President

The current rise in defaults reflects a combination of factors, includingflat or falling home prices, weaker underwriting standards (including higherloan-to-value ratios), regional economic weakness, and interest rate resetson subprime ARMs. About 1.8 million owner-occupied loans in subprimemortgage pools are scheduled to reset in 2008 and 2009. For mortgagesissued in the past several years, defaults are occurring well before interest ratesreset, which suggests soft housing prices and weak underwriting standardsmay be more important factors. As housing prices began to falter, flat orfalling home prices combined with weaker underwriting standards meant thatborrowers lost their “equity cushion” and had more difficulty refinancing orselling their homes. Borrowers who had purchased homes (particularly homesfor investment purposes) but now owed more than the properties were worthhad incentives to stop making mortgage payments in order to minimizetheir financial losses. Rising interest rates increased the probability of defaultand foreclosure for borrowers with adjustable-rate mortgages because theirmonthly payments grew as rates were climbing. The relative importance ofthese factors may vary geographically, as discussed in Box 2-3.Worries in late summer about exposure to risk increased in the marketsfor other mortgages as well. In particular, interest rates on jumbo mortgages(mortgages in excess of the “conforming loan limit” of $417,000) rose, andjumbo mortgage originations slowed. Chart 2-2 shows the increase since thesummer of 2007 in interest rates for fixed-rate jumbo mortgages relative tofixed-rate conforming mortgages.Box 2-3: Geographic Variations in Housing MarketsHome prices vary significantly from neighborhood to neighborhood,State to State, and region to region. In 2006, for example, the mediansale price for an existing home sold in the western United States waswell over $300,000 compared with just $170,000 in the Midwest. WithinCalifornia, the median price in San Jose was $775,000, while the medianprice a few hours away in Sacramento was only $375,000.Home prices increased from 2001 to 2007 and boomed from 2003 to2006, rising over 35 percent on average across the Nation, but thosegains also showed large regional variations. House prices rose mostdramatically in the southeastern and western United States and, toa lesser extent, in New England and the mid-Atlantic. Likewise, thesubsequent deceleration (or outright declines) in house prices in 2007also varied, with the largest changes occurring in those places that hadpreviously shown the most rapid appreciation or were experiencingprolonged economic weakness.continued on the next page58 | Economic Report of the President