Fresh Evidence on Housing Foreclosures

This past weekend's Wall Street Journal had an editorial by Stan Liebowitz, a professor of economics at the University of Texas in Dallas. He writes a very compelling piece demonstrating that current policy makers are wrong in both their beliefs as to what brought about the mortgage default crisis and what will resolve it.

He wrote,

"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.)

Sharing the blame in the popular imagination are other loans where lenders were largely at fault -- such as "liar loans," where lenders never attempted to validate a borrower's income or assets.

This common narrative also appears to be wrong, a conclusion that is based on my analysis of loan-level data from McDash Analytics, a component of Lender Processing Services Inc. It is the largest loan-level data source available, covering more than 30 million mortgages.

The analysis indicates that, by far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home. The accompanying figure shows how important negative equity or a low Loan-To-Value ratio is in explaining foreclosures (homes in foreclosure during December of 2008 generally entered foreclosure in the second half of 2008). A simple statistic can help make the point: although only 12% of homes had negative equity, they comprised 47% of all foreclosures.

Further, because it is difficult to account for second mortgages in this data, my measurement of negative equity and its impact on foreclosures is probably too low, making my estimates conservative."

Thus, according to Liebowitz' analysis of available data, people defaulted on mortgages mostly because they should never have been in those homes in the first place.

He continues,

"To be sure, many other variables -- such as FICO scores (a measure of creditworthiness), income levels, unemployment rates and whether the house was purchased for speculation -- are related to foreclosures. But liar loans and loans with initial teaser rates had virtually no impact on foreclosures, in spite of the dubious nature of these financial instruments.

Instead, the important factor is whether or not the homeowner currently has or ever had an important financial stake in the house. Yet merely because an individual has a home with negative equity does not imply that he or she cannot make mortgage payments so much as it implies that the borrower is more willing to walk away from the loan.

The difference in policy implications is enormous: A significant reduction in foreclosures will happen when and only when housing prices stop falling and unemployment stops rising (see chart nearby).

Although the government is throwing money -- almost $2 trillion and counting -- at the mortgage markets with the intent of stabilizing house prices, its methods are poorly targeted. While Federal Reserve actions have succeeded in reducing mortgage interest rates, low interest rates induce refinancings more than they do home purchases."

This is a very important point. Once again, goverment meddling in asset prices only prolongs pain and adjustments of the market to the correct price levels. The recent subsidies to promote home purchases simply represent another form of the government actions which facilitated the original mortgage default debacle, i.e., promoting purchases of housing and creating false floors under prices.

Liebowitz concludes by noting,

"Unfortunately, recent attempts by politicians such as Barney Frank (D., Mass.) to again artificially increase homeownership levels might delay this return to sustainable equilibrium prices.

Other government policies are likely to be even less effective in reducing foreclosures. The Obama administration's "Making Homes Affordable" plan focuses on having the government help lower obligation ratios (the share of income devoted to house payments) down to 31% from levels somewhat above 38%. But my analysis finds that mortgages having such obligation ratios at closing did not later experience high foreclosure rates. This suggests that reducing these ratios is not likely to significantly improve the foreclosure problem.

Understanding the causes of the foreclosure explosion is required if we wish to avoid a replay of recent painful events. The suggestions being put forward by the administration and most media outlets -- more stringent regulation of subprime lenders -- would not have prevented the mortgage meltdown regardless of their merit otherwise.

Rather, stronger underwriting standards are needed -- especially a requirement for relatively high down payments. If substantial down payments had been required, the housing price bubble would certainly have been smaller, if it occurred at all, and the incidence of negative equity would have been much smaller even as home prices fell. A further beneficial regulation would be a strengthening, or at least clarifying at a national level, of the recourse that mortgage lenders have if a borrower defaults. Many defaults could be mitigated if homeowners with financial resources know they can't just walk away.

We are at a crossroads where we can undo the damage to the housing market by strengthening underwriting standards in a reasonable way. But to do so political leaders must face up to the actual causes of the mortgage crisis, not fictitious causes that fit political agendas and election strategies."

It's sound advice as we continue to see government intervention in housing finance. Chances are it is all detrimental and distorting, just like Fannie's and Freddie's original market-distorting activities which incented lenders to make imprudent loans on too little buyer equity.

Boone Pickens' Energy "Plan" A Year Later

I saw Boone Pickens on CNBC Tuesday morning. He was there to mark the one-year anniversary of his non-plan national "energy plan."


Suffice to say, Boone was crowing about Congressional legislation including natural gas. But he begged off commenting on 'cap and trade.'


This seems totally disingenuous to me. He claimed he isn't an expert on that topic, so he refused to comment whatsoever on the bill.


Personally, I don't think that dog hunts. Pickens is smart enough to judge whether or not distorting the prices of energy sources via political machinations is a wise thing.

And nobody has yet explained how we know when we spend "too much" on any one good that requires foreign exchange.

In an unrelated article, for example, I read one pundit ask why spending what the US spends on healthcare is "too much," but continuing to pump dollars into union-run schools isn't?

It's still the same with energy. While it may be unwise to leave so many dollars in the hands of unfriendly powers, that's different than buying a fairly-valued commodity input in the market, to use to create value in the US.

Lastly, if Pickens isn't smart enough to have any opinion on 'cap and tax,' why should we believe he's intelligent enough to propose a sound energy policy/plan?

He can't have it both ways. Either he has informed opinions on energy policy in general, or he doesn't. It can't be a pick and choose thing. Even for Pickens.

Morgantown Still Economically Vibrant

Last year at this time, I wrote a post about Morgantown, West Virginia. At that time, I noted that, though many talked of recession, this city certainly didn't exhibit any such signs.

I'm back here in Morgantown again, and the picture looks quite similar.

For example, on a Monday evening, a bit later than the Thursday evening last year, the same Olive Garden restaurant was still busy. Not full, though. It was about half full and we were seated immediately this time.

But there is a new Red Lobster across the parking lot, and people were waiting outside to get into that restaurant when we left after 8pm.

The Wal-Mart was still busy this year. Shopping carts were still being filled, and shelves were fully-stocked.

Traffic in Pennsylvania and Maryland was a bit lighter than last year, which fits the recent survey suggesting a 2% decline in driving over the holiday.

Never the less, the mix of activity I've seen in areas typically viewed as economically challenged, still seems vibrant.

More Stimulus?

Unbelievable as it sounds, members of Congress are pleading for another deficit-busting stimulus bill.



Apparently they are worried because the ill-designed first $787B bill didn't work. Much of the spending went to transfer payment programs, some went to temporary road-building jobs, and much is planned for out-years.



There were critics of the bill which warned of this result, but Congress passed it so fast there literally was not enough time from the bill's being written, and then voted on, for any one of them to have actually read the bill.



Meanwhile, last week's unemployment rate went to 9.6%. Far higher than the 8% this administration assumed when it pushed for the stimulus bill.



A common definition of insanity is doing the same thing again, but expecting different results. That's where we seem to be with our economy, unemployment and stimulus bills.



Perhaps, if anything were to be done, it would be to shift existing, unspent so-called stimulus funds to direct income tax rebates, in advance.



At least doing this would insure that the money is spent now, by consumers, rather than politicians.

Have Banks Been 'Too Big To Fail' Since 1975?

Holman Jenkins, Jr.'s column in last Wednesday's Wall Street Journal contended that there's really nothing new about large US banks being bailed out by Bernanke's Fed.

After arguing that if BofA shareholders had known about Merrill's worse-than-expected condition, they may have voted down the deal. As it was, Jenkins notes, BofA's Ken Lewis promptly sought Fed financial aid after the deal closed.

Fair enough. But I don't think it's correct to say that US government policy for 30-odd years has been to save all large commercial banks.

The period Jenkins references just about covers the time from when I was in college, so I have a fairly good recollection of the era.

Names which were once prominent, but are no longer with us, include: First Pennsylvania, Seattle First, Texas Commerce, Bank of New England, Continental and Bankers Trust.

In fact, it was just about the mid-1970s when technology was beginning to lead to excess capacity in banking, setting the stage for eventual consolidation.

Usually, I agree with Mr. Jenkins. But not this time.

There hasn't been a 'too big to fail' ethic in US banking for three decades. Rather, it's been more like the last ten years, dating roughly to Greenspan's Fed stage-managing Long Term Capital Management's demise.

So, oddly, I would contend that it wasn't even a commercial bank that was the first instance of the 'too big to fail' doctrine. In today's financial sector, any sufficiently large institution, even a privately-owned one, such as a hedge fund, has enough implicit influence on asset prices, and enough complicated entanglements with other firms, to cause regulatory panic at the thought of failure.

For the most part, though, with size goes mediocrity. Most of the financial utilities- Citigroup, Chase, BofA, to name three- got that way through federally-approved mergers, not organic growth.

These super-sized financial entities are our own governmental creation, rather than that of simple business acumen.

Maybe it's appropriate, given government's permissiveness in allowing these gargantuan banks to merge themselves into existence, that government must clean up the mess when they begin to fail.