Liebowitz on Foreclosures

Stan Liebowitz, who has investigated the impact of changing lending standards on the housing market ("Anatomy of a Train Wreck: Causes of the Mortgage Meltdown," Independent Policy Report, October 3, 2008.), has extended his research to analyze the causes of the increase in foreclosures since 2007. He reports on some of his findings for the Wall Street Journal in, "New Evidence on the Foreclosure Crisis," (July 3, 2009).

What is really behind the mushrooming rate of mortgage foreclosures since 2007? The evidence from a huge national database containing millions of individual loans strongly suggests that the single most important factor is whether the homeowner has negative equity in a house -- that is, the balance of the mortgage is greater than the value of the house. This means that most government policies being discussed to remedy woes in the housing market are misdirected...

The...data allowed me to construct a housing price index at the zip code level and then calculate the current equity position of each homeowner. I was thus able to compare the importance of negative equity to other variables related to foreclosures.

The analysis indicates that, by far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home...A simple statistic can help make the point: although only 12% of homes had negative equity, they comprised 47% of all foreclosures.

Further, because it is difficult to account for second mortgages in this data, my measurement of negative equity and its impact on foreclosures is probably too low, making my estimates conservative...

The difference in policy implications is enormous: A significant reduction in foreclosures will happen when and only when housing prices stop falling and unemployment stops rising...

...stronger underwriting standards are needed -- especially a requirement for relatively high down payments. If substantial down payments had been required, the housing price bubble would certainly have been smaller, if it occurred at all, and the incidence of negative equity would have been much smaller even as home prices fell. A further beneficial regulation would be a strengthening, or at least clarifying at a national level, of the recourse that mortgage lenders have if a borrower defaults. Many defaults could be mitigated if homeowners with financial resources know they can't just walk away.