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Are Courts Dragging out the Housing Crisis?

Posted by Mark A. Calabria

Despite what looks like a national mortgage market, what we do not have is a national foreclosure process.  Almost all the law that matters in terms of foreclosures is at the state level (which is both good and bad, and it is not clear to me which dominates).  One of the biggest differences is whether a lender has to go before a court to seek a foreclosure, or whether such can be handled administratively.  Although even in administrative states, borrowers do have redress to the courts when things go wrong (besides the actual fact of a foreclosure).

The following chart, put together by the Mortgage Bankers Association, lists states by percentage of loans in some stage of the foreclosure process.  Also listed (color-coded) is which states have a judicial, that is court-driven, foreclosure process and that those that do not.  The most noticeable difference is that, with a few exceptions, the states with the highest percentage of properties still in foreclosure are those with a judicial foreclosure process.  Perhaps most surprising is that states like California and Arizona, which were ground-zero for the housing bubble, have foreclosure inventories, as a percent of loans, below the national average.

A common refrain for slowing the foreclosure process is that such is thought to slow the decline in housing prices.  The facts, as they relate to judicial foreclosures which do take considerably longer, is just the opposite.  Based on state-level price data from Zillow, non-judicial states saw prices fall 3.3% over the course of 2011, whereas prices fell 4.5% in judicial states.  While there’s a lot driving house price declines, it doesn’t look as if the judicial process is helping.  Similar results hold if you date back to the peak of the bubble.  Judicial states have seen, on average declines of about 20%, whereas non-judicial have seen declines of about 17% (not population weighted).

Now, I am a big believer in respecting contracts, and the existing legal environment is part of the contract, so I’m not advocating that states change their foreclosure process for existing loans.  For loans not yet made, however, there appears to me to be the case for at least examining the merits of judicial foreclosure (or even better let borrowers and lenders freely contract to choose their own rules).

Obama Fixes the Housing Market Again (and Helps the Troops)

Posted by Mark A. Calabria

Yesterday President Obama announced yet another set of programs intended to help the housing market.  The majority of these are aimed at helping active service members of the military.  For instance the proposal would compensate service members who were wrongly foreclosed upon and help re-finance into lower rates service members wrongly denied that opportunity.  Assistance would also be provided to service members who suffered losses because they had to sell their homes due to a change in station (that is the military ordered them to move).

While some of these changes are likely to benefit service members, the impact on the overall housing market is likely to be very small.  From what little details we have, it appears most benefits will be limited to currently active service members.  Let’s start with the re-finance piece.  There are just over 1 million active military living in the U.S. (another quarter million stationed overseas, who we lack data on), of those just over 300,000 both own their home and have a mortgage (about 80,000 own free and clear).  Interestingly just over 2/3rds purchased their home since the housing bubble burst.  During this time mortgage rates have been fairly low, so its probably reasonable to assume that these borrowers already have low rates and won’t benefit from a re-finance.  I haven’t been able to find data on how many longer-term borrowers have already re-financed, but its sure to be a significant amount.  So our upper-bound is that about 100,000 service members might be able to benefit from a re-finance, I suspect the actual number is much lower.  And of course, who knows what “wrongly denied” means.

The “wrongly foreclosed” piece is a lot harder to estimate, so take this with a huge margin of error.  First we don’t know how many active duty borrowers have even been foreclosed upon.  If we assume foreclosure rates similar to the VA loan program (good reasons to think it could be higher or lower), then about 12,000 service members are likely to have been foreclosured upon since the bubble burst.  The “wrongly” is even harder to figure out.  If interpreted narrowly, then say 1%, gets us to just over 100 loans.  Even 10% gets us to about 1,000 loans.  Under any reasonable estimate a pretty small number compared to the overall housing market.

The permanent change of station piece is the other big piece.  Setting aside that service members taking a loss on their home has long been an issue and just why it has become important now we will leave to the imagination (an election year perhaps?).    Of those active duty service members who moved in the last year, about 100,000 had a mortgage, and so could have taken a loss.  If they were underwater to the same extent as the general population (probably an under-estimate), then this program will help somewhere between 20,000 and 30,000 borrowers.

While it is important that anyone actually wronged be compensated (that’s what we have courts for), the impact of Obama’s latest plan, like his previous plans, is likely to be extremely small and do almost nothing to help the overall housing market.

Note:  data are my estimates from Census’ American Community Survey.  If you have better, please share.

Tim Geithner’s Amnesia

Posted by Mark A. Calabria

In case you missed Treasury Secretary Tim Geithner’s revisionist fiction in today’s Wall Street Journal, he takes the critics of Dodd-Frank to task for forgetting about the financial crisis and how it came about.  Sadly it is Geithner who forgets (or willfully ignores) the causes of the crisis.  Just a few highlights:

Geithner reminds us of the AIG bailout.  He forgets that it was the NY Fed’s approval of using credit default swaps to lower bank capital that lead to so much bank counter-party risk being concentrated in AIG (see Gillian Tett’s Fool’s Gold), as well as increasing bank leverage.  But then who was heading the NY Fed at this time?  Tim Geithner.

Mr. Geithner goes on to complain about the growth of the shadow banking sector.  Who was it that approved banks’ exemption from the Sarbanes-Oxley rules on off-budget entities, which lead to the growth of various bank off-budget, hidden liabilities?  Again, Geithner’s NY Fed gave that approval.

Geithner raises the issue of “risky short-term financing” but does so without mentioning that the primary reason for such was the low interest rates and steep yield curve created by. . . again Geithner’s NY Fed (and the rest of the Federal Reserve System).  There’s a reason that MF Global failed in basically the same way that Bear Stearns did, because monetary policy provided both with strong incentives for maturity mismatch.  But since Geithner also acts shocked that “household debt rose to an alarming 130% of income” perhaps he needs a few lessons in monetary policy.  Did he seriously not think that cheap credit, via the Fed, would result in increased debt?

Perhaps all this amnesia should not be surprising coming from the same guy who told Congress he had never been a bank regulator.  He certainly never acted like one, despite the title of NY Fed President.  The real amnesia is that despite about two decades of engineering one bank rescue after another, beginning with his role in the peso crisis, Mr. Geithner still does not understand the concept of moral hazard.  When he complains about late night calls from “then giants of our financial system” I, for one, wish he had just stayed in bed.  Would have saved us all a lot of money and we’d have a much more stable financial system.

I have no sympathy for bankers afraid to lose their subsidies.  What our financial system needs is a  dose of real market discipline.  Mr. Geithner’s rants only serve to distract from the fact that Dodd-Frank will make the next crisis more severe and more likely.  It fails to address the actual causes of the crisis while further extending the worst features of our regulatory system.  Worst of all it distracts from having a conversation about fixing this system.  Repeal and Replace.

Some Consequences of Government Ownership of Banks

Posted by Mark A. Calabria

Despite the substantial and continuing repayment of TARP bank assistance, the U.S. government maintains an equity interest in 371 banks.  A small number of those banks actually have the government as a majority owner.  For instance the former GM financing arm, now known as Ally Bank, has a government interest of 74 percent.  Sadly the United States is not alone in this regard.  The Royal Bank of Scotland (RBS) is still majority owned by the UK government.  And of course the U.S. government owns Fannie Mae and Freddie Mac, even if the Office of Management and Budget denies that reality.

Should we be concerned about all this government ownership of financial institutions?  The small body of empirical literature on the topic suggests a strong “yes.”  Probably the most comprehensive research was published in the Journal of Finance by La Porta, Lopez-de-Silanes, and Shleifer.  The authors find “that higher government ownership of banks is associated with slower subsequent development of the financial system, lower economic growth, and, in particular, lower growth of productivity.”  Let’s keep in mind that the last one, productivity, is ultimately what drives wage growth.  So for several very important reasons we should be doing our best to get the government out of ownership in the financial sector.  Recent research in the Journal of Financial Intermediation confirms these findings, and also finds that political inference is what primarily drives these bad results.

As much as it pains me to say it, the recent suggestion by Paul Myners and Manus Costello in the Financial Times that, in the context of RBS, we are better off as taxpayers taking our losses and getting out of these companies rather than holding out for better returns, is probably correct.  The damage to the greater economy from political interference in the financial system (witness the demands for Fannie and Freddie to take losses to support the housing market) is likely to outweigh the losses to the taxpayer from an early ownership withdraw.

Local Governments Also To Blame For Housing Crisis

Posted by Mark A. Calabria

Most narratives of the financial-mortgage-housing crisis tend to focus on what are essentially demand-side factors.  Whether it is federal mortgage subsidies, like Fannie Mae, or reduced interest rates via loose monetary policy, these policies increase the demand for housing by allowing, and encouraging, more buyers to enter the market.  As I’ve written in more detail elsewhere, this narrative ignores the supply side of the market.

If housing supply could easily adjust to the increased demand that arises from other policy interventions, then prices would be unlikely to increase.  In fact, if supply increased more than demand, we could see falling house prices, despite the various federal subsidies.  The point is that for a price boom to develop, you need some sort of rigidity in supply (inelastic supply, as we economists would say).

So who has the most influence over housing supply?  Local governments.  A recent article in the January 2012 issue of the Journal of Urban Economics provides empirical evidence ”that more restrictive residential land use regulations and geographic land constraints are linked to larger booms and busts in housing prices. The natural and man-made constraints also amplify price responses to the subprime mortgage credit expansion during the decade, leading to greater price increases in the boom and subsequently bigger losses.”  A similar argument has been made by Cato scholar Randal O’Toole.

The lesson here is that if we want to avoid future property booms and busts, with their devastating impact on financial institutions, we also need to reform our local land use controls to allow for the more rapid response of supply to changes in demand.   Again, it wasn’t a lack of regulation that caused the crisis, but too much regulation, particularly of the land/housing market.

Where’s the Compensation for Victims in the Mortgage Settlement?

Posted by Mark A. Calabria

After reading the few details provided on the mortgage settlement, it could be easy to forget that this whole thing was supposed to be about compensating families who lost their homes to foreclosure due to “robo-signing” and other foreclosure process abuses.

Out of the $25 billion settlement, guess how much goes to borrowers who “lost” their homes to foreclosure?  $1.5 billion.  That’s correct, only 6% of the settlement actually could go to the victims it was all supposed to be about.  What’s worse is that the settlement does not even require that money to go to parties actually harmed.  The money can go to any borrower that had a foreclosure, harmed or not.  In fact, as far as I can tell, a borrower could get the money even if he got into the house via fraud, like over-stating his income.

While coverage has been a little loose on details, it appears that about $3 billion of the settlement is going into the coffers of state governments.  You read that right: state governments are looking to get about twice what the actual victims might get.  But then that doesn’t sound too far off from the typical class-action: lawyers make out like bandits and victims get peanuts.

If you’re wondering where the rest of the money is going, it is headed to homeowners who are still in their homes, and hence  by defintion not victims of foreclosure abuse.  So much for actually helping victims.  But then, since the state AGs apparently never bothered to look for any real victims, it should not be too surprisingly that they completely forgot about them when crafting the settlement.

Questions and Thoughts on the Mortgage Settlement

Posted by Mark A. Calabria

If you missed the news (Obama actually made a “big” speech about it), the federal government, along with 49 state AGs, reached a settlement with the largest mortgage servicers over servicing violations.  In some ways, what little detail has been offered raises more questions than answers.

Perhaps the biggest question is how much of the actual losses will be borne by the banks and how much will be passed along to investors, who were not even represented at the table.  One hears that both first and second mortgages would be written down “in proportion” so that if the first loan is reduced 10%, then the second is also reduced 10%.  Obviously this flies in the very face of what a first and second loan are.  The first shouldn’t take any loss until the 2nd is completely wiped out.  But since investors often hold the first while banks hold the second, it looks like Obama has blessed the banks sticking a good deal of their losses to the investors, which include pension funds, retirement accounts etc.

And while I was of course moved by the touching picture of a couple and their child featured so predominantly on the settlement’s website, I was also left wondering, what is the process for determining which foreclosed homeowners receive assistance.  The settlement is actual quite clear that  “$1.5 billion will be distributed nationwide to some 750,000 borrowers” but that such borrowers need not have actually been harmed.  This really seems little more than a lottery trying to pass as consumer protection.  But then I suspect your chances for getting a piece are bigger if you happen to live in a swing state (sorry California).

What really worries me is the massive payment to states.  Of course they claim this is going to help “fund consumer protection” but then we also told that the tobacco settlements would help smokers; it instead turned into state government slush funds.  Even more troubling is the high probability that such funds will flow to various non-profits, whatever the current incarnation of ACORN is calling itself.

Fortunately the entire settlement has to be approved by a federal judge.  Given that these issues really should have been decided in the courts in the first place (separation of powers, anyone?), this is the opportunity for the courts to ask for the AGs and Obama to actually produce some evidence of wrong-doing.  And also to ask that parties actually harmed be the ones compensated.  Anything else would be a perversion of justice.

Which Way Is Inflation Headed?

Posted by Mark A. Calabria

First let me admit I do not have a crystal ball, nor does anyone I know, so given the limitations of economic forecasting, one can only attempt educated guesses as to the direction of any economic variable.  That said, I found the chart below, taken from the most recent Bureau of Labor Statistics’ Consumer Price Index release, to be interesting in terms of the clear trend.

The lower line is core CPI, the Federal Reserve’s preferred measure of inflation, the upper line is the full CPI, which includes food and energy prices.  The good news is that while still higher than I’d prefer, food and energy prices started to moderate in the fall of 2011.  That moderation in food/energy prices, however, did not translate into a lower core CPI.  In fact the core CPI continued its fairly steady increase.  Since September 2011, core CPI has been, on an annualized basis, above the Fed’s target of 2 percent (let’s set aside, for the moment, whether this is the right target or if it is even measured appropriately).  Remembering that monetary policy works with “long and variable lags” the time to worry about inflation is before it hits, not after.  Given the clear upward trend in the government’s own charts, I’d say we are already past the point where we should start worrying.