Posts Tagged ‘Foreclosures’

Housing problems: what could have been done better.

August 26, 2011 1 comment

First of all, some history of what has already been done. Consider the following example : suppose you borrow 100$ from a bank for 2 years to buy a house. The APR is 10%. If it is a mortgage then if you don’t pay, the bank gets your house (this is what is called foreclosure). Suppose you make a payment of 50$ in the end of the first year and the rest of the debt in the end of the second year. Then evolution of payments looks like that:

Time period House price Debt before the payment Payment  Debt outstanding Equity
Year 0  100  100  0 100  0
Year 1  150  110  50 60  90
Year 2  150  66  66  0  150

If house price evolves in the way it is described in the table, you end up  with equity equal to $150.” Shareholder’s equity” is the difference between your assets (the house) and liabilities (the mortgage).

Now suppose things don’t go that well and the evolution of house’ s price is different

Time period House price Debt before the payment Payment Debt outstanding Equity
Year 0 100 100 0 100 0
Year 1 50 110 50 60 -10
Year 2 50 66 ? ? ?

Now suppose that things don’t go that well and the house’s price decreased, instead of increased, say to 50$. Well, in this case your  equity in the end of the year 1 is negative. This is called being underwater. Would you be willing to pay the bank even 60$ if you had these 60$ in the end of year 1? Maybe, but you would probably think twice. As soon as you equity becomes negative, having mortgage is like paying expensive rent for the house.

What can the bank or government do in this situation and what was actually done?

  • Decrease the interest on the loan? Would it work? No, just because your equity is already negative in the end of the first year. If the bank says that the APR is now 5% it wont make any difference because it still not worth it paying the mortgage in the end of year 1.  But this is what 70% of voluntary modifications were about –  missing payments and fees were added at the end of year 1 making the equity even more negative and less attractive for homeowners. So it should be no surprise that the number of foreclosure has actually increased not decreased and people ended up even deeper underwater.
  • Would it make a difference if the bank decreases the amount of the principal (the 60$ at the end of year 1)? Yes, because your equity becomes positive and it is profitable for homeowners to keep paying. There are programs out there that advocate for this.
    Why did not this happen? Because banks would have lost money!  Moreover, some people might stop paying just because they think their principal would be reduced. Another potential problem: second liens. Second lien is a loan that was borrowed against shareholder’s equity. So the problem is that even if the principal is reduced the homeowners would still be underwater, because the injected money would just be a gift to the servicers of the second liens.
  • Government can buy mortgages from the banks for a discounted price (most of the morgages are valued from 30 to 50 cents per dollar and most second liens several cents per dollar) and then reduce principals to make loans affordable to  consumers and then when the homeowners are back on track sell the motgages to the banks potentially for a slight profit. Problem: banks might not be willing to sell mortgages for a discounted price simply because they know the government would want to buy them.
  • Government can legally take over mortgages using so called “eminent domain”.  This method is used when a new freeway needs to be built in some area or the area is contaminated and needs to be demolished.  Basically the government tells the banks that they the houses belong to the government and the banks get market price for it. Of course, not all mortgages should be acquired – only owner-occupied. No Congress approval is needed for this action. The money from allocated for the previous (unsuccessful) modification program – HARP – can be used. Too harsh? Not democratic? Well, it was a democrat congressman who suggested it. A similar program was run by FDR in the 1930s. Moreover, the banks generally already have been treated too nice by the government since the beginning of the recession. This action will also encourage other banks  to modify the mortgages they own if they want to keep them.

General problem with loan modifications: mortgage back securities, sometimes called “toxic assets” that many investors have. What are they? The picture below should help:


In fact, many banks do not own the mortgages themselves. They resold them to companies like Fannie Mae and Freddie Mac, who pooled the loans in several pools depending on how likely people that own the money are likely to repay the mortgages. After that these pools were split in securities (like “shares” of the pools)  and sold to different investors. This process is called “securitization”. Investors were supposed to be paid when people pay their mortgages. Further, there exist financial derivatives (stocks that depend) on these MBS such as credit default swaps (CDS) that pay if a person defaults on his mortgage. In other words, default on the mortgages is profitable for the owners of CDS on them (you don’t have to even own the mortgage to own a CDS on it).  So any action by the government would benefit some people and hurt others, so as Adam Levitin put it

the government needs to settle on its policy goal. Why are we trying to prevent foreclosures? Is it a macroeconomic goal of stabilizing the housing market? Is it a macroeconomic goal of deleveraging consumer balance sheets? Is it a moral goal of helping unfortunates? Is it an electoral goal of making people feel that the government is doing something/is on their side?

And then do something, not just say everything is alright. Because 9% unemployment for 3 years is not alright, even if fundamentals are fine.


Unemployment, mobility and foreclosures

August 20, 2011 Leave a comment

Unemployment Variation Across States Kyle posted a very interesting picture not a long time ago (see above) according to which there is  a clear increase in the variance of the variance across states in 2008-2011 that coincided with the the Great Recessions. So why don’t the unemployed workers move from the most troublesome states such as California, Nevada, Arizona to the East, where job prospectives seem to look more promising? It seems like moving  to a different state is very costly for the workers that the variance in the unemployment rate does not converge to its 2001-2008 level. Presumably a decrease happened somewhere between 2005 and 2008, because pre-2005 spike and after-2005 levels of  the variance are  essentially the same. The question is that whether foreclosure delay explain this lack of mobility?

There are two main points that I wanted to make here. One is one is my own that I have not seen mentioned anywhere (yet?) and the other one is a summary of the existing evidence on the problem.

In the ongoing debate about whether the unemployment rate for the most is structural (supply side caused, skill/education mismatch) or cyclical (demand side caused, lack of aggregate demand) no consensus has been reached, but many people tend to believe that the demand explanation is more likely (see below).

However, suppose for a second that supply side does explain a portion of the unemployment rate. Then it is probably those construction workers in California, Nevada etc. that do not want to move to the East are causing the large spread in the unemployment rate across states- most of the “structural” unemployment is usually attributed to the lost jobs in construction industry and financial services. I say “want” instead of “cannot” because if “structural unemployment” theory does explain high unemployment rate, it would be equally hard for those workers to find a job in the East. SO they just stay where they had their last job – in the states that experienced the housing boom and where the unemployment rate is the highest in the country. In this case the graph above might have nothing to do with interstate mobility, but just reflect the difference in “structural unemployment” rates.

Moving on to the second part of my post, Mike Konczal posted the following picture on mobility that comes from Census:

Percentage of workers that move as a share of population

As Mike points out

The quick read was that everyone, post bubble-popping, was abandoning their properties and moving across the town to live with their parents and friends while looking for a new local job to save their house, a house they couldn’t sell because they were underwater.

However, as he later points out, the paper by Greg Kaplan from Minneapolis Fed Interstate Migration Has Fallen Less Than You Think: Consequences of Hot Deck Imputation in the Current Population Survey says that

…much of the recent reported decrease in interstate migration is a statistical artifact. Before 2006, the Census Bureau’s imputation procedure for dealing with missing data inflated the estimated interstate migration rate. An undocumented change in the procedure corrected the problem starting in 2006, thus reducing the estimated migration rate. The change in imputation procedures explains 90 percent of the reported decrease in interstate migration between 2005 and 2006, and 42 percent of the decrease between 2000 (the recent high-water mark) and 2010. After we remove the effect of the change in procedures, we find that the annual interstate migration rate follows a smooth downward trend from 1996 to 2010. Contrary to popular belief, the 2007–2009 recession is not associated with any additional decrease in interstate migration relative to trend.

Which probably means that housing boom and subsequent number of foreclosures has nothing to do with the decline in workers interstate mobility. Another piece of evidence is the paper by Colleen Donovan and Calvin Schnure “Locked in the House: Do Underwater Mortgages Reduce Labor Market Mobility?” and its summary that originally belongs to Kash Mansori. The main question was whether the fall in house prices since 2007 in the US created a lock-in effect that depressed labor mobility. The paper finds that even though

the evidence presented in the paper indicates that the fall in house prices has indeed caused a “lock-in” effect, but has not significantly impacted labor market efficiency.

and even more

The lock-in, however, results almost entirely from a decline in within-county moves. As local moves are generally within the same geographic job market, this decline is not likely to affect labor market matching. In contrast, moves out-of-state, which are more likely to be in response to new employment opportunities, show no decline, and in fact are higher in counties with greater house price declines

which together with the previous evidence reasserts the fact that the foreclosure rates did not significantly affect labor mobility.

[Update: Aug 20 1:30pm]
Kyle posted a reply to my post. However, there is no difference between Bob Hall’s graph (Figure 1) and the one I posted – the drop on both graphs happened in 2005 and is the size is the same – approximately 35%! I think there was no drop in labor market mobility due to the foreclosure issues. There was no drop at all! It is just an artifact in calculating procedure as I mentioned in the post and the paper I mentioned.

Clarification about my point about construction workers: I did not mean only construction workers, but all workers who are considered to be “structurally” unemployed: construction, financial services, etc. Even if those people do not contribute to the national unemployment rate, they might contribute to the variance of the unemployment rates across states – just because there are more construction workers in the states where was housing boom.