Who Defaults?
- Posted by ryan on May 6th, 2009 filed in Economics
Atrios has been sounding the alarm over a coming “second wave” of foreclosures, generated by the recasting of Option ARMs. Now, it’s true that these recasts are a different animal from your basic interest rate reset on a fully amortized ARM, but I think that the trajectory of housing defaults to date indicate that this might not be as big a problem as Duncan thinks (or not a problem in the way Duncan imagines).
Since the housing bust began, people have approached the problem of rising defaults as being principally about payment shocks, but that’s not really borne out by the data. In his long and fascinating look at the unfolding of the financial crisis, Phillip Swagel discusses how the Bush Treasury’s initial approach to the foreclosure crisis focused on interest rate resets, but he says they quickly discovered that wasn’t the main problem. He notes that if you chart 2/28 and 3/27 mortgage defaults over time, you don’t see the kink at the 24 or 36 month mark you’d expect if the reset was doing most of the work in generating foreclosures. What they found was that defaults were happening surprisingly quickly — basically, underwriting standards were so terrible that borrowers couldn’t even afford the initial payment.
As the bust has proceeded, by contrast, defaults have mainly resulted from the combination of negative equity and some kind of income shock — job loss, death or illness, divorce, and similar. A recent paper from economists at the Boston Fed found evidence along these lines and concluded that policymakers would have better luck reducing defaults through, say, fully funding unemployment insurance programs than through trying to reduce payments.
The logic behind these findings is that you have a lot of homeowners who are just a little underwater, and they’re mostly going to keep paying their mortgages (assuming they don’t lose their jobs) because they don’t want to ruin their credit and there’s a decent chance that within a few years they’ll be back in positive equity territory. You then have a lot of really underwater homeowners. You can reduce their payment by 50% and it still wouldn’t make sense for them to stick around. You have to figure anyone who’s been in a negative amortization situation in recent years is seriously underwater, and I just don’t see that a payment recast is going to have much of an effect on the decision to stay or walk away.
May 8th, 2009 at 1:23 am
RYAN: “income shock — job loss, death or illness, divorce, and similar” have *always* been the major trigger of default. Yet, default rates are much higher now than in the past.
The Boston Fed found that negative equity was the key driver, something that is unique in this housing bust since it was preceded by a zero down boom
May 8th, 2009 at 11:55 am
Good post. However, you seem to make the same error that virtually every other poster on foreclosures makes. That is, that they are somewhat uniformly distributed.
They are not. 4 state (CA, NV, AZ and FL) account for something like 50-60% of all foreclosures (I got that from RealtyTrac last dec or so. Don’t quote me on the percentage). An article in USA Today a month or two back said that over 50% of all foreclosure actions in 2008 occurred in just 35 counties. It had a map showing them and all were in those 4 states.
So why are foreclosures so concentrated geographically? I’ve tried to find out without much success. Some anecdotal evidence says that many of the foreclosures are not primary residences but rental and vacation properties.
Another story I read said that AZ’s problem stems from the crackdown on illegals in 2007. They moved on, leaving people who had rented properties to them unable to fill the property.
CA is a non-recourse state but many, most? of the US is not. Does this knowledge that they can just hand the keys back and be clear (other than bad credit) make people more likely to do this? I’ve discussed this elsewhere and gotten mixed opinions. I doubt it makes anyone less likely to send the keys back though.
Have you ever looked at the geographic distribution of foreclosures? Might be interesting.
John
BTW: SHout out to Megan, I am here from her blog.
May 8th, 2009 at 12:16 pm
This blog post hit home, as someone who is worried about going into foreclosure, probably in Summer 2010. I’ve owned and lived in my home for over 20 years. I still have plenty of equity, even at today’s depressed prices. I even managed to get one of those temporary census jobs (which expired after 2 months). I’ve been looking for work since last September. It’s an incredible experience to sit here in the home where I’ve lived since 1988, confident I can stay here for another year, but worried about 2010, desperate for any kind of work, with a master’s degree in computer science and desperate for any kind of work, and knowing that there is very little chance that I will find a job in the next 12 months. Actually, I spoke with someone earlier this week who is in a similar position, but she has 2 years to go before she has to worry about foreclosure. I’d be so happy to get a job, or a modest $20,000 loan. I really feel like I’m living in a third-world country.