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Federal Reserve Reduces Stress on Housing Markets

2016 Supervisory Scenarios

David Stiff    |    Housing Policy

The Federal Reserve’s recently released 2016 Supervisory Scenarios for home prices paint a slightly less pessimistic picture for housing markets in the event of a sharp economic downturn or another global financial crisis, compared to the Fed’s 2015 scenarios. Home prices fall 12 percent and 25 percent from peak to trough in the 2016 Adverse and Severely Adverse Scenarios, respectively. Although these are dismal numbers, they are better than the 14 percent and 26 percent declines posited by the 2015 scenarios. The Baseline Scenario stays roughly the same with 9.0-9.5 percent cumulative appreciation over three years.

This less pessimistic view of housing market downturns reflects a change in the Fed’s narratives of hypothetical economic shocks. The 2016 Adverse and Severely Adverse Scenarios assume that the U.S. and global economy will experience severe disinflationary/deflationary recessions, with periods of negative or nearly negative inflation and short-term interest rates.  The Fed’s thinking about how things could go wrong in 2016 reflects the current state of the global economy – commodity prices are crashing, manufacturing output is slowing in some countries and falling in others, and inflationary pressures are non-existent. The Fed’s 2015 Adverse Scenario, on the other hand, followed the pattern of all post-World War II recessions prior to the financial crisis – economic downturns that resulted from the Federal Reserve increasing short-term interest rates to cut off rising inflation.

In its 2015 Severely Adverse Scenario, the Fed also assumed that the economic crash would be caused by a deflationary shock, but a shock that was mostly limited to asset prices.  In the 2015 Severely Adverse Scenario, goods and services inflation never declined below 1 percent, while in the 2016 version it drops close to zero and only slowly climbs back to the Fed’s 2-percent target rate.

Because inflation rates are assumed to be lower in the 2016 Adverse Scenarios, the Fed also assumes that mortgage interest rates will be lower than in the 2015 scenarios. Lower mortgage rates provide a bit of protection to housing markets exposed to moderate or extreme recessions, so home prices track a little higher in the 2016 Adverse Scenarios.  This is despite the fact that labor market losses are larger in the more recent scenarios – the unemployment rate increases by 2.5 and 5.0 percentage points in the 2016 Adverse and Severely Adverse Scenarios, respectively, compared with 1.9 (Adverse) and 4.0 (Severely Adverse) percentage point increases in the 2015 scenarios.

The CoreLogic Home Price Index (HPI) Forecasts Stress-Testing Scenarios have been updated to incorporate the Federal Reserve’s 2016 HPI Supervisory Scenarios.  The CoreLogic HPI Forecasts Stress-Testing Scenarios disaggregate the Federal Reserve’s national HPI Supervisory Scenarios to state, Core Based Statistical Area (CBSA), county and zip code geographic levels.  They can help identify sub-national markets that are most vulnerable to large home price declines in periods of economic stress and, as a result, improve the accuracy of stress-testing modeling.

[1] For a more detailed introduction to CoreLogic HPI Stress Testing Scenarios, please visit the Insights Blog: Locating Home Price Risk with the CoreLogic Home Price Index Forecasts Stress-Testing Scenarios

[2] CoreLogic produces HPI Forecasts Stress-Testing Scenarios that are consistent with the Federal Reserve’s National Supervisory Scenarios for the Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank Act Stress Testing (DFAST) programs. Since the Federal Reserve’s national scenarios are developed in collaboration with the OCC and the FDIC, the new CoreLogic scenario forecasts are applicable for stress testing by any financial institution with more than $10 billion in assets. The HPI Forecasts Stress-Testing Scenarios may also be useful for smaller institutions since OCC guidelines state that: "The OCC expects every bank, regardless of size or risk profile, to have an effective internal process to (1) assess its capital adequacy in relation to its overall risks, and (2) plan for maintaining appropriate capital levels.” Furthermore, the National Credit Union Administration (NCUA) issued rules that will require federally insured credit unions with more than $10 billion in assets to perform annual stress tests.