycles over 
a period of almost 30 years indicates that the metropolitan-area 
housing booms that have recently occurred in record numbers cannot last 
indefinitely. In their aftermath, there will almost certainly be one of 
two possible outcomes: (1) a period of stagnation with weak home prices 
and even weaker measures of housing market activity; or (2) a price 
bust, or a sharp decline in home prices with severe adverse 
consequences for homeowners, lenders and the real estate sector as a 
whole.
    The historical experience clearly implies that a widespread price 
bust remains an unlikely outcome for two reasons. One is that 
historically price busts are typically associated with severe local 
economic distress that arises from outside the housing sector itself. 
While recent macroeconomic performance has benefited a great deal from 
expansion in the housing sector, the prospects appear good that the 
solid growth in jobs and incomes that has occurred in recent quarters 
will continue to be supported by other sectors of the economy, 
including business investment, exports and nonresidential construction.
    The second reason a home price bust remains an unlikely outcome is 
the anticipated response on the part of homeowners to weakness in their 
local real estate market. As was mentioned earlier in my testimony, 
home prices tend to be ``sticky downward'' in large part because 
homeowners are usually extremely reluctant to sell their homes at a 
loss unless forced to do so by the relocation or loss of their jobs. 
Under a wide range of adverse economic scenarios, homeowners have 
proven to go to extraordinary lengths to avoid selling their homes at a 
loss. Most commonly, they will simply choose to remain in them, or to 
rent them so as to cover at least part of their debt service costs. 
While the reluctance to sell has the effect of limiting the extent of 
the decline in home prices, the resulting period of stagnation can last 
for years.
    The exception to this rule has been episodes of severe local 
economic distress that produce large job losses, declines in personal 
incomes, and, in many cases, out-migration to other areas where job 
prospects are brighter. While such circumstances remain possible in 
areas dominated by troubled industry sectors, they will remain the 
exception rather than the rule.
    What is yet to be determined is the effect that recent changes in 
the mortgage lending business may have on the ability of homeowners to 
meet their monthly obligations under adverse housing market conditions. 
While adjustable-rate mortgages are not new in the marketplace, many of 
the newly popular interest-only and payment option structures may lead 
to a significant increase in monthly payments due to higher short-term 
interest rates or simply the expiration of low introductory interest 
rates. It remains uncertain how much the ``payment shock'' associated 
with these structures may contribute to selling pressure in local 
housing markets on the part of distressed homeowners or lenders looking 
to sell foreclosed properties.
    It is important to note that the overall prevalence of 
nontraditional mortgage structures remains fairly limited. While total 
ARMs originated in 2004 and 2005 are estimated to represent 
approximately 22 percent of all U.S. mortgage loans, it is likely that 
just under half that amount is comprised of interest-only and payment 
option structures.\9\ Borrowers who took on nontraditional loans as a 
means to afford a more expensive home may be particularly vulnerable to 
adverse housing market conditions. However, other borrowers who have 
used these structures to help manage their wealth or compensate for 
irregular income streams will be less severely affected.
---------------------------------------------------------------------------
    \9\ ``Mortgage Payment Resets: The Rumor and the Reality,'' C. 
Cagan, First American Real Estate Solutions, February 8, 2006.
---------------------------------------------------------------------------
Conclusion
    In conclusion, FDIC studies indicate that housing price booms 
historically have not necessarily been followed by housing price busts. 
Instead, they found that housing busts were usually associated with 
episodes of local economic distress, such as the energy-sector problems 
that beset Houston in the mid-1980s. Housing booms are more frequently 
followed by periods of housing stagnation that tend to be characterized 
by steep declines in common measures of housing market activity, 
including new home sales, existing home sales, and housing starts. Home 
price stagnation can also be marked by declines in home prices that do 
not meet the FDIC's criteria for a bust.
    Although housing price booms have not necessarily been followed by 
housing price busts, there are two factors in today's markets that are 
different from the historical experience. The number of boom markets is 
substantially higher currently than the historical experience. In 
addition, the use of ARMs and non-traditional mortgage products is 
unprecedented and could have an impact on future market performance.
    This concludes my testimony. I will be happy to respond to any 
questions the Subcommittees might have.
                                 ______
                                 
                  PREPARED STATEMENT OF DAVID SEIDERS
         Chief Economist, National Association of Homebuilders
                           September 13, 2006
THE HOUSING DOWNSWING: CAUSES, DIMENSIONS AND ECONOMIC CONSEQUENCES
    Chairman Allard, Chairman Bunning, Ranking Member Reed, and Ranking 
Member Schumer, my name is David Seiders and I am the Chief Economist 
for the National Association of Home Builders (NAHB). I am pleased to 
appear before you today to share NAHB's views on the outlook for 
housing and the economy. NAHB represents 235,000 member firms involved 
in home building, remodeling, multifamily construction, property 
management, housing finance, building product manufacturing and other 
aspects of residential and light commercial construction.
Summary and Conclusions 
    The U.S. housing market exhibited ``boom'' conditions during most 
of the 2004-2005 period but home sales and housing production now are 
coming down. Indeed, housing has already swung from a powerful engine 
of economic growth to a significant drag on the economic expansion, and 
there are serious questions about the impacts of housing on the economy 
going forward.
    This statement outlines the basic causes of the current housing 
downswing, estimates the depth and duration of the downswing, and 
discusses the likely economic consequences of the falloff in housing 
market activity as well as the likely impacts of several secondary 
effects of the evolving housing cycle. The basic conclusions are as 
follows:

            Both the housing boom of 2004-2005 and the current 
        housing contraction have unique features that make them 
        substantially different from previous housing market swings. 
        The big differences relate primarily to unusually stimulative 
        financial market conditions during the boom, record-breaking 
        increases in inflation-adjusted house prices, and an outsized 
        presence of investors/speculators in single-family and condo 
        markets.
            The current contraction amounts to an inevitable 
        mid-cycle adjustment, or transition, from unsustainable levels 
        of home sales, housing production and house price appreciation 
        to levels that are supportable by underlying market 
        fundamentals.
            The previous boom involved more than two years of 
        unsustainable housing market activity, and we're likely to 
        experience a below-trend performance of home sales and housing 
        starts of roughly similar duration. The downswing in home sales 
        and housing production should bottom out around the middle of 
        next year before transitioning to a gradual recovery that will 
        raise housing market activity back up toward sustainable trend 
        by the latter part of 2008.
            National average house price appreciation is likely 
        to be quite limited in the near term. Indeed, some decline is a 
        distinct possibility, and the rate of price appreciation should 
        remain below trend for some time. ``True'' house price 
        appreciation, accounting for upward bias in key price measures 
        as well as price support from non-price sales incentives 
        provided by sellers, presumably will be even weaker.
            The downswing in home sales and housing production 
        will continue to detract from overall economic growth through 
        mid-2007. However, much of this negative impact should be 
        offset by strengthening activity in other sectors of the U.S. 
        economy, keeping GDP growth reasonably close to a sustainable 
        trend-like performance.
            There are bound to be some adverse secondary 
        effects of the recent housing boom and the subsequent downswing 
        on the ongoing economic expansion. These effects include 
        negative impacts on consumer spending from a fading wealth 
        effect as house prices adjust as well as from the impacts of 
        ``payment shock'' on homeowners facing upward adjustments to 
        monthly payments on ``exotic'' types of adjustable-rate 
        mortgages (ARMs) originated since 2003. However, the size and 
        timing of these effects are not likely to seriously threaten 
        the economic expansion.
            The housing and economic outlook characterized 
        above rests on a number of key conditions, and downside risks 
        to the outlook are considerable. These risks include the 
        possibility of spikes in interest rates or energy prices as 
        well as large resales of homes back onto the markets by 
        investor/speculators. There also are considerable uncertainties 
        about the true dimensions of the risk facing homeowners with 
        ``exotic'' ARMs, and there are major uncertainties regarding 
        the size of the inventory overhang in the market for new homes.
Causes of the Housing Downswing
    The roots of the current housing downswing were cultivated before 
and during the housing boom of 2004-2005. The housing boom actually was 
touched off by the extraordinary monetary stimulus enacted by the 
Federal Reserve to fight off the threat of price deflation in the U.S. 
economy. The Fed dropped the federal funds rate to 1 percent at mid-
2003 (a negative ``real'' rate), held it there through mid-2004 and 
then embarked on a gradual path back toward monetary ``neutrality''--a 
journey that didn't reach its goal until the early part of this year. 
Furthermore, the extraordinary degree of monetary stimulus in the U.S., 
together with low long-term rates abroad, kept long-term interest rates 
in the U.S. at historic lows during most of the 2003-2005 period. This 
extremely favorable financing environment fueled buying activity in the 
interest-sensitive housing sector, pulling some demand forward in the 
process.
    The surge in housing demand quickly put substantial upward pressure 
on house prices, aided and abetted in many parts of the country by 
land-use constraints that limited the amount of supply that builders 
could bring onto the markets in short order. Surging prices bolstered 
expectations of future price appreciation, driving down the user cost 
of capital and bolstering the investment aspects of homeownership. The 
extremely favorable tax treatment of capital gains on housing (enacted 
in 1997) certainly contributed to these developments.
    The extraordinarily low interest rate structure and the rise in 
house price expectations attracted many households out of rental 
apartments and into first-time homeownership, driving both the 
homeownership rate and the rental vacancy rate to record highs by early 
2004. Furthermore, waves of investors/speculators bought into the 
single-family and condo markets to share in the unprecedented real 
capital gains being generated--at a time when our stock market was in 
questionable condition, yields on interest-bearing investments were at 
rock bottom and it was difficult to find attractive investment 
alternatives in foreign markets.
    The mortgage lending community also contributed to the housing 
boom, marketing a wide range of ``exotic'' ARMs (to coin a Greenspan 
term) that were designed to help get prospective buyers (including 
subprime credit risks) into homeownership and to accommodate investors/
speculators with short-term investment objectives. These lending 
practices naturally fueled demand further, adding to the already 
considerable upward pressures on prices of single-family homes and 
condo units. Both federal regulators of depository institutions and 
financial rating agencies raised flags about overly aggressive mortgage 
lending practices, particularly payment-option ARMs that permit 
negative amortization, but these flags apparently had little influence 
on lending practices in either the regulated or unregulated markets.
    The ongoing accumulation of large house price increases began to 
weigh on housing affordability measures by the early part of 2004, 
despite the stubbornly low interest rate structure. However, 
proliferation of the ``exotic'' ARMs kept a lot of prospective 
homeowners in the game, particularly in relatively high-priced markets. 
Meanwhile, the investors/speculators continued to plough ahead, still 
drawn by the lure of future price appreciation.
    Home sales and house price appreciation kept rising to higher and 
higher records throughout 2004 and into 2005, and the affordability 
measures kept falling. Affordability was subject to additional downward 
pressure after mid-2005 as the whole interest rate structure finally 
shifted upward, and the aggregate demand for homes finally started to 
give way in the third quarter of last year.
    The combination of fading demand on the part of prospective 
homeowners and a supply train that still was moving ahead quickly 
changed a raging ``sellers' market'' into a market where inventories 
were climbing and buyers could shop and bargain. Symptoms of the switch 
naturally caught the attention of savvy investors who cut back on 
buying, started cancelling sales contacts before closing and even 
started reselling vacant units they had closed on earlier.
    In retrospect, it was the finance- and price-driven acceleration of 
buying for homeownership and for investment that drove housing market 
activity into unsustainable territory during the boom. We're now 
experiencing a ``payback'' in demand for homeownership, following the 
surge that pulled demand forward into the boom years, and net purchases 
by investors/speculators are coming down considerably as price 
expectations are being marked down.
Dimensions of the Housing Downswing
    The 2004-2005 housing boom took home sales and housing production 
well above levels supportable by demographics and other fundamental 
demand factors. The cumulative excess of housing starts apparently 
amounted to at least 400 thousand units, and the excess supply now 
resides in builder inventories or in the hands of investors who may 
cancel contracts or sell vacant units at any time. In this regard, it's 
worth noting that the single-family rental vacancy rate soared to 
record highs during the boom, came down to some degree during the first 
half of this year, and presumably is heading lower for some time.
    It's clear that the housing downswing still has some distance to 
go, if only to work off excess supply in markets for both new and 
existing homes (including the condo market). Builders are cutting back 
on new permit authorizations as well as on starts of new units, and 
they are trimming prices and offering sizeable non-price sales 
incentives to limit cancellations and bolster sales. Furthermore, 
various economic and financial market fundamentals figure to be 
supportive of housing demand for the foreseeable future, helping to 
facilitate the inventory correction. These fundamentals include the 
following:

            Payroll employment growth is proceeding at a decent 
        and sustainable pace.
            Household income growth is strengthening as the 
        economic expansion proceeds.
            The interest rate structure is favorable, mortgage 
        credit is readily available and monetary policy has stabilized 
        following a long run of upward rate adjustments.
            Energy prices have receded from record highs 
        earlier this year.

    As long as the economy remains in good shape, interest rates remain 
close to current levels, energy prices remain below recent highs and 
sellers of new and existing homes adjust prices or offer incentives to 
fit current market realities, the rest of the housing market correction 
should be of limited depth and duration. It's likely that the bulk of 
the downswing in home sales and housing production will occur this 
year, with market activity stabilizing around mid-2007 and moving back 
up toward trend by late 2008. NAHB's forecast has a cumulative 
shortfall of housing starts (below our estimate of sustainable trend) 
of roughly 400 thousand units from the middle of this year through the 
end of 2008, in line with the estimated excess supply generated during 
the boom period.
House Price Adjustments
    House price appreciation was very rapid during the housing boom, 
and ``real'' house price appreciation soared to record rates. The 
national appreciation rate has slowed considerably since then, in both 
nominal and real terms, as sales volume has fallen and inventories of 
both new and existing homes have climbed. Absolute price declines 
actually were recorded for some markets in the second quarter of this 
year, although most of these markets were located in the beleaguered 
economies of the Great Lakes region rather than in previously 
overheated areas.
    The size of the current inventory overhang and the marked slowdown 
in price appreciation that's already occurred point toward a 
generalized flatness in nominal house prices in the near term, and some 
price erosion certainly could occur in coming quarters. In any case, an 
extended period of below-trend national house price appreciation lies 
ahead, and ``real'' house prices should come down to some degree. These 
adjustments certainly will give a boost to affordability for 
prospective homeowners as time passes.
    It's worth noting that all available measures of house price 
appreciation have technical deficiencies--even the purchase-only 
version of OFHEO's quarterly repeat-sales House Price Index. This 
measure is not reflective of the entire market, it contains some upward 
bias because it does not account for improvements to homes over time, 
and there's no way to adjust price appreciation downward to account for 
non-price sales incentives provided by sellers. Despite these 
limitations, it's the best available gauge of house price change in the 
U.S. as well as in regions, states and metro areas.
Economic Consequences of the Housing Downswing
    The U.S. economy can continue to grow at close to a trend pace even 
as the downswing in home sales and housing production runs its course. 
For one thing, the housing correction is a relatively isolated sectoral 
event, primarily reflecting recoil from earlier excesses within the 
sector. Unlike previous downswings, housing affordability has been 
squeezed primarily by price increases and the normally close 
correlation between housing activity and other interest-sensitive 
components of aggregate demand is not strong this time.
    It's also true that the housing downswing is occurring at the same 
time that other sectors of the economy are in mid-cycle expansion 
phases. This apparently is true of spending on capital equipment and 
software, nonresidential structures and exports. This type of sectoral 
rotation actually could give new life to the economic expansion (now 
nearly 5 years old), and the net outcome could very well be trend-like 
GDP growth with manageable core inflation and reasonably stable 
interest rates. That's an environment where housing would be able to 
deliver healthy trend-like performances of its own, riding on strong 
demographic trends and other fundamental demand factors.
Household Wealth and Consumer Spending
    The ongoing deceleration of house prices, and possible national 
house price declines, will take some strength out of consumer spending. 
After all, the rapid runup in house values and household wealth clearly 
fueled consumption expenditures during the housing boom, allowing the 
personal saving rate to go negative for an extended period of time. 
Furthermore, much of this spending was financed via borrowing against 
accumulated housing equity (cash-out refinancings and home equity 
loans) at a time when interest rates were lower than now.
    It's true that the housing wealth effect on consumer spending will 
be weakening to some degree as house prices slow and possibly even 
decline, but the erosion of support to consumer spending should be 
gradual over time and occur primarily after the downswing in home sales 
and housing production has run its course and residential fixed 
investment has completed its contraction (mid-2007). Households 
typically react to changes in wealth with long lags (one to three 
years), and the influence of the recent dramatic wealth buildup on 
consumer spending should carry through for some time.
    With respect to the influence of increases in the cost of accessing 
housing wealth via mortgage borrowing, a wealth of research shows that 
it's the wealth (or net worth) effect that really matters, not the 
amount of housing equity that's ``withdrawn'' via mortgage borrowing. 
Wealth-driven consumer expenditures can be financed by spending more 
out of current income (for those with positive savings), by running 
down financial assets or by using non-mortgage debt (e.g., personal 
loans).
Mortgage Payment Shock
    The proliferation of ``exotic'' ARMs during the housing boom 
(payment-option, interest-only, etc.) has raised the specter of 
widespread ``payment shock'' for homeowners when such loans hit their 
first rate resets and/or when the loans begin to require repayment of 
principal. These adjustments, when they occur, will put heavier demands 
on household budgets, with downside implications for consumer spending, 
and some homeowners will be forced into delinquency and even loan 
default. Subprime mortgage borrowers presumably are the most at risk.
    There's no doubt that the surge of ``exotic'' ARMs, and the 
associated relaxation of lending standards at both regulated and 
unregulated financial institutions, helped fuel the housing boom and 
will be creating problems for some homeowners. However, most 
outstanding mortgage debt is either fixed-rate or standard types of 
ARMs, and household income growth since loan origination should enable 
the majority of homeowners facing ARM payment adjustments to handle the 
higher monthly payments. Price appreciation since origination also will 
provide a financial buffer for many of those facing unanticipated 
increases in monthly payments.
    Homeowners facing large payment adjustments on exotic ARMs also can 
refinance into other types of ARMs or into fixed-rate mortgages at 
historically low rates, and most of the ``exotic'' ARMs apparently do 
not carry substantial prepayment penalties.
    It's also worth remembering that there was a strong correlation, 
across metro areas, between the frequency of ``exotic'' ARMs and 
investor shares of home mortgage originations. Many investors 
apparently used these types of loans to minimize short-term financing 
costs, and many presumably will be paid off or refinanced before upward 
payment adjustments occur.
    Everything considered, payment shock associated with ``exotic'' 
ARMs written during the boom will most likely be a negative for 
consumer spending in the next few years but should not threaten the 
projected economic expansion.
Downside Risks
    The housing and economic outlook described above rests on a number 
of key conditions, and downside risks to the outlook are considerable. 
Housing forecasts always are subject to the risk of unanticipated 
interest rate spikes, and reluctance by foreign investors to continue 
to finance our huge current account deficit could put serious upward 
pressure on the U.S. interest rate structure. Furthermore, recent 
experience in energy markets suggests that a major surge in energy 
prices can't be ruled out.
    There also are major uncertainties about the prospective behavior 
of the unprecedented numbers of investors/speculators that bought 
single-family homes and condo units during the boom. NAHB's surveys of 
builders show large numbers of cancellations of sales contracts before 
closing as well as less-frequent reports of resales of units closed on 
earlier. Our forecasts assume that any reflow of units back onto the 
markets is of manageable proportions and that wholesale dumping does 
not materialize.
    The prospective impact of payment resets on ``exotic'' ARMs, 
particularly payment-option ARMs with negative amortization, also is 
difficult to predict. It's possible to estimate the volume of 
potentially troublesome loans outstanding as well as the approximate 
timing of the first payment resets. However, there are a lot of 
uncertainties about the quality of loan underwriting during the boom 
housing years, including the degree of ``layering'' of permissive 
lending practices, and it's hard to predict the ultimate outcome on 
loan quality and consumer spending.
    Another uncertainty relates to the true size of the inventory of 
new homes for sale. The Commerce Department's estimates exclude homes 
left with builders when sales contracts are cancelled, and 
cancellations have been rising sharply since this time last year. 
NAHB's forecast attempts to account for this factor, but the true size 
of the inventory overhang remains a grey area at best.
    Mr. Chairman, that concludes my remarks. Again, thank you for the 
opportunity to appear before this joint subcommittee today. I look 
forward to answering any questions you or the members of the joint 
subcommittee have for me.
                                 ______
                                 
                   PREPARED STATEMENT OF TOM STEVENS

        President, National Association of Realtors'
                           September 13, 2006
    Chairmen Allard, Bunning and Ranking Members Schumer and Reed, and 
Members of the Subcommittees, my name is Tom Stevens, and I am the 
former President of Coldwell Banker Stevens (now known as Coldwell 
Banker Residential Brokerage Mid-Atlantic)--a full-service realty firm 
specializing in residential sales and brokerage. Since 2004, I have 
served as senior vice president for NRT Inc., the largest residential 
real estate brokerage company in the nation.
    As the 2006 President of the National Association of 
REALTORS', I am here to testify on behalf of our nearly 1.3 
million REALTOR' members. We thank you for the opportunity 
to present our views of the current real estate market as well as 
prospects for the future. NAR represents a wide variety of housing 
industry professionals committed to the development and preservation of 
the nation's housing stock and making it available to the widest range 
of potential homebuyers. The Association has a long tradition of 
supporting innovative and effective housing programs and we continue to 
work diligently with the Congress to fashion housing policies that 
ensure housing programs meet their mission responsibly and efficiently.
    For the past five years, the housing market has been a steadfast 
leader in the U.S. economy. In 2005, mortgage rates remained near 45-
year lows while the nation's economy generated 2 million net new jobs. 
Existing-home sales rose 4.4 percent in 2005, resulting in five 
successive record years. Both new-home sales and new single-family 
housing starts also set new high marks in 2005. Overall, the housing 
sector directly contributed more than $2 trillion to the national 
economy in 2005, accounting for 16.2 percent of economic activity. In 
addition, commercial real estate contributed an additional $330 billion 
to the nation's economy.
    After five years of outstanding growth and being the driving force 
of the U.S. economy, the housing market is undergoing a period of 
adjustment. I have experienced this first hand as my prior home has 
been on the market, in Northern Virginia, for over a year. Existing 
home sales in July fell 11.2 percent from a year ago. New home sales 
are down 22 percent from a year ago. The inventory of unsold homes on 
the market is at an all-time high of 3.9 million, which is a 40 percent 
rise from a year ago. Given the falling demand and increased supply, 
home prices have seen less than 1 percent appreciation from a year ago 
compared to the double-digit rate of appreciation in 2005.
    While recent developments raise concerns, it is important to 
remember that the housing market varies significantly across the 
country. One-third of the country (by population) is still seeing 
rising home sales. They include Alaska, Vermont, New Mexico and many 
states in the South (excluding Florida). The remaining two-thirds of 
the country is experiencing lower sales with some states feeling acute 
adjustment pains. Sales are down significantly in Florida, California, 
Arizona, Nevada, Virginia, and Maryland. These regions experienced the 
greatest rise in home prices in recent years and affordability has 
become a major issue. The sharp decline in sales have resulted in a 
much higher housing inventory (tripling and quadrupling in some cases) 
and these areas are vulnerable to outright price declines, particularly 
if interest rates were to rise further.
    The industrial Midwest region did not participate in the nationwide 
housing market boom of the past five years due to weaker job market 
conditions. Job gains have been minimal in Ohio and Indiana during the 
recent nationwide economic expansion. Job losses have been continuing 
in Michigan--for five straight years.
    Contrary to many reports, there is not a ``national housing 
bubble.'' All real estate is local. For example, the housing market in 
California is extremely different from Oklahoma. Home price-to-income 
ratio, home price-to-rent ratio, and more importantly, mortgage debt 
servicing cost-to-income ratio have greatly increased in some markets 
to worrisome levels. Markets in Florida, California, Arizona, Nevada, 
Virginia, and Maryland exhibit trends far above the local historical 
norm, thus it would not be surprising for these markets to experience a 
price adjustment. However, these states have solid job growth--Because 
of solid job growth, price declines are likely to be short-lived as new 
job holders provide demand and support for the housing market.
    If the mortgage rates were to rise measurably--to say 7.5 percent 
or 8 percent from the current 6.5 percent--for whatever reasons (be it 
Chinese dumping dollars on the market, higher inflationary 
expectations, or monetary tightening by the Federal Reserve) then the 
housing market would certainly come under more pressure and many 
markets would likely undergo price declines.
    The most influential factor is the rising mortgage rates. Many 
homebuyers in coastal markets have resorted to more exotic mortgages. 
Due to very high home prices, interest-only, adjustable rate, and/or 
option-ARMS became the only way to enter the housing market for some 
homebuyers. In essence, the homebuyers in the coastal markets are at 
their financial capacity. With rising mortgage rates, homebuyers are 
becoming exhausted financially, which explains why sales have tumbled 
in high priced regions of the country. In the industrial Midwest, as I 
said earlier, the housing market is more job market dependent and less 
mortgage rate dependent.
    Another factor is the insufficient presence of Government Sponsored 
Enterprises (GSEs) and the Federal Housing Administration (FHA) in the 
high priced regions. The increases in GSE/FHA loan limits have not kept 
pace in places like California, Florida, and parts of New York among 
others. For example, loan limits rose 7.8 percent in 2005 while home 
prices rose 19 percent in Los Angeles, 25 percent in the D.C., and 30 
percent in Miami. Consider, for a moment, that FHA's share of loans in 
Los Angeles went down from nearly 20 percent in 2000 to essentially 
zero today.
    As you know, FHA loans often serve neglected demographic segments 
of the housing market--first time, lower income, minority, and 
immigrant homebuyers. NAR applauds the Bush Administration's FHA reform 
proposal currently being considered in Congress. A modernized FHA will 
be a valuable tool to people seeking to buy a home in softer housing 
and mortgage markets. As we have seen in the past, in soft local and 
regional markets, FHA has filled significant gaps in the private sector 
lending market, becoming the predominant tool to achieve homeownership 
and helping to carry regions out of an economic downturn. In the mid 
1980s, in Colorado, Oklahoma, Louisiana, and Texas, the FHA loan 
program stepped in, while private mortgage providers left those in 
distressed economic areas, and took over a substantial role in 
providing available mortgage credit to those in affected states. An FHA 
with the tools to complete the task will be important to thousands of 
Americans hoping to buy a home, but in particular, in those markets 
that really need the help.
    Florida has also been hit by another unique factor--the lack of 
affordable property insurance. The unprecedented number of strong 
hurricanes hitting the Florida shores in 2004 and 2005 has resulted in 
a dysfunctional insurance market where premiums have either increased--
literally through the roof--or are simply not available. We have heard 
many stories from our membership in Florida about how potential 
homebuyers backed away at the last moment either due to the insurance 
sticker shock or due to outright unavailability of insurance.
    The national forecast for the coming year, based on stabilizing 
mortgage rates and a modestly expanding economy through 2007, predicts 
that existing home sales will fall 8 percent in 2006 followed by 
another 2 percent decline in 2007. New home sales will fall by an even 
greater amount of 16 percent in 2006 and then 7 percent in 2007. Home 
price growth will be minimal (less than 3 percent) in both of these 
years, again, it is important to remember that all real estate is 
local. Therefore, some local markets will not comport with the national 
forecast. Any significant shift in mortgage rates and the state of the 
economy will also alter the outlook.
    Based on the housing market forecast mentioned above, the 
residential construction spending portion of the economy will contract 
3.4 percent in 2006 and 8.5 percent in 2007. In other words, $21 
billion will be subtracted from GDP in 2006 and another $49 billion 
slashed in 2007. That would be a sharp contrast to the near $50 billion 
in additions during the housing market boom.
    The more important contribution of the housing sector has not been 
in the direct employment of real estate agents, mortgage lenders, 
construction workers, or expansion of Home Depot and Lowe's to name a 
few. Consumer spending of all things (from furniture and autos to 
travel and education) has been greatly supported by the increase in 
housing equity accumulation. A typical homeowner in the U.S. gained 
$72,300 in housing equity in the past five years, including over 
$20,000 just last year. Nearly all economists will say that consumer 
spending has been far more robust than can be explained by income 
growth, job gains, and stock market gains. GDP growth would have been 
1.5 percent points lower had the housing market not provided the wealth 
accumulation in recent years.
    NAR understands that the housing sector could not maintain a record 
setting pace indefinitely. A soft landing is certainly possible and 
under the right circumstances likely, but that soft landing is 
critically dependent upon policies that support a transition to a more 
normalized market and mitigate changes in local markets in the 
availability of mortgage financing and other essential elements to 
homeownership.
    In conclusion, the National Association of REALTORS' 
commends the Subcommittees for holding this important hearing and for 
its leadership in fashioning housing and economic policies that 
stimulate the U.S. economy. The NAR stands ready to work with Congress 
to continue to open the door to the American Dream--Homeownership. This 
concludes my testimony and I look forward to answering any questions 
you may have.
                                 ______
                                 
              ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD
                            Housing Policy Council,
                         The Financial Services Roundtable,
                                Washington, DC, September 12, 2006.
Senator Wayne Allard,
Chairman, Subcommittee on Housing and Transportation

Senator Jim Bunning,
Chairman, Subcommittee on Economic Policy, US Senate Committee on 
        Banking, Dirksen Senate Office Building, Washington, DC.
    Dear Chairman Allard and Chairman Bunning: Thank you for holding a 
joint Subcommittee hearing on the current state of the U.S. housing 
market. This is a timely subject and the Housing Policy Council (HPC) 
welcomes the opportunity to share its views on this issue and an 
important step that Congress can take to provide increased support and 
protection for our Nation's housing finance system.
    The Financial Services Roundtable's Housing Policy Council's 
members are twenty-two of the nation's leading mortgage finance 
providers. We estimate that Housing Policy Council member companies 
originate over sixty-four percent of mortgages for American consumers. 
The Financial Services Roundtable is the national trade association of 
one hundred of the nation's leading diversified financial services 
companies.
    As your subcommittees considers data on the current state of the 
nation's housing market, we urge you to keep in mind that Congress can 
take a very strong step to insure the safety and soundness of the 
housing finance system by passing legislation to strengthen the 
regulatory oversight of the housing GSEs. The GSEs--Fannie Mae, Freddie 
Mac and the Federal Home Loan Bank System are integral parts of the 
secondary mortgage market. Their safety and soundness is essential to 
effectively managing changes in the housing market. The current 
regulatory system, particularly the statutory authority of the Office 
of Federal Housing Enterprise Oversight (OFHEO) is currently inadequate 
to effectively regulate Fannie Mae and Freddie Mac in the increasingly 
complex housing finance system.
    As you will hear from a variety of sources, the U.S. housing market 
in recent years has experienced some of the strongest growth in our 
history. That unprecedented growth is now slowing significantly as 
indicated by a variety of indicators:

            Housing starts are down from the January 2006 peak 
        and are the lowest since November 2004
            New and Existing Home Sales have declined over the 
        past year
            Mortgage applications to purchase homes are down 
        over 23% from the 2005 peak.

    It is anticipated that this weakening of the housing market will 
continue for the near future. While the strength of the housing market 
in recent years has been a tremendous boon to individual Americans and 
the overall economy, the current weakening of the housing market 
reemphasizes the need to put safeguards in place now to deal with 
possible housing market developments.
    Improving the ability of the federal regulator to oversee the 
housing-GSEs is one step that Congress is very close to accomplishing, 
and we urge that the final steps be taken to enact this needed reform 
legislation.
    Failure to pass GSE regulatory reform legislation this year would 
limit OFHEO's ability to deal with potential safety and soundness 
matters at the GSEs, which could become serious, if the weakening of 
the housing market is worse than most currently expect.
    OFHEO currently lacks some of the fundamental safety and soundness 
regulatory authority that other financial services regulators have long 
possessed. For example, unlike the federal banking agencies, OHFEO 
lacks the authority to adjust capital for the GSEs to address safety 
and soundness problems. OFHEO must rely upon its cease and desist 
powers to force adjustments in capital. Those cease and desist powers 
also are more limited than the powers Congress has granted to the 
federal banking agencies. Congress has given the federal banking 
agencies the authority to bring cease and desist actions against any 
officer, employee or consultant of a bank for a violation of any law or 
regulation. OFHEO, on the other hand, cannot issue a cease and desist 
order to an employee or a consultant of a GSE, and may only issue such 
an order when certain laws and regulations are violated. Furthermore, 
because OFHEO is subject to the Congressional appropriations process, 
the agency has often lacked the resources necessary to properly review 
the activities of the GSEs. No federal banking agency is subject to the 
Congressional appropriations process.
    We believe that remaining issues regarding the appropriate 
authority for the regulator can be addressed. For example, on the issue 
of regulating the size of retained mortgage portfolios of the GSEs, the 
new regulator clearly needs the ability to adjust the portfolios of the 
GSEs to reflect the needs of the housing market and potential systemic 
economic risks.
    Improving the regulatory oversight of the housing-GSEs would 
strengthen the foundation for our housing finance system. Congress is 
very close to achieving this goal and should complete it this year. 
Creating a strong, independent regulator with authority comparable to 
other federal financial services regulators is long-overdue and much 
needed for the future of our housing finance system.
    Thank you for considering our views.
    With best wishes,
                                            John H. Dalton,
                                 President, Housing Policy Council.
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