Housing and the Banking Industry
The deterioration of the housing market shows few signs of nearing an end. The S&P/Case-Shiller home price index registered year-over-year quarterly declines of -14.2 percent and -15.4 percent in the first half of 2008, extending its record drop. OFHEO's price index has also remained in negative territory after dipping below zero for the first time in its 17-year history in the fourth quarter of last year. While both indexes show downward pressure on home prices, the magnitude of the declines differs significantly across the two. The reason is that OFHEO tracks only homes with mortgages below Fannie Mae and Freddie Mac's conforming loan limit, which was set at $417,000 in 2006 and 2007. (That limit has been temporarily raised to $729,000 or 125 percent of an area's median home price, whichever is lower). The S&P/Case-Shiller index tracks home sales in all price ranges and is therefore more affected by the pricey housing of the coastal areas.
As housing-market conditions continue to worsen, mortgage-related losses are taking a big bite out of mortgage lenders' profits. Thrifts - FDIC-insured depository institutions that specialize in mortgage lending - began to record losses in the fourth quarter of 2007. The industry's aggregate profits - which were around $4 billion a year ago - fell to -$5.3 billion in the second quarter of this year.
Increasingly, the deterioration in earnings is affecting more than a few large institutions and becoming a widespread problem. Evidence of this can be seen in the share of the industry's assets that is owned by unprofitable institutions. This share was high in 1990, fell to much lower levels thereafter, and has been shooting back up since 2005. In 1990, for example, almost 50 percent of the assets owned by large thrifts those whose total assets exceed $1 billion - were owned by large thrifts that were unprofitable. This share fell to 3.5 in the first quarter of 2007 and to 1.8 percent in the second quarter. But by the second quarter of 2008, 56 percent of these institutions' assets were owned by large thrifts that were unprofitable - a higher share than during the thrift crisis of the late 1980s. Note that we have not adjusted asset sizes for inflation, so a $1 billion thrift in 1990 was an economically bigger institution than a $1 billion thrift today.
Further evidence of the spreading effects of the housing situation is the growing number of unprofitable institutions. In the first quarter of 2007, about 20 percent of thrifts with assets less than $300 million and 10 percent of thrifts with assets greater than $1 billion were unprofitable. Those numbers jumped to 28 percent and 29 percent, respectively, by the first half of 2008. The proportions of unprofitable institutions in each size category are well below the levels they reached in late 1980s, but their increases now suggest that profitability is being squeezed across thrift institutions of all sizes as home prices fall.
Bank holding companies and financial holding companies (BHCs and FHCs) seem to have fared slightly better in these difficult times, but their luck might be changing. These holding companies own a diverse set of financial institutions, ranging from depository institutions to insurance companies and investment banks. Although total holding company profits remained barely positive at $5.5 billion last quarter, the number of companies reporting losses has been steadily increasing over the past year. In the second quarter of 2008, about 15 percent of holding companies of all sizes were unprofitable.
As thrift and other financial institutions' profits have been pressured by housing declines, insured deposits across the banking system have continued to rise, reaching $4.4 trillion by the end of the first half of 2008. Bank failures during early 2008 have contributed to a depletion of the Federal Deposit Insurance Corporation's reserves, which have fallen below the target range of previous years to 1.01 percent of total insured deposits as of June 2008. What's more, the FDIC's data are current only as of the second quarter of this year, so they do not include the seizure of IndyMac in July. The largest thrift failure in U.S. history, IndyMac will cost the insurance fund an estimated $4 billion to $8 billion to cover. Nor does the FDIC's data include the recently enacted increase in the limit of insured deposits from $100,000 to $250,000.
FDIC data on troubled banks and recent failures, like the home price indexes detailed earlier, provide little assurance that pressures on financial institutions will ease in the near future. While the number of failed institutions remained modest up through June, the size of these banks with regard to assets is already at or near levels last seen following the 2001 recession. Before the failure of IndyMac, the number of troubled institutions nearly doubled from 61 in 2007 to 117 this year.