Writing in today's Wall Street Journal, economist Stan Liebowitz reports the results of his careful study of the data on mortgage foreclosures. Liebowitz finds that the chief reason homeowners default is negative equity in their homes (and, hence, not upward adjustments in the interest rates owed on ARM mortgage loans, or any other of the alleged culprits). Here are some key paragraphs:
Many policy makers and ordinary people blame the rise of
foreclosures squarely on subprime mortgage lenders who presumably
misled borrowers into taking out complex loans at low initial interest
rates. Those hapless individuals were then supposedly unable to make
the higher monthly payments when their mortgage rates reset upwards.
But the focus on subprimes ignores the widely available industry
facts (reported by the Mortgage Bankers Association) that 51% of all
foreclosed homes had prime loans, not subprime, and that the
foreclosure rate for prime loans grew by 488% compared to a growth rate
of 200% for subprime foreclosures. (These percentages are based on the
period since the steep ascent in foreclosures began — the third
quarter of 2006 — during which more than 4.3 million homes went into
foreclosure.)
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{ 33 comments }
I've been reading that prime is getting hammered too.
Is there any breakdown on the unemployment figures? Who are losing jobs? Is it minimum wage workers, management?
Losing a well paying job right now is bad. Nobody is hiring. If you go one the roll, you could stay on the roll for a while, and being upside-down is all the more incentive to walk away.
Leibowitz stopped well short of root causes according to the Austrian theory which points not only to the extensions of loans of various and sundry unsecured forms, but also to the gasoline poured on the fire by the Fed loaning money into existence. Leibowitz should read Roger Garrison's book Time and Money and should listen to Steve Horwitz's recorded remarks a FEE if he want to explore these aspects.
The Austrian story of the business cycle claims that credit expansion by a central bank enables people to get loans who otherwise would never have qualified, and not just that a new class of subprime loans will become available to risky borrowers. The mistakes induced by a central bank's credit expansion create mistakes across all classes of loans.
The emergence of more subprime lending occurs, because when interest rates are very low investors are attracted to risk to increase their rate of return, and when there is an ongoing boom, they are relatively more confident in risky assets.
Lee Kelly,
Thanks for spelling it out so clearly.
I don't know the facts, but this conclusion doesn't follow from the premise or from any quoted facts. A "prime" loan can have a variable interest rate, and a mortgage with negative equity can also fit this description, so the fact that most foreclosures involve prime loans and negative equity is no evidence that rising mortgage payments aren't involved.
Regardless, if a mortgagee finds himself deep in negative equity, foreclosure is a perfectly reasonable option, and I don't have the slightest problem with it. Not extending inflationary credit is the creditor's responsibility. He's the professional manager of money he creates, not his borrowers. [No sexism intended, Methinks.]
If creditors inflate, they should suffer consequences. A borrower finding himself in negative equity when prices decline also suffers, but the creditor certainly should suffer consequences as well.
If we had free banking and privately issued currency, foreclosures of this kind would be the primary pressure on creditors not to inflate. Protecting creditors from default is what state banking is all about, and bank depositors are creditors.
I favor non-recourse mortgages for this reason. They're sensible and necessary in the free banking context. If a creditor extends a loan explicitly secured by particular assets, giving him access to other assets to recover the nominal credit extended is a recipe for inflation.
Here in Kentucky, a friend of mine bought a house in 2002. Her plan was to live in it a few years, sell it and move back to California. She got an ARM loan that reset to the higher rate after 5 years.
Well, during the course of time, she gradually changed her mind about moving back to California and decided to stay here.
After the 5 years was up, she blamed the bank for pushing this kind of loan on her.
I don't get it. If she had followed through with her plan to move back to California, it was exactly the right loan for her. She's the one who changed her mind.
Oh well. She refinanced to a fixed rate but still blames the bank for making her have to do that.
Whatever.
What Martin said!
Leibowitz's article only explains part of the dynamics of mortgage defaults. Loss of employment, death of a wage earner, divorce, unexpected sudden large expenses, such as medical expenses, and other losses of income are the major causes of mortgage defaults.
Rate of home sales and the amount of equity in the home determines if the home goes into foreclosure, refinanced or is sold. If an income loss event happens, homeowners start defaulting and the first choices of the borrower and the lender are for a home sale or a mortgage refinance. With negative equity and a low home sales rate, homeowners have little option but to walk away from their homes and the homes are foreclosed.
Negative equity is not the cause of the need for a homeowner to cease paying the mortgage. Negative equity limits the options that a homeowner has that cannot afford to continue paying the mortgage. Positive equity allows a sale, or refinance, and payment of debt and cash in the pocket of the homeowner. Negative equity results in foreclosure because the homeowner cannot sell or refinance the home, payoff the debt and put cash in their pockets. A significant number of these homeowners walk away from their homes because they will lose them anyway.
Raising the minimum down payment to 20 percent would not have stopped foreclosures in parts of the US, such as California, Florida, and Arizona, where home prices declined by 50 percent or more. In these areas, homeowners with large down payments who cannot afford their mortgage payments would still have negative equity and those that cannot afford to continue to pay would still walk away from their homes.
Furthermore, bigger down payments would just increase the transaction costs of owning a home. Buyers would resort to other means to make the down payment, such as borrowing from relatives, credit cards, etc. If people want something, they look for ways to get it.
The article author's analysis is based on data after home prices reached their peak and started to decline. Once home prices decline, negative equity will increase and foreclosures increase among those who cannot afford their mortgages. With the advent of the recession, unemployment and partial loss of wages increased further, precipitating an increase in foreclosures in negative equity homes.
Negative equity does not cause the need for a homeowner to get out from the mortgage, but it does limit the homeowner's options once the need arises.
Home price bubble causes are a chicken and egg problem. Did consumers' insatiable demand for housing (even if it were to speculate and flip) cause the bubble, and lax lending standards to compete with competition, or did lax lending standards cause the insatiable demand and the bubble.
In a capitalistic market, that suppliers (banks and homebuilders) will meet demand at profit maximizing prices is much more logical then consumer demand will meet supply and that oversupply of homes and mortgages caused a price bubble.
Martin Brock: Can you post a link to some source that explains privately issued currency? Thx.
Over at The Big Picture, Barry Ritholtz takes a look at the Liebowitz piece and finds it seriously lacking:
http://www.ritholtz.com/blog/2009/07/zero-down-is-a-foreclosure-factor-duh/
Martin – by your logic, unsecured loans should be banned as inflationary, right?
A staggering amount of responsible people have lost their jobs since the recession began.
I'd bet that if you dig deep enough, it's more than just the loss of value of the home that's influencing the foreclosure rates – the loss of income to support a mortgage of any kind is likely a factor as well….
Green shoots die rapidly when your income's dried up to nothing in the economic drought we're experiencing these days (outside of Wall Street, that is.)
Mr. Recht – your first three paragraphs are lucid and correct. Your fourth and fifth paragraphs seem to me to be flawed.
Certainly it is true that in areas of extreme depreciation of home prices, default rates would rise even if higher down payment requirements had been in effect. But – those default rates would not have risen as much, because of two effects of higher down payments.
First, with a higher down payment, the owner would have more equity, or at least less negative equity. That means that more of these houses could be sold or refinanced instead of foreclosed.
Second, with a higher down payment, the monthly payments would be less. That means that more of the owners could afford to continue to make monthly payments, even in a down turn.
Your conclusions also seemed flawed. Your assertion that insatiable consumer demand caused the bubble ignores the fact that demand is always insatiable – people always want to own their homes. For decades lenders resisted the temptation to lend money without a substantial down payment. What changed in recent years is that the lenders made very high asset-to-value loans, a change which fueled the residential real estate bubble.
Explanations for economic changes that rely on "greed" or the ordinary workings of the market in matching demand with supply normally are inadequate, because they fail to account for the fact that greed and the market have been in place for a long, long, time. Why were there lax lending standards in 2000 but not in 1990, 1950, or 1900? In all those eras consumers wanted houses.
I agree with Martin Brock & Lee Kelly.
I don't know about Martin, but I don't think that is necessary. lenders should be allowed to suffer the consequences when the creditor defaults.
S Andrews: What consequences? Does the lender throw up its hands and get nothing? Does it get to sue the borrower and seize the borrower's assets? What?
No. A home mortgage is not just another loan. A home of some sort on some terms is a necessity for practically everyone. Even renters often occupy homes mortgaged by someone else. Home mortgages are the largest and longest term credit that a financial system commonly extends to people.
Mortgage credit is an essential element of monetary policy for this reason, in a way that other personal credit is not. Conflating this particular credit with all credit is not useful. Subjecting home mortgage lending to a particular standard is not unreasonable.
If you borrow ten grand on a credit card to buy a boat, unsecured, I have no problem with a creditor seeking liens on other assets to recover the credit extended, but even in this scenario, I oppose states subsidizing the cost of recovery, and I want bankruptcy available on reasonable and customary terms.
The volume of unsecured, personal credit is much smaller than the volume of mortgage credit, but creditors could in principle overextend unsecured credit to an inflationary degree. The best remedy for this ill is liberal bankruptcy protection. Creditors should understand that overextending credit will cost them, that Uncle Sam won't bail them out either by direct subsidy or by squeezing every possible dime out of their debtors at taxpayer's expense.
George Selgin seems to be the respected authority around here, so I'd start with the 11/17/08 podcast of EconTalk and the interview with Selgin that Don linked here in May. Here's an interesting article on private currency in the developing world by Selgin and White at EconLib.
Avoid identifying private money with a commodity like gold, because this misconception is very common, and you'll encounter it a lot if you explore this subject. Even under a gold standard, gold is not money. It is the standard of value, relative to which the value of other things is measured, but it is not money.
Banknotes under a gold standard are not limited, in a one-to-one ratio, to gold on deposit at a bank. These notes represent the value of everything securing bank credit, from houses to the labor of borrowers, not only the value of gold on deposit.
When a banker extends credit against the purchase of a house worth a hundred ounces of gold, he doesn't literally lend a thousand ounces of gold. Rather, he equates the market value the house with this quantity of gold. He assumes that he could, if necessary, obtain this quantity of gold for the house.
A free banker need not possess this quantity of gold to extend credit on this house, any more than the home's builder must possess this quantity of gold to extend the same credit in a "rent-to-own" fashion.
When a banker extends credit against the purchase of a house worth a hundred ounces of gold, he doesn't literally lend a hundred ounces of gold.
That depends on whether the lender has any recourse on the terms of the loan. If the loan is a non-recourse variety, lender can throw up his hands, or throw up, commit suicide; other than the right to take back any collateral, lender will no other way to recover the whole or part of the loan.
That depends on the kind of gold standard. IF law says that gold and only gold can be money then obviously there needs to be a 1-1 ratio on any monetary contracts. If however, there are no legal tender laws and people are free to use anything commonly accepted as money ( including private bank notes ), then there is no need for a 1-1 ration.
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The lender gets the value of the house securing the mortgage. That's what "mortgage" means. He doesn't the value of the mortgagee's car, wedding ring or first born son. The mortgagee loses any equity he thought he had in the house, including any down payment. The bank loses the balance owed that can't be recovered by selling the house. In a deflationary scenario, this division of the nominal loss seems perfectly reasonable to me. If creditors don't like it, they can simply refrain from inflating.
No law has ever said so, not in the U.S. anyway, and if a law tried to say so, people would necessarily ignore it. Actual free banking systems, like the Scottish system, did not operate this way, even though they operated under a gold standard.
Legal tender laws don't prevent private banknotes. We had private banknotes at the state level many times in the U.S., even though only gold and silver were legal tender in the states.
Again, banknotes promising gold do not represent banked gold. They represent the value of assets securing credit relative to the value of gold.
If I have a hundred ounces of gold in my vault and I've lent banknotes promising a thousand ounces of gold against ten houses each worth a hundred ounces of gold, my bank is perfectly solvent, because I don't only have the hundred ounces of gold to meet my obligations. I also have the houses.
If demand for my gold increases, so that my gold reserve falls to fifty ounces of gold, I liquidate capital by calling in one of my loans. I might require the mortgagee to pay off the loan in gold, probably by moving out and selling the house, or I might sell the mortgage for gold to another bank with a larger gold reserve. Then I have 150 ounces of gold in my vault, plus nine houses, and I can easily meet my note holder's demand for gold.
So Martin – just so I understand, is your objection to recourse against residential mortgagors based on some ethical principle, or is it because of the inflationary effect?
If the latter, I presume you are also against recourse against commercial borrowers, since I'm guessing that commercial real estate lending represents a substantial fraction of all bank lending.
Yes sir, sir!
I don't have the slightest problem with it.
I favor non-recourse mortgages for this reason.
Posted by: Martin Brock | Jul 3, 2009 11:32:43 AM
It is definitely good to know that you don't have a problem with it. I know the real estate and credit industry breathed a huge sigh of relief when they read that, Martin. Oh, and did I mention the legal industry as well? Sorry, but of course they thank you also.
And, how many non-recourse mortgages will you be granting this week, month, quarter, year? Since you favor them, I am sure most of America will be interested in jumping into one.
Martin, I thank you, my mind is at ease now that I know your position and how it will effect my next commercial venture into real estate.
Does Liebowitz break out how many of the defaulting loans were recourse to the buyers? If most are non-recourse, it points to unsecured put writing as an important cause of this break. It wouldn't be the first time.
Also, related to Martin's topic, is there any data for recovery rates in excess of the home's value for busted recourse loans? Or better yet, is there any public evidence of the difference between how banks price recourse loans versus non-recourse?
One point that no one has mentioned. When the lending stabdards were reduced, this created a much higher demand for houses almost by definition. This increased demand will increase prices. Conversely, things work the same on the other side. As loans start to get into trouble, the shakiest borrowers are excluded, which reduces demand, lowering prices. Therefore what is most needed are stable standards of lending. This leads to pridictabilaty. As you have by now guessed, the people who lose the most are those shaky borrowers this nonsense was designed to help.
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Copy of my post on WSj.com regarding this article:
Prof. Liebowitz deserves credit for examining the data, addressing some of the myths regarding foreclosures, and acknowledging that politicians' actions to purportedly help are usually not only futile but also counterproductive.
However, I suggest that the government, rather than just modify its specific commands and controls, deregulate the mortgage market and close down its secondary mortgage market monopoly. In a free market, lenders and borrowers would be able to enter into any mortgages that met their mutual needs and satisfied their respective risk tolerance. The market will always be wiser than politicians, bureaucrats, and academics.
If we further eliminate federal bank insurance, any lending issues would be private, not public, and the government would have one less excuse to declare that a "crisis" requires more regulation and deeper socialism.
Academics arguing without understanding reality… All home loans are full recourse except in a few states with homestead law exemptions (small number).
Two key things to understand today's meltdown.
1. The departure of a large number of the 12 million illegals has depressed demand – particularly in the low-priced segment and for rentals.
2. Bank's stupidity in not renegotiating loans. A typical foreclosure costs $75,000 to handle the sale, secure the property, insure the property, carry the property, and eventually sell the property. That doesn't even count the loss on the eventual sale. Wouldn't it make more sense to reduce payments for a year or two and lose some interest rather than half your principal? Instead of making this easy, banks are treating modifications like refinances.
"
greed and the market have been in place for a long, long, time. Why were there lax lending standards in 2000 but not in 1990, 1950, or 1900? In all those eras consumers wanted houses.
Posted by: Ak Mike | Jul 3, 2009 3:43:27 PM
"
Always endless demand, always greed, with endless deception we don't need. Always endless people from government to crunch the numbers, always central banks watching, and endless accountants with their eyes on the fries. But this was different. In this case there was expansion of the money supply by counterfeit value, unbacked mortgage-backed-securities, auction-rate-securities de novo, back-to-back indexed-securities, default-swaps spewing out of copy machines run by girls gone wild, futures contracts on the above, call and put options on all of the above, and many more deceptions to inflate credit.
Central Banks had synchronized their dozing. Unable to invent a good fit mathematical model for the enormity of the deception economistos & economistas were crunching the qualitative but at a loss to crunch the quantitative.
Our central bankers were also dozing and snoozing and snoring in unison with bankers the world over. Until suddenly we had a changing of the guard.
Ach! Ach! And then along came Ben. Slow walking Ben, slow talking Ben. Along came wrong and lanky Hankey.
They could smell a rat! Only one draconian thing to do.
Raise rates to 6%
2B Continued
Someone deleted my worthy comment. Do you only like the droning sound of your humourless voice? The Islamo-fascists in Iran can delete a page or two out of your playbook without affecting the drivel that drips from your defective quill. I feel most sorry for the bird who lost its feathers so that you can blindside the field of economics, and your unfortunate students, with so much unchallenged BS.