What Causes Foreclosures?

The Wall Street Journal had a great article on the housing foreclosure crisis last week. Thanks to reader Alan M. for bringing it to my attention. Stan Liebowitz, professor of economics at the University of Texas, breaks down the statistics of the mortgage market to reveal the real problems.

We all marveled at the creative financing that was done. Only in America could you find a zero down, adjustable, interest only, low documentation loan. It takes a special kind of marketing department to dream up these kinds of financial instruments.

It takes a congress to encourage this kind of stupidity. Professor Liebowitz digs into millions of individual loans and discovers “the single most important factor is….negative equity in a house.”

Subprime did not cause the mortgage crisis, according to Professor Liebowitz, because people don’t walk away from a home if they have some “skin in the game.” Fifty-one percent of loans in foreclosure had prime loans, a 488% increase over normal according to the Mortgage Bankers Association. Subprime foreclosures only increased 200% over norm.

Professor Liebowitz sites analysis of 30 million mortgages compiled by McDash Analytics, 35% of the defaults were caused by negative equity, 18% subprime, and 7.5% interest rate reset. The loss of a job caused 23% of the foreclosures, and low down payments accounted for 16%.

If you combine the negative equity and low down payment loans, the combination accounts for 51% of foreclosures.

The fact that a homeowner has no equity in the home does not affect ability to make payments, rather it influences the willingness to make mortgage payments. Barney Frank is pushing to reduce underwriting standards, again. He believes that high down payments are too onerous for people that desire to own their own home. So, the cycle begins again.

It appears that common sense agrees with the statistics. The level of compliance with contract law is directly correlated with the punishment one feels by violating the contract. This will be news to some on Capitol Hill. When has common sense been displayed in the halls of Congress?

Disclosure: No positions

Comments

[axelrod608:]

>> "When has common sense been displayed in the halls of Congress?" >>

Perfect concluding sentence. Only when Congress stops trying to GIVE stuff to people will things change for the better.

Anyone who can't SAVE the downpayment can't save for the new roof, the new AC, the new water heater that we all know they will eventually need. The absolute reliance on credit and Uncle Sam to bail us out of every problem under the sun just plain doesn't work over the long haul.

This morning's news announced a new Florida $8000 downpayment program for first time homebuyiers. We have learned NOTHING in the past 3 years and will surely repeat the mistakes..

Jul 08 08:57 AM

[jeandit75:]

The home builders lobby are way too powerful. The current home owners ought to create an association to defend their right and stop the massive construction of new houses otherwise, they will never be able to sell their homes. The market is oversupplied with empty homes. Giving these king of down payment only drives more irresponsible construction. What a great country! They never learn.

Jul 08 09:27 AM

[Barbara Horne:]

It seems like Negative Equity is more of a short term issue then a long term issue. If you purchase your home with the intent to live in it for 10 or so years you would probabbly still view the value as increasing, even if there is a temp slump.

I thought 1. adjustable rates 2. job loss contributed more to the crisis, but I'm not sure, time will give us a better picture.

Jul 08 10:20 AM

[cadoggy:]

Barbara, negative equity is both a long term and a short term problem. The median length of a mortgage in America was 7.5 years before this debacle started. If you're even slightly underwater then you don't need to be an expert to realize you'll still be underwater 7.5 years from now.

The ding to your credit will evaporate decades before your home is back to $0 equity again.

Jul 08 10:59 AM

[billddrummer:]

Barbara,

According to the above statistics, more than 50% of the foreclosures resulted from a lack of initial equity--either low down payments or negative equity at the time of foreclosure.

A rational investor cuts his losses when it's clear that recovery is remote.

The people with minimal equity who let their houses go appear to be operating like rational investors.

One wonders how many others will follow that same path, since equity growth in homes looks like a long way off.

Jul 08 11:57 AM

[cadoggy:]

One important factor I haven't seen mentioned in the blogosphere is that the government is now encouraging people to walk away from their homes by the end of the year.

The Mortgage Debt Relief Act temporarily excludes foreclosed mortgage debt from taxes through 2012. So any homeowner who's on the fence about walking away has a strong incentive to get the job done before this lucrative tax relief goes away.

Jul 08 12:40 PM

[Gregman2:]

Well, if FICO and standard appraisals had been adequate they would have prevented this foreclosure crisis, right? Perhaps the way underwriting occurs is flawed. See www.homevaluepredictor...

Jul 08 12:43 PM

[ejhickey:]

From the article: " Barney Frank is pushing to reduce underwriting standards, again. He believes that high down payments are too onerous for people that desire to own their own home."

I remember an interview that Bloomberg did with Barney Frank in September 2008 in which he said "We encouraged too many people to buy homes and failed to recognize that some people are not culturally suited for home ownership." Barney should listed to his own advice but then listening or consistency has never been part of his personality.

Jul 08 05:27 PM