An interesting paper from several economists including two from Fannie Mae studies the causes of foreclosures in Southern California over the last few years. The paper seeks to determine whether it was home value declines or excessive borrowing at the time of the purchase and in subsequent refis that cause foreclosures. This is the sort of question that's fascinating to economists and academics but doesn't matter much to the homeowner who finds himself out on the street. But it does have important policy implications and it's helpful for us to understand as we start to post mortem the housing crash of the last few years.
Their conclusion? Excessive borrowing is the culprit, more so than home value declines:
"While capital losses resulting from the house prices declines that began, in most cases, in 2006 contributed to incidence of negative equity, excessive borrowing was clearly an equally important contributory factor. In addition, while house price declines were important in explaining the incidence of negative equity, its magnitude was strongly influenced by increased debt usage. Hence, borrower behavior, rather than housing market forces, seems to be the predominant factor affecting outcomes."
30 Comments on What causes foreclosures? Excessive borrowing, not home price declines
AUG
04
2009
True....but the creative financing was intended to be temporary. The assumption was that they could then have a history of good mortgage credit to refi into a permanent situation that they couldn't qualify for at this point.....speaking of the first time home buyers of course. Then the decline in demand and prices made the refis unfeasable because they had 100% financing and no equity. A bad idea all around.
There are people who borrowed too much, and consequently couldn't make the scheduled payments. That is, people who perhaps should have clearly known that they were over borrowing, such as 125% LTV, or 75% debt:asset.
Then, there are people who owned property that drastically declined in value. Suddenly they were upside down. Doesn't much matter if they are staying in place, have a steady income, ... And, their loan payment was in line with their income. Maybe it was an 80% LTV loan. Maybe they stayed well below 50% debt:asset, at least when the loan was originated. But, then their is an unexpected change in income because the economy tanked. Or, they have a job move, and have to sell.
I have a bit of a different opinion on this whole debacle. Lending to a ham sandwhich is what drove prices up through lack of inventory. Anyone could buy a home so why not?
Foreclosures go up slightly at end of 2006 and major lending sources started to fold by Dec. Saw lending products being taken away around Jan 1, 2007. Less and less people could buy homes as guidelines changed on almost a daily basis (and they still are changing folks!)
Prices would decline because affordability is out of reach.
Investors would say "I am outta here" by mid 2007. Tenants would be left as the carnage.
Normal people say "I got a couple hundred grand out of it through my refi" and never looked back.
Some with funky purchase money would be unable to refi.
Now everyone is scratching their heads saying "it ain't worth anything so what's the point?"
DISCLAIMER: My opinion is not the word of god but trust me, I have seen a lot through the course of the last (almost three) years. Just when I don't think attitude or foreclosure profiles couldn't get any stranger.........
Excessive borrowing certainly impacts the probability of a foreclosure. That being said, the person that bought in 2006 and put down 20% would beg to differ.
Now the person who put down 20% and had their home devalue 30% needs to move because they lost their job. If everything had stayed status quot then all may have been fine.
Just about every foreclosure I've seen has stemmed from medical expenses or loss of income. People are losing their jobs and staying unemployed for long periods that go beyond whatever savings they have. I'm surprised that this wasn't mentioned as a key reason.
I don't agree. It seems that there's pleny of blame to go around, and like the pyramid scheme, as long as people are buying below those at the top, there doesn't appear to be a problem until everything blows up.
Spencer- I see this a lot here in South Florida. I don't know many people during the boom who were putting 20% down- they were mostly leveraging as much and as fast as they could. Refinancing was the thing to do if you did put 20% down years before.
I just met a man who bought his house back in 1995 for 125K. Great price, great loan, great time to buy. He had a fixed note and could take care of the payments. No problems. But then it became just too easy to turn that house into an ATM machine because his house went up in value to over 350K. So they refi'd to the max. Then they chose a neg ARM. Then they chose to make the lowest payment each month. Now their home is worth 225K. But they owe $290K. So wasn't that their decision? Sure, there were luring ads on tvs and the urge to follow the jones is strong, but at what point does personal responsibility take over?
If this person gets a job transfer does that change the paradigm? I don't think so. If you are in a job where you may have a chance of getting relocated, should that not be taken into consideration when you decide to buy new cars, go on a cruise and buy new furniture with refi money?
We do a lot of short sales, we carry a lot of listings. And for the most part; with some exceptions- the folks are sleeping in the beds they made. I have to agree that from the volume of transactions we are involved with and attorneys we know are involved with ( as we have meetings regularly to discuss the market, etc) are those who either refi'd like in this example or were making 35K to 45k a year and buying homes that were 600K to 900K and never should have bought that house in the first place or they were wannabe investors who got caught with their shorts down when the bubble burst. We have subdivisions where people bought 3,4,5- 600K to 900K homes to flip before closing! Katerina
Excessive borrowing but in many cases due to less than ethical loan officers pushing their negative amortization loans and other products than borrowers did not understand or just could not afford. Of course there's enough blame for everyone.
This world wide recession was caused by a housing debacle caused by greed from top to bottom in the lending industry.....a happening loved by REALTORS...and encouraged by both parties in the Congress and two administrations in the White House.
But what enabled it was greed on the part of a lot of borrowers.
But if the fundamentals of our economy had actually been sound, the depth of the crisis would have been much easier to fix.
The fundamentals of most importance were: Too much private debt. Too much public debt. Too little personal savings,
We may move out of this buyers market....but we are long way from being safe on the fundamentals.
It seems that many borrowers have at any level have pretty much not looked beyond the end of their nose... can I handle the payment? Maybe that payment was going to adjust every 12 months, but they didn't consider that... it's can I make the payment right now that they expect me to?
We as a nation live way beyond our means, it's all about leveraging and have the grand life. How can our government talk about the overextension of borrowing when they are doing the very same thing!
Yes, my clients of all my short sales were "excessive borrowers" and it wasn't because of the lenders making it easy for them to sign and get more money. .
it's like saying . .
A crack cocaine user becomes dependent and hooked because of their excessive consumption of crack . .and the dealer that gives them those drugs. . is FREE OF GUILT!
I think it is a combination of personal resposibility, ethical lending and loose regulations that pushed this bubble ( which was ready to pop years earlier but was just lulled along) to burst. From that set of circumstances naturally brought forth a declining of some home values. Not everyone is as careful and common sensical as everyone else so this plethora of different mind sets (buyers) made some take risky steps to own a home they probably should not have while others simply did the math in their head, decided that the risk was not worth it and spent conservatively and are now still living comfortably.
it's funny - the two correlate with each other! Excessive borrowing made the prices rise, and when the prices rose the financing had to get creative to continue the excessive borrowing!
Instead of making excuses for everyone, we need to start moving on and learning from the problem. Not everyone has the ability to own a home, and lenders do not deserve our tax money for loans they should have never dispersed. I think that the failures of this economy show that we are not all financial equals - I personally can not afford a high end luxury automobile, but I was approved to purchase one! Just because you can, does not mean you should. The point is that we can not blame the lenders without blaming the borrowers - and all of us saw it, you know the listing appointments with the seller who wanted to price their homes $30k higher than the last sale.
I also disagree about the whole regulations and watchdog mantra - if a business decides to run poorly, then let them pay the consequences. Regulations only hinder recovery - the solution is accountability. If some company is willing to give money out to someone who says they have a job making x, then those companies should be forced to face the music when their troubles start mounting.
Seems that the mortgage brokers, or "Instigators" of the mortgage melt down, where mainly located in places like California & Florida, where they where putting people earning $20 an hour, into$300,000 adjustable rate mortgages, and, somehow, qualifying them on their current income vs the max. amount the payment could increase to.
But, no matter what your mortgage payment, if your job goes south, or your hours are cut back and you can't make your payment, you don't have any stimulus money available to help you out until things improve ...........
Lets just hope the price of gasoline doesn't go back up again, or we will see the cycle repeat again. If faced with having to choose, will a family spend money getting to work so they can put groceries on the table, or will they make the mortgage payment? That's a no brainer.
At lease the people with money are out buying up the foreclosures, off the not so fortunate, giving the "appearance" of a rebound in housing sales.
I mostly agree. For years Ive seen people outspend themselves, pull equity out to pay off the cards, than start the circle again and again. ARTIFICIAL values fueled this fire. How did the values go so high? Mostly because of state income loan products.
Finall we hit the perfect storm where investors WOKE UP and stopped buying all the dangerous product. They could no longer hide the losses and faked books used to get the final purchasers to take the loans. Without the product available to refinance all the short term fixed and rising adjustables, things had to break. People who would have come up with a house paymnent come hell or high water to save the equity no longer had a reason as the values turned upside down. The foreclosure process and 'no recourse' laws make it easy. With the partial death of the housing market, our general ecomony started to fail. Imagine how many jobs in ths country are related to housing?! From roofers to the land owners who grow grass seeds for lawn care companies. The person in a store who grinds extra keys for the new purchasers. All the folks in lumber mills. On and on.
Excessive borrowing made possible by false equity. Had to end.
Spenser... Thanks for the interesting post...but, DUH! I agree that borrower behavior and excessive borrowing seem to be the causal factors. That's not rocket science. But even more interesting would be impetus for the buyer behavior. Could it have been something that Barney Frank and Christopher Dodd said???
I agree with some of the points in the paper. In Tampa Bay Florida I have seen some houses foreclosed upon partly because the homeowners upgraded themselves out of their house.
However there are some homeowners who did not upgrade themselves out of their house and/or gambled against their equity line of credit (page 17 and 18.) The contributors of this paper seems to have extrapolated too much about the Southern California market in order to save face for Fannie Mae.
Two people who contributed are Eric Rosenblatt and Vincent Yao and they're from Fannie Mae. They seem to try to shift blame onto the consumer without pointing out that some representatives of the government rid some companies of underwriting which is significant.
So to me this paper tries to blame the consumer but IMO it is also some of the representatives of the government who did favors for some of their corporate allies in order to make money. Now some people are blaming the consumer. I am not surprised. They work for the government. Of course they will not take responsibility for their actions. Instead they blame the consumer.
Funny that this study came from Fannie Mae, which was all too happy to cause this problem in the first place. Look at the rules Fannie had 20 years ago vs. 2 years ago and you will see THEY are the ones that let people borrow too much in the first place. There has to be common sense on both sides.
I think there are plenty of consumer who thought their houses were piggy banks--and I see many who have 2 or 3 lines on their homes and don't understand why we cannot get them out of the mess they put themselves into.
Yep... Of course there are the strategic foreclosures, but even many of those are because people throught they could borrow more to stay ahead of the mortgage long enough to sell for a profit.
Forclosures cause not because of home price decline but yes, the excess borrowing terms. When people plan to buy home they must know each and every aspects of home loan and they are even ready to pay the mention amount per month as per loan company. But becuse of some reason the limited income become insufficient and they starting borrowing and after taking excess borrowing the states of foreclosure come. People should plan about the mentioned payment every month and try to minmize his borrowing. Else forclosure arise. If luck still with them, they may get some profit else....
A fascinating read which supported thoughts I've had for the past ten years. I particularly liked how Little started off by likening the activities to puts and calls (although I liken the equity harvesting more to "selling short against the box"). I recommended that strategy (equity harvesting) for the reason Little cited; a hedge against future price declines.
I didn't quite understand Little's explanation about the effect of high-LTV purchase originations on the decline. Were you able to discern whether borrowers with high LTV purchases performed differently from borrowers who extracted equity? Little's conclusion didn't address those differences.
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True....but the creative financing was intended to be temporary. The assumption was that they could then have a history of good mortgage credit to refi into a permanent situation that they couldn't qualify for at this point.....speaking of the first time home buyers of course. Then the decline in demand and prices made the refis unfeasable because they had 100% financing and no equity. A bad idea all around.