FOMC/FOMC20050503meeting/FOMC20050503meeting--8.txt CHAIRMAN GREENSPAN 6 , CHAIRMAN GREENSPAN. , '' It 's sort of sad to look at the composition of the Lehman Brothers high-yield index . FOMC/FOMC20050503meeting/FOMC20050503meeting--8.txt CHAIRMAN GREENSPAN I 'm looking at some of the names in the context of 30 years ago -- General Motors , AT&T , and Georgia Pacific . FOMC/FOMC20050503meeting/FOMC20050503meeting--8.txt CHAIRMAN GREENSPAN To what extent do the GM , Ford , and collateral issues , as they move out of investment-grade May 3 , 2005 7 of 116 the supply of marginally non-investment-grade bonds . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT Thus , institutions with large amounts of mortgage credit risk on their portfolios are well positioned to handle severe losses . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT However , as shown on line 4 , 19 percent of the mortgages guaranteed by the GSEs carry some form of credit enhancement . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT For a given drop in nominal house prices -LRB- the horizontal axis -RRB- , the vertical axis gives the percent of borrowers who would have negative equity . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT As I noted earlier , recent anecdotal reports have highlighted a second potential risk lurking within mortgage markets -- the sudden popularity of interest-only mortgages . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT June 29-30 , 2005 9 of 234 Turning to the data , line 1 of the top left panel shows that the dollar value of RMBS pools has nearly doubled over the past two years . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT The middle right panel summarizes average LTVs at origination for homes purchased in 2004 , by state , relative to price appreciation in that state over the previous four years . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT Moving to the right , the next two sets of bars show that the great majority of IO borrowers had solid credit scores between 660 and 779 . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT An obvious measure of the vulnerability of a borrower to a decline in his house price is the ratio of the current mortgage balance to the current value of his home ; this ratio is known as the current loan-to-value , or LTV , ratio . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT Moreover , as shown in line 2 , RMBS pools backed by interest-only , or IO , mortgages have increased almost sixfold , and now amount to nearly $ 300 billion . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT While the principal value of an IO loan does n't decline , if the initial down payment is large enough , the borrower may have a substantial equity cushion against price shocks . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT Thus , homebuyers in California and other high-appreciation states made larger down payments relative to the price of their house than homebuyers in low-appreciation states such as Oklahoma . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT The top panel of your first exhibit compares the distribution of the estimated current LTV as of September 2003 -LRB- the black bars -RRB- with the distribution as of March 2005 -LRB- the red bars -RRB- . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT Finally , anecdotes often emphasize that IO loans are extended to borrowers with lower credit quality . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT If one of these mortgages defaults , the GSE receives a payment from the insurer , usually a private mortgage insurance , or PMI , company . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT The average LTV on mortgages has declined over the past 18 months , and most households currently have substantial equity in their homes . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT Nonetheless , even the most sanguine analyst quails when contemplating a historically unprecedented drop in nationwide nominal house prices . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT 7 , MR. LEHNERT. , '' As Josh noted , everyone 's talking about house prices ; but they also seem to be talking a great deal about mortgages . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT Indeed , the evidence points in the opposite direction : borrowers have large equity cushions , interest-only mortgages are not an especially sinister development , and financial institutions are quite healthy . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT RMBS pools -LRB- line 3 -RRB- , as well as banks and thrifts -LRB- line 4 -RRB- , hold a wide variety of different mortgage types , including traditional fixed - rate mortgages as well as variable-rate and junior liens . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT Thus , perhaps it would be best simply to venture the judgment that the national mortgage system might bend , but will likely not break , in the face of a large drop in house prices . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT The red line -LRB- right axis -RRB- shows net underwriting income -- that is , income from premiums less losses and expenses , relative to capital . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT In practice , however , investors price these mortgages using loss models , which are estimated using relatively little data from major house-price declines . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT Private mortgage insurers , line 2 , insure the component of mortgage principal that exceeds 80 percent of the property 's value and so are effectively exposed to the credit risk associated with high-LTV loans . FOMC/FOMC20050630meeting/FOMC20050630meeting--9.txt MR. LEHNERT As shown in the memo line , interest-only RMBS pools now account for 3.6 percent of all home mortgage debt , up from less than 1 percent two years ago , but still a small share of all mortgages . FOMC/FOMC20050630meeting/FOMC20050630meeting--196.txt MS. JOHNSON To the extent people walked away from the houses , the financial intermediaries were getting collateral that perhaps no longer equaled the value of the loan . FOMC/FOMC20050630meeting/FOMC20050630meeting--196.txt MS. JOHNSON 194 , MS. JOHNSON. , '' Well , for one thing , the U.K. 's 1990 cycle was amplified by regulatory changes that preceded it , which led to mortgage lending that was excessive and not well supervised . FOMC/FOMC20050630meeting/FOMC20050630meeting--196.txt MS. JOHNSON It was a kind of blind-leading-the-blind situation : The regulator changed the rules and the financial institutions moved into the market and practices and norms changed . FOMC/FOMC20050630meeting/FOMC20050630meeting--196.txt MS. JOHNSON And all three statements the media chose June 29-30 , 2005 68 of 234 -LSB- Laughter -RSB- And all of the statements were slightly two-handed , along the lines of : Monetary policy should not be driven by housing prices , but we must look at them closely . FOMC/FOMC20050630meeting/FOMC20050630meeting--196.txt MS. JOHNSON U.K. officials think they 've seen a lessening to some degree of this tight link between housing wealth and consumption so that they 're not both on the run-up and then , when it stops , extrapolating what the consequences would be . FOMC/FOMC20050630meeting/FOMC20050630meeting--196.txt MS. JOHNSON And there is the fact that house prices actually fell in the U.K. , so they had big negative equity problems , which complicated the process of how to unwind the interaction of household behavior and financial intermediary behavior .