Friday, May 30, 2008

Fed's Rosengren on Housing

by Calculated Risk on 5/30/2008 01:17:00 PM

From Boston Fed President Eric S. Rosengren: Current Challenges in Housing and Home Loans: Complicating Factors and the Implications for Policymakers .

Here is an excerpt from the section: Length and Duration of Housing Downturns, and Other Recent Research from the Boston Fed

New England is no stranger to falling asset values. As you no doubt know, during the early 1990s, New England experienced a steep decline in housing prices. We at the Boston Fed think it may be useful to compare that experience to what we have experienced to date with falling housing prices, and we are pursuing a number of research avenues to do that. ...
Figure 4: 1990Figure 5: 1992

As you can see in Figures 4 and 5, Massachusetts moved quite rapidly from a situation of relatively limited foreclosures in 1990 to a period of very high foreclosures in 1992. The timing is interesting. By late 1989, Massachusetts house prices had begun to fall, but delinquencies and foreclosures did not really accelerate until there was also a significant weakening of the economy. In fact, the unemployment rate in Massachusetts, which had declined to 3.1 percent in late 1987, peaked at 9.1 percent in the second half of 1991. Declining housing prices alone did not cause very elevated foreclosures; it was significantly compounded by an economic shock such as the loss of a job which disrupted the ability of many borrowers to make payments. As house prices fell, many homeowners who lost their jobs in the early-1990s recession could not sell their homes to pay off their mortgages because they owed more than their homes were worth. For unemployed homeowners with “negative equity,” foreclosure was often the only option.
Figure 6: 2005Figure 7: 2007
The more recent period also points to the importance of falling house prices and negative equity in foreclosures. In the more recent period (shown in Figures 6 and 7), the foreclosure rate – which was not particularly elevated in 2005 – had become quite elevated by 2007 as house prices softened. This increase in foreclosures occurred even though the Massachusetts unemployment rate averaged 4.5 percent for the year.

Why are foreclosures so high today, given that the economic situation is so much better than it was during the early 1990s? Even in expansions, many homeowners undergo adverse life events – like a job loss, a divorce, a spike in medical expenses, or the like – that disrupt their ability to make mortgage payments. Of course, with regard to unemployment, such household-level disruptions are not as prevalent in expansions as they are in recessions. But when such a life event does occur, it can still precipitate a foreclosure if the homeowner has negative equity because of a fall in house prices.

Another reason for elevated foreclosures today concerns changes in the susceptibility of mortgages to economic shocks. In the late 1980s, many borrowers had made significant down payments and had good credit histories. But the recent ability of borrowers with weak credit histories and little or no down payments to purchase homes, often with subprime loans (and sometimes with minimal income verification), means that a greater share of today’s mortgages are a good bit more susceptible to the types of disruptive life events that precipitate foreclosure. These borrowers were fine when housing prices were rising because if needed, they had the ability to refinance or sell their homes and pay off (or more than pay off) their mortgages. In contrast, in the current environment of falling housing prices, borrowers who made small down-payments or have otherwise risky mortgages are now more likely to end up in foreclosure if they experience an adverse event that interrupts their ability to make mortgage payments.

So, in short, we have seen similar foreclosure numbers this time around without a technical recession, and with a more modest fall in home prices. Boston Fed researchers attribute that to the prevalence of riskier loans and higher combined loan-to-value ratios in general.
...
Several lessons from the historical comparison can be highlighted. First, should the economy worsen and suffer a period of significant job losses, the housing problem could become much more severe. Second, past episodes of elevated foreclosures lingered well after the peak in foreclosures had passed, indicating that the duration of today’s situation may be longer than some are anticipating. ...
emphasis added
Read on ... this is a long excerpt.