What's Behind Foreclosures?

[phk]

What's Behind Foreclosures?

Don Boudreaux

Writing in today's Wall Street Journal, economist Stan Liebowitz reports the results of his careful study of the data on mortgage foreclosures.  Liebowitz finds that the chief reason homeowners default is negative equity in their homes (and, hence, not upward adjustments in the interest rates owed on ARM mortgage loans, or any other of the alleged culprits).  Here are some key paragraphs:

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.)

[opebo]

The obvious solution is to reflate the prices of the homes, and/or forgive the debt by revaluing mortgages to a reasonable percentage of the new valuations.

For example if a house used to be $500,000, and the mortgage is $400,000, but the house has gone down to $200,000 in value, the new mortgage could be set at $160,000 (80% of $200,000).  The remaining $340,000 can be electronically created by the Fed.

[Beet]

If the Fed printed that much money, interest rates would go sky high on expectation of inflation. This would effectively destroy the long term lending markets, consumer demand for large ticket products including housing, and business investments.

[opebo]

If the Fed printed that much money, interest rates would go sky high on expectation of inflation. This would effectively destroy the long term lending markets, consumer demand for large ticket products including housing, and business investments.

That makes no sense as the printed money would only be replacing the magically 'disappearing value'.

[Smid]

The obvious solution is to reflate the prices of the homes, and/or forgive the debt by revaluing mortgages to a reasonable percentage of the new valuations.

For example if a house used to be $500,000, and the mortgage is $400,000, but the house has gone down to $200,000 in value, the new mortgage could be set at $160,000 (80% of $200,000).  The remaining $340,000 can be electronically created by the Fed.

And in the years previously, when asset prices increased, should the person who borrowed $350,000 on a $400,000 house, only to see it increase in value to $500,000, have to repay $420,000?

[opebo]

The obvious solution is to reflate the prices of the homes, and/or forgive the debt by revaluing mortgages to a reasonable percentage of the new valuations.

For example if a house used to be $500,000, and the mortgage is $400,000, but the house has gone down to $200,000 in value, the new mortgage could be set at $160,000 (80% of $200,000).  The remaining $340,000 can be electronically created by the Fed.

And in the years previously, when asset prices increased, should the person who borrowed $350,000 on a $400,000 house, only to see it increase in value to $500,000, have to repay $420,000?

No, but a very high tax rate on such inflation would be good policy.  (I guess that is another way of saying 'yes, but only to an extent').

One wishes both on the up and downside to reduce the volatility of 'capitalism'.

[Former Moderate]

I could afford my home when I had my $50,000 a year job.  I could not afford my house when I lost my job.

Think that may have something to do with it all?

[opebo]

I could afford my home when I had my $50,000 a year job.  I could not afford my house when I lost my job.

Think that may have something to do with it all?

Of course, but having the Fed print the money to pay your mortgage payment thus cannot be inflationary, because it is merely replacing lost income (your wage).

[Beet]

If the Fed printed that much money, interest rates would go sky high on expectation of inflation. This would effectively destroy the long term lending markets, consumer demand for large ticket products including housing, and business investments.

That makes no sense as the printed money would only be replacing the magically 'disappearing value'.

Yes but psychology may send interest rates sky high anyway- at least temporarily. Just look at what happened in Indonesia 1998, or Britain 1931-- high interest rates first, debt deflation afterwards.

[opebo]

If the Fed printed that much money, interest rates would go sky high on expectation of inflation. This would effectively destroy the long term lending markets, consumer demand for large ticket products including housing, and business investments.

That makes no sense as the printed money would only be replacing the magically 'disappearing value'.

Yes but psychology may send interest rates sky high anyway- at least temporarily. Just look at what happened in Indonesia 1998, or Britain 1931-- high interest rates first, debt deflation afterwards.

We already have the debt deflation right now, so there's no harm in printing up the money which has disappeared.  Even if it caused some kind of 'scare inflation' it couldn't last long.

[Torie]

Defaulting when you have negative equity (the amount of course is relevant, and if it is your personal residence, convenience and emotional attachment comes into play as it should) is an entirely rational financial decision, and one I would make myself under certain circumstances, and have made/advised for clients, including one with a very deep pocket, which resulted in litigation and a judicial foreclosure, but it was still the right decision because of the complexity and risk of getting a deficiency judgment in California, and for how much.