Economic Recovery: The Role of Low Rates and the Housing Agencies

The full article Economic Recovery: The Role of Low Rates and the Housing Agencies is on http://www.tabbforum.com.  It started out as two articles, one on low rates, and one on the role of the housing agencies Fannie Mae and Freddie Mac now that they've gone bankrupt and have been taken over by the federal government.  One must register on the web site to read the article, so I'll reproduce the rest of it here when I have a chance.

Low Rates and Mortgage Debt

The mortgage debt market is the largest debt market in the U.S. Before the credit crisis, the housing market was expanding at a high rate. From mid-2003, when interest rates fell to 5.1 percent, through the beginning of the credit crisis (mid-2008), the debt outstanding grew 63 percent (see the above chart). Since then, it has fallen 4.8 percent. While low rates caused an explosion of mortgage debt, they had little overall impact on corporate and federal debt. Corporate debt has grown slowly and independently from interest rates. Federal debt grew steadily since mid-2001, only to take off due to the government’s attempts to remedy the crisis, growing 41 percent from mid-2008 to September 2010.

The growth in different sectors’ debts gives some insight into the mechanism whereby low rates fueled the economy. While we cannot say that corporations did not benefit from low interest rates, one would have expected their debt to have grown faster with low rates if their borrowing played a major part in fueling the economy through its previous woes (the Internet bubble, the effects of the 9/11 terrorist attack, the 2002 stock market crash, etc…). And, while we do not know exactly what was done with the money borrowed by home buyers and homeowners, the huge growth in mortgage debt does lead one to suspect that homeowners made substantial use of low rates and high home prices to remove a large amounts of equity from their homes.

The large growth in mortgage debt compared to the relatively flat level of corporate and federal debt leads one to believe that the previous economic troubles were largely mitigated through homeowner spending fueled by their use of low rates to leverage the housing bubble.

With the housing market deflated, and banks unwilling to make nonconforming loans, this is unlikely to happen again, as is evidenced by the drop in outstanding mortgage debt since mid-2008.  If this is the case, how exactly will low rates help revitalize the economy today?

More information about interest rates and mortgage debt can be found in my article Analysis of Mortgage-Backed Securities: Before and After the Credit Crisis, which can be found in the new book Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity.

New book - Credit Risk Frontiers

Credit Risk Frontiers is now available on Amazon.  The full title is Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity, edited by Tomasz Bielecki, Damiano Brigo, and Frederic Patras.  I wrote two chapters for the book:

   Counterparty Valuation Adjustments
 
and

   Analysis of Mortgage-Backed Securities: Before and After the Credit Crisis

If you are interested, please pick up a copy and write a nice review!  Thanks.

For reference, here's the table of contents:

Foreword (Greg M.Gupton).
Introduction (Tomasz R. Bielecki, DamianoBrigo, and Frederic Patras).
PART I: EXPERT VIEWS.
CHAPTER 1: Origins of the Crisis and Suggestions for Further Research (Jean-Pierre Lardy).
CHAPTER 2: Quantitative Finance: Friend or Foe? (Benjamin Herzog and Julien Turc).
PART II: CREDIT DERIVATIVES: METHODS.
CHAPTER 3: An Introduction to Multiname Modeling in Credit Risk (Aurelien Alfonsi).
CHAPTER 4: A Simple Dynamic Model for Pricing and Hedging Heterogeneous CDOs (Andrei V. Lopatin).
CHAPTER 5: Modeling Heterogeneity of Credit Portfolios: A Top-Down Approach (Igor Halperin).
CHAPTER 6: Dynamic Hedging of Synthetic CDO Tranches: Bridging the Gap between Theory and Practice (Areski Cousin and Jean-Paul Laurent).
CHAPTER 7: Filtering and Incomplete Information in Credit Risk (Rudiger Frey and Thorsten Schmidt).
CHAPTER 8: Options on Credit Default Swaps and Credit Default Indexes (Marek Rutkowski).
PART III: CREDIT DERIVATIVES: PRODUCTS.
CHAPTER 9: Valuation of Structured Finance Products with Implied FactorModels (Jovan Nedeljkovic, Dan Rosen, and David Saunders).
CHAPTER 10: Toward Market-Implied Valuations of Cash-Flow CLO Structures (Philippos Papadopoulos).
CHAPTER 11: Analysis of Mortgage-Backed Securities: Before and After the Credit Crisis (Harvey J. Stein, Alexander L. Belikoff, Kirill Levin, and Xusheng Tian).
PART IV: COUNTERPARTY RISK PRICING AND CREDIT VALUATION ADJUSTMENT.
CHAPTER 12: CVA Computation for Counterparty Risk Assessment in Credit Portfolios (Samson Assefa, Tomasz R. Bielecki, Stephane Crepey, and Monique Jeanblanc).
CHAPTER 13: Structural Counterparty Risk Valuation for Credit Default Swaps (Christophette Blanchet-Scalliet and Frederic Patras).
CHAPTER 14: Credit Calibration with Structural Models and Equity Return Swap Valuation under Counterparty Risk (Damiano Brigo, Massimo Morini, and Marco Tarenghi).
CHAPTER 15: Counterparty Valuation Adjustments (Harvey J. Stein and Kin Pong Lee).
CHAPTER 16: Counterparty Risk Management and Valuation (Michael Pykhtin).
PART V: EQUITY TO CREDIT.
CHAPTER 17: Pricing and Hedging with Equity-Credit Models (Benjamin Herzog and Julien Turc).
CHAPTER 18: Unified Credit-Equity Modeling (Vadim Linetsky and Rafael Mendoza-Arriaga).
PART VI: MISCELLANEA: LIQUIDITY, RATINGS, RISK CONTRIBUTIONS, AND SIMULATION.
CHAPTER 19: Liquidity Modeling for Credit Default Swaps: An Overview (Damiano Brigo, Mirela Predescu, and Agostino Capponi).
CHAPTER 20: Stressing Rating Criteria Allowing for Default Clustering: The CPDO Case (RobertoTorresetti and Andrea Pallavicini).
CHAPTER 21: Interacting Path Systems for Credit Risk (Pierre Del Moral and Frederic Patras).
CHAPTER 22: Credit Risk Contributions (Dan Rosen and David Saunders).
Conclusion (Tomasz R. Bielecki, Damiano Brigo, and Frederic Patras).
Further Reading.
About the Contributors.
Index.