March 21st, 2012
Econintersect: The housing crisis which began post financial crisis has continued to force policy makers to review strategies to halt this downward spiral in home prices. More than 3 million homes have already been foreclosed since 2008. Another 2 million are currently in the process. This post is based on a foreclosure study by Liberty Street Economics (NY Fed).
This week literally most economic releases are on housing, and it seems the Fed and the USA Administration are trying to keep housing in the forefront of news.
Some argue we need to focus our efforts on preventing losses for the population whose homes are presently at risk of foreclosure. On February 2, 2012, President Obama gave a speech promoting his argument for the expansion of refinancing opportunities and his support for diverting already foreclosed upon homes into rental properties.
The foreclosure study isolates the causes of the housing / foreclosure crisis:
- the negligence of nonprime underwriting pre-housing bust
- the large number of homebuyers taking on loans which they could never pay back
- the flattening of housing prices in 2006
The vast numbers of sub-prime mortgages were the main contributors to the housing crisis initially - but is no longer the largest percentage of foreclosures.
From 2009 to present day, majority of homeowners being foreclosed upon today are the holders of prime mortgages.
There is a relationship between unemployment rates and foreclosures. At the outset of the housing crisis, the share of foreclosed upon properties shifted from homes experiencing rising house prices to homes experiencing lowering prices in 2011. Local unemployment rates (defined by the metropolitan area) are also also seen on the chart below. At the beginning of the crisis, the majority of foreclosed upon homes was focused in areas where unemployment rates were declining. By 2011, the lion's share of foreclosures was concentrated around areas with rising unemployment rates.
The study concludes that falling house prices combined with increasing unemployment rates affects both sub-prime and prime borrowers in an local housing market.
These foreclosure numbers can also be viewed from a perspective of the time before mortgage delinquency. According to the study:
In the design of housing policy, an important consideration is the extent to which foreclosures result from situations where borrowers cannot afford their mortgage from the outset. In these circumstances, foreclosures can be viewed as the market process for removing borrowers who should not have been approved for a mortgage in the first place or who cannot sustain their mortgage going forward. When affordability is the key determinant of foreclosures, policies aimed at reducing the flow into foreclosure run the risk of slowing an adjustment process necessary for an eventual housing market recovery. A useful metric for the ability of a borrower to afford a mortgage is the “debt-to-income” (DTI) ratio. This measures the cost of the mortgage (monthly payments, property taxes, and homeowner’s insurance) relative to the borrower’s income. Unfortunately, because the data that we use from Lender Processing Services do not consistently report the DTI ratio, we cannot assess this affordability measure across time for foreclosure starts.
However, we provide an alternative indirect measure of affordability. The basic idea is that in cases where a borrower cannot afford a mortgage from the outset, payment problems are likely to materialize sooner rather than later. In the chart below, we look at the time between the origination of a mortgage and the beginning of the string of missed payments that ultimately led to foreclosure. We show the 25th percentile (25 percent of the times were shorter, P25), the median (50 percent of the times were shorter, P50), and the 75th percentile (75 percent of the times were shorter, P75). Initially, when most foreclosure starts were associated with non-prime mortgages, 25 percent of the borrowers had been in the house fewer than eight months before falling behind on their payments, and 50 percent fewer than eighteen months. However, more recently, as the composition of foreclosures shifted to prime borrowers, 75 percent had been in the house more than three years, and 50 percent more than four years. This suggests that as the recession hit, foreclosures shifted from borrowers who often could not afford their houses to borrowers who had demonstrated that they could (by virtue of making payment for several years) but began to fall behind on their payments when they were hit by the dual crises of house price declines and high unemployment.
In 2011, the number of homeowners with FICO scores considered moderate-good going into foreclosure was on the rise along with homeowners with poorer FICO scores.
In 2006, 25 percent of foreclosure starts were associated with borrowers who had a credit score of 580 or below at the time they took out the mortgage, and 50 percent had credit scores of 620 or below. However, by 2009, as the recession set in and shifted the mix of foreclosures to prime borrowers, 50 percent of new foreclosures had origination credit scores of nearly 680, and 25 percent had credit scores of 720 or higher.
The foreclosure study concludes:
A large foreclosure pipeline hangs over U.S. housing markets, creating headwinds for housing market recovery. What began as a non-prime mortgage problem has evolved into a prime mortgage problem with the onset of the recession. The inability to afford a home has been replaced by declining house prices and high unemployment as the primary driver of new foreclosures. Clearly, these changes have implications for the design of housing policy: By recognizing the shifting face of foreclosures, policymakers can make more informed choices about the most effective forms of intervention and the groups of borrowers that could best be served by them.
Liberty Street Economics (The Changing Face of Foreclosures, Joshua Abel & Joseph Tracy)