Sunday, June 08, 2008

The right House Price Index for Analyzing Fannie/Freddie's Finances

In this month's Atlantic, Bob Shiller has a thought-provoking piece on how to attenuate the mortgage meltdown. In that piece, however, he juxtaposes Freddie Mac Chief Economists' Frank Nothaft's statement that the company has modeled the company's financial health assuming a 13.8 percent decline in house prices with his own that real house prices have fallen by 15 percent from peak to trough.

From the standpoint of mortgage performance, it is nominal, not real, house prices that matter, because mortgage balances do not adjust to changes in the price level. So long as nominal prices rise, the incentive to default is low, because home equity will be increasing.

Just as problematic, Shiller is applying the Case-Shiller Index to make conclusions about Fannie/Freddie performance. But for evaluating Fannie/Freddie, the OFHEO purchase index is best, because it only contains loans that Fannie/Freddie actually fund, and because it is based only on transactions. This index has fallen 3.1 percent from peak so far. This is nothing to celebrate, but it is well within the realm of what Freddie modeled.


Anonymous said...

The universe of transactions may favor the OFHEO index over the Case-Shiller, but the weighting scheme favors the use of Case-Shiller. OFHEO is unit weighted, while C-S is dollar weighted, so that C-S gives a lot more weight to California. And the failure of a $300K California loan costs you twice as much (roughly) as the failure of a $150K Ohio loan.

Also, the OFHEO index might be more applicable to their normal business, but C-S might be more applicable to their non-agency portfolio investments.

Of course, nominal makes a lot more sense than real.

Richard K. Green said...

Except that Fannie's non-agency business is less than 4 percent of its total business. See . And Freddie's non-agency business is about 10 percent. See

On the other hand, the point about dollar weighted vs. unit weighted is a good one.

Dan said...

IAS360 House Price Index Provides First Monthly View of Housing Price Trends Based on Neighborhood Level Data.

Integrated Asset Services (IAS), a leader in default management and residential collateral valuation, just launched its monthly-reported IAS360 House Price Index

The new Index represents the industry’s first clear representation of U.S. housing market trends at a county level. IAS360 House Price Index is a comprehensive housing index tracking monthly change in the median sales price of detached single-family residences in more than 15,000 “neighborhoods” across the U.S. This data is then rolled up to report on the changes in 360 counties, nine census divisions, four regions, and the nation overall. The timeliness of the data, which is based on all arms-length transactions occurring in underlying neighborhoods, makes the IAS360 the leading indicator for housing price trends in the U.S. April Index:

Mark O. said...

Richard: Your main point is well-taken, but Freddie's figures look a little different from the OFHEO figures you cite. Here's the first sentence of Freddie's May 29, 2008, press release ("NATIONAL HOME VALUES FALL IN FIRST QUARTER"):

"Freddie Mac (NYSE: FRE) announced today that its Conventional Mortgage Home Price Index (CMHPI) Purchase-Only Series registered a 10.4 percent drop in U.S. home values during the first quarter of 2008 on an annualized basis, following a downward revised 9.9 percent annualized drop in the fourth quarter."

doc said...

One thing to note (in re Mark O.'s comment. A 10% annualized decline in the 4th quarter is really a 2.5% decline during the fourth quarter. Similarly, the 9.9% annnualized decline in the first quarter is a 2.5% decline in the first quarter. That's a 4.9% cumulative decline in the fourth and first quarters...not a 20% decline.

Anonymous said...