US Economics Analyst

Issue No: 09/42October 23, 2009

Goldman Sachs Global Economics,

Commodities and Strategy Researchat https://360.gs.com

Housing Policies and Home Prices: A Big Boost

Jan Hatziusjan.hatzius@gs.com212 902 0394Ed McKelveyed.mckelvey@gs.com212 902 3393Alec Phillipsalec.phillips@gs.com202 637 3746Andrew Tiltonandrew.tilton@gs.com212 357 2619David Kelleydavid.kelley@gs.com212 902 3053

Over the last year, policymakershave boosted the housing market by reducingforeclosures, slowing the pace of distressedsales, and stimulating demand for owner-occupied housing. The effects of these policies are evident in a swelling foreclosure pipeline, a surge in first-time home purchases, and abnormally low mortgagerates.We estimate that these policies have reducedforeclosure supply by 450,000 and increaseddemand by 200,000. Taken together, thesemoves might have added 5% to home pricesnationally.If this estimate is correct, it suggests thatmost of the increase in home prices since thespring—which has totaled between 2% and4% in seasonally adjusted terms—has beendue to temporary factors.In 2010, we expect some of these supports tofade. Fed and Treasury purchases of mortgage-backed securities will taper off,and the pause in foreclosures created byfederal mortgage modification programsmay end.The federal tax credit for first-timehomebuyers appears likely to be extendedfor at least a few months, but probably nolonger than through the first half of 2010.Our conclusion is that despite the better recent data—including today’s stronger-than-expected report on existing home salesin September—the risk of renewed home price declines remains significant, and our working assumption is a further 5%-10%decline by mid-2010. However, the cloudy policy outlook adds to our alreadyconsiderable uncertainty of where house prices will ultimately bottom.

Incentives Drive First Time Purchases

01000200030004000500060007000DecJanFeb MarAprMayJun JulAugSep01000200030004000500060007000Other BuyersFirst Time BuyersNormal Share First Time Buyer SAAR, ThousandsSAAR, ThousandsSource: Natl. Assoc. of Realtors Practitioner Surveys. Our estimates.Existing Homes:

Foreclosure Pipeline Swells AsForeclosures Hit a Bottleneck

-30-150153045607590JunAugOctDecFebAprJunAug-30-150153045607590Notices of Defaultsminus Notices of Foreclosure SaleNotices of Foreclosure Saleminus Real EstateOwned FilingsThousandsThousandsSource: RealtyTrac. Our calculations.

Important disclosures appear at the back of this document.

This week, the US economics team received the 2009 Lawrence R. Klein Award for Blue Chip Forecast Accuracy over the 2005-2008 period. We thank our readers for their questions, com-ments, and critic-isms over the years and trust you will continue to keep us on our toes.

GS Global ECS US Research US Economics AnalystIssue No: 09/42

October 23, 2009

Housing Policies and Home Prices: A Big Boost

For more than a year, policymakers have attempted toreduce the number of foreclosures, slow the pace atwhich distressed properties reenter the market, and boost demand for owner-occupied housing. Weestimate that this has reduced foreclosure supply by450,000 and increased demand by 200,000. Takentogether, these moves might have added 5% to home prices nationally.If this estimate is correct, it suggests that most of theincrease in home prices since the spring—which hastotaled between 2% and 4% in seasonally adjustedterms—has been due to temporary factors. In 2010,some of these supports (such as Fed and Treasury purchases of mortgage-backed securities) will end,although others (such as the federal tax credit for first-time homebuyers) are likely to be extended.Our conclusion is that despite the better recent data— including today’s stronger-than-expected report onexisting home sales in September—the risk of renewed home price declines remains significant, andour working assumption is a further 5%-10% decline by mid-2010. However, the cloudy policy outlook adds to our already considerable uncertainty of wherehouse prices will ultimately bottom.

A False Bottom?

Home prices have firmed over the last few months, asmeasured by any of the national price indexes (seeExhibit 1). And there are several reasons to beoptimistic that the brunt of the price decline is behindus: the price-to-rent ratio has declined substantially,and home sales seem to have bottomed, which isusually a good indicator that prices aren’t too far behind. However, much of this strength seems to have been policy-induced, through foreclosure changes andloan modification programs on the supply side and taxincentives and artificially low mortgage rates on thedemand side.

Foreclosure moratoria:

In November 2008 the GSEshalted foreclosure sales and evictions. Thissubstantially reduced foreclosure sales throughFebruary (Exhibit 2). At that point, the moratoriumexpired, was briefly reinstated, and then lapsed for good at the end of March. In total, this probablyreduced foreclosure supply by around 50,000 units.In addition to the GSE-imposed moratoria, most major servicers slowed processing of foreclosures inanticipation of the administration’s mortgagemodification program, discussed below. The resultwas a substantial buildup in foreclosures near the endof the process that had not resulted in repossession(and thus unsold inventory). Exhibit 3 shows thenumber of notices of foreclosure sale, which is thestep servicers take before repossessing a property, andthe number of properties of which servicers actuallytook possession. The difference between these figureswas fairly small until late last year, but has sinceswelled. Foreclosure prevention policies appear to bethe driver, along with lengthening foreclosuretimelines due to strained administrative resources.

Loan modification programs.

The most recent phenomenon to affect the level of distressed propertysales is the recent federal mortgage modification effortknown as the “Home Affordable ModificationProgram” or HAMP. This program provides federalsubsidies to mortgage servicers to undertakemodifications, and shares in the cost of interest ratereductions. Servicers and borrowers also receive

Exhibit 1: Home Prices Have Stabilized

-30-20-1001020302007200820092010-30-20-100102030Loan PerformanceFHFA, Purchase-OnlyCase-Shiller Percent change, MoMPercent change, MoMSource: Loan Performance. S&P, Fiserv, and MacroMarkets LLC. FHFA.House Price Indices, SAAR:

Exhibit 2:The GSEs Held Back Distressed Sales

010203040506070JulAugSepOctNovDecJanFebMarAprMay

010203040506070

Foreclosure Starts, 5Months LaggedShort Sales, Deed inLieu, and ForeclosureSales

Units, thousandsUnits, thousands

Fannie Mae andFreddie Mac:GSE Foreclosure MoratoriumEffective Period

Source: Federal Housing Finance Agency.20082009

GS Global ECS US Research US Economics AnalystIssue No: 09/42

October 23, 2009

additional payments if the modification is effective, asdo lenders in certain circumstances.Once the program rules were finalized, the process of qualifying borrowers began. This process started inearnest in June, and meant that mortgage servicerswould not begin the foreclosure process until they had been either qualified or disqualified for the HAMP program, or would not complete a foreclosure in process if the borrower was being evaluated.The HAMP program has had clear success inextending trial modifications to borrowers; to date justover 500,000 loans have been modified on a trial basisthrough the program. The difficulty is making these preliminary modifications permanent: so far, only 1%of these loans have qualified, mainly due to stringentdocumentation requirements (for instance, two yearsof tax returns are required).This is an important issue because trial modificationsdon’t last forever. The HAMP program originallyenvisioned a three-month trial period, during whichtime the permanent modification would be put in place. Given slow progress to date, this period haseffectively been extended by an additional twomonths. However, unless the rate of conversion to permanent modifications is increased, servicers willsoon be faced with a choice: modify these loansoutside of the HAMP program, which reduces theeconomic incentives and legal certainty the program provides, or restart the foreclosure process where itleft off, belatedly adding these properties to theforeclosure supply.Assuming that half of the mortgages that have beenmodified on a trial basis in the HAMP programultimately default—hopefully this number will belower, but recidivism rates for modifications outsideof HAMP often exceed 50%—250,000 propertieswould emerge from the foreclosure pipeline sometimeearly next year.

State foreclosure laws.

A number of states haveenacted laws to prevent or at least delay foreclosure.These laws tend to fall into four categories, shown inExhibit 4: (1) moratoria or other unspecifiedmediation periods, which work to delay foreclosures;(2) process changes that extend the timeline by greater than 90 days or (3) less than 90 days; and (4) changesto improve the process, but with little effect on timing.Anecdotal reports from mortgage servicers indicatethat laws to extend the foreclosure timeline in somestates—as well as bottlenecks due to rising defaultsmoving through systems with fixed resources—haveincreased the pipeline of foreclosures in process.There is some evidence that state foreclosure lawshave had an effect on foreclosure sales distinct fromother national trends. Using the number of foreclosures in these states compared with the nationalaverage as a proxy for the effect that these laws have

Exhibit 4:States Have Passed Laws…

Timeline extended less than 90 daysMoratorium or open-ended mediation periodNo significant statewide foreclosure law passedTimeline extended 90 days or moreSource: National Conference on State Legislatures. Our estimates.

Exhibit 5: …To Delay Foreclosures

30354045505560-3-2-101230354045505560NFSNODPercentSource: RealtyTrac. Our calcuations.Share of Filings in Foreclosure Law States as Shareof National Total (Implementation Month = 0):Percent