July 13, 2010

Is this a statistical optical illusion?

From the New York Times last week:
Biggest Defaulters on Mortgages Are the Rich

LOS ALTOS, Calif. — No need for tears, but the well-off are losing their master suites and saying goodbye to their wine cellars.

The housing bust that began among the working class in remote subdivisions and quickly progressed to the suburban middle class is striking the upper class in privileged enclaves like this one in Silicon Valley.

Whether it is their residence, a second home or a house bought as an investment, the rich have stopped paying the mortgage at a rate that greatly exceeds the rest of the population.

More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic.

By contrast, homeowners with less lavish housing are much more likely to keep writing checks to their lender. About one in 12 mortgages below the million-dollar mark is delinquent.

Though it is hard to prove, the CoreLogic data suggest that many of the well-to-do are purposely dumping their financially draining properties, just as they would any sour investment.

“The rich are different: they are more ruthless,” said Sam Khater, CoreLogic’s senior economist. 

This has been a popular topic lately, with Ross Douthat and Megan McArdle weighing in. 

What hasn't been interesting to people, however, is whether the the following isn't misleading: "More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, ... About one in 12 mortgages below the million-dollar mark is delinquent."

It's fun to think that the rich are worse than the rest, and they may well be. I'm sure there are a lot of "strategic defaults." But it strikes me that this 1/7th v. 1/12th comparison may be mostly the statistical equivalent of an optical illusion. And that can give a misleading view of recent history.

Let's even leave aside the excellent question of whether people who are underwater on their homes are now, or ever were, "rich" as opposed to "high roller."

No, what I think could be misleading here that isn't obvious to commentators is that they're probably comparing oranges to lemons when comparing total mortgages to million dollar mortgages. That's because until the last decade, there just weren't that many million dollar mortgages. And even in 2003-2007, there weren't that many million dollar mortgages in parts of the country where home prices weren't wildly over-inflated.  

The total set of mortgages that are still being paid off goes back to 1980 and is from all over the country. If you're paying off a $40,000 mortgage you got in Fargo in 1985, well, you've built up enough equity that you might as well not default. 

But there aren't a lot of mortgages from the 1980s in North Dakota among the ranks of the million dollar mortgages. Indeed, there aren't a lot of million dollar mortgages at all from North Dakota because there wasn't a housing bubble there in the last decade. In contrast, a large fraction of the million dollar mortgages that are delinquent had to have been originated in the Bubble Years (roughly 2003-2007) and in the Sand States, especially California.

Right now, even after the crash, 14% of the homes for sale in Los Angeles County, which is by far the nation's largest county with 10 million people, are listed for sale at >= $1 million. (That doesn't mean they'll get it, of course, and overpriced homes tend to be overrepresented on the MLS because they don't get delisted by being sold.)

In other words, a lot of the million dollar mortgage folks are people who bought in at the top of the market in time and place. People who have had a mortgage less than 6 or 7 years haven't built up much equity to lose, and have been gone way under water.

Take a look at the New York Times' graph:

Notice in the owner occupied left hand graph that the delinquency rate on total mortgages was running about 2 percent in the Bubble Years of 2005 and 2006. That's the default default rate, the actuarial rate, of people who can't pay because their lives have happened to fall apart and so they lose their houses.

In contrast, the delinquency rate million dollar mortgages was negligibly small in late 2005. Why? Because "the rich" had better personal character back then? 

Nah. It was because home prices were skyrocketing in the expensive parts of the country, like California, and everybody was doing everything they could to stay in the game of real estate appreciation. If your life fell apart in California in 2005 and you were out of cash, you could sell your house for a profit or refinance it. Now, however, if you have a million dollar mortgage, you probably got in 2003-2007 in a Bubble part of the country, and you're probably underwater now.

Does that make sense?


Udolpho.com said...

As always, lucid explanation for something that an NYT reporter still can't quite figure out.

Journalists do love their just-so stories, don't they?

epobirs said...

It doesn't strike as a very useful statistic without knowing more about the people involved. For instance, the Thousand Oaks house my family lived in during my earliest memories was listing before the crash for $500K. This is just insane. It comes with a big lot but of very limited value due to most of it not being horizontal. To the best of my mother's recollection, my folks bought the place for about $15K in the late 60s.

This really drives home just how insane the market became. It's no wonder that people who got sucked into these ridiculous prices chose to skip out when reality set in and they knew they'd never get back that much on a resale. Of course, they had to be a little stupid to believe this was a reasonable purchase in the first place. Not so much rich people as people who managed to use easy credit to get in far, far, far over their heads.

l said...

Has anyone from the NYT who's covered this story actually interviewed people who have defaulted on 'jumbo' mortgages to ask them "Why?" Seems like I've seen dozens of stories about the sub-prime mess where the focus is the hard luck of individual borrowers. The tone is always sympathetic -- those stories do not begin with "No need for tears." There is something perverse about a newspaper (whose editorial staff and target audience are upper income) that delights in the misfortune of others.

l said...

Meanwhile, back in the 'burbs:


dearieme said...

"Does that make sense?"

Much more than the NYT ever does. "Not just dull, but stupid" should be its slogan.

ben tillman said...

Yes, it makes sense. Your analysis was excellent.

Anonymous said...

My wife and I live in North Scottsdale. We moved here from the Midwest in late 2006. A close friend also moved here about the same time. He bought a 2.6 million dollar place that is now worth somewhere around 1.3. He's thinking about walking away. We owned a place back east and sold it for a small profit after owning for a couple of years. He thought that we were crazy not to buy in NS. We're still renting. I saw the writing on the wall. Of course, I've been concerned about a housing bubble since reading a 2004 American Conservative coverstory.

Mr. Anon said...

That the NYT would seriously think that actual rich people are defaulting at record rates is not surprising given thier innumeracy - the same innumeracy which permits them to publish an almost entirely meaningless graph with no vertical axis.

A few years ago, the house I grew up in in California was put on the market for over a million dollars. It's not inconceivable that someone took out a million dollar mortgage to buy it. And it is not a rich man's house. It was in a neighborhood that (in the 70s) was solidly middle class. It's more upscale now - solidly upper middle class - but still not what I would call wealthy.

mnl said...

A statistical optical illusion or a bit of tautology?

As long as the author defines "the rich" as those who took out pricier mortgages, then all the article's really saying is that more expensive mortgages are more difficult to maintain and show a greater default rate. Put that way, the article's conclusion doesn't seem terribly newsworthy. Of course more expensive mortgages are more difficult to pay for: they're more expensive!

It would be a whole lot more helpful here if "the rich" were defined separately from the size of the mortgage (not) getting paid-off.

Anonymous said...

I'm no expert but there would seem to be a difference between a "million dollar mortgage" and a regular mortgage. In the former case it would require something called a Super Jumbo loan.

Conventional loans don't go that high. The FHA limit for my county is $729,000 and its just about the highest in the nation.

The web site I found that specializes in these big loans also advertise that the amount of equity is much lower and their risk tolerance is "aggressive". They allow interest only loans too.

It seems to me that the financial instruments used above a million dollars are only vaguely similar to conventional government backed mortgages. So I'm wondering if any of these statistics cited in the Times are meaningful.


Mike said...

You are over thinking the issue. Resets for the low end spiked in 2007 and we had subprime.
Resets for ALT A and every other variety of million dollar plus garbage loans are spiking now and the high end is failing.
How "rich" came to be confused with a large mortgage is another issue. Anyone that is rich has no need of a mortgage by definition. There is no smart reason to pay a mortgage if you can afford to pay it off, despite the overwhelming middle class belief that this is true. Show me a "rich" person with a mortgage and I'll show you someone faking it.

The Anti-Gnostic said...

Mike's comment is on the money.

How "rich" came to be confused with a large mortgage is another issue. Anyone that is rich has no need of a mortgage by definition. There is no smart reason to pay a mortgage if you can afford to pay it off, despite the overwhelming middle class belief that this is true. Show me a "rich" person with a mortgage and I'll show you someone faking it.

Or, as Steve puts it, there's "high rollers" (I call them "cash-rich assholes" myself) and there's "rich."

A million dollar mortgage for a residence makes no financial sense. You are going to pay that 2+ times, once you include interest, maintenance and taxes, and your neighborhood will have to stay whiter than the Kennedy compound. The odds are also pretty long on you having that much cash flow, year in and year out.

Frankly, I think the cutoff for a sensible mortgage is probably around $300K (more like $200K), meaning there are a lot of people in this country who are way more hosed than they think.

Anonymous said...

It's very hard to sort the homeowners here from the amateur real estate speculators. Many bad Alt-A loans are really to the latter class. Southern California was an area of particularly strong speculative activity.

A few years ago, after seeing an episode of "Flip this House" on cable TV, I was reminded of Bernard Baruch's observation that he knew it was time to get out of the stock market when he began hearing stock tips from his bootblack. Easy money and the allure of quick profits on highly leveraged investments posed the same danger to real estate speculators in 2005-8 as they did to stock speculators in the late 1920s. When unsophisticated players got into the market, it was only a matter of time before the bubble burst.

As J.P. Morgan is supposed to have remarked, crashes and panics are nature's way of returning capital assets to their rightful owners.

Gene Berman said...

Anonymous (below Anti-Gnostic):

I don't really know the facts of the matter but, more than 50 years ago, I heard the "shoeshine boy" story attributed to Joe Kennedy, who, according to the story, closed out all his stock holdings and went to Hollywood to try his hand at that business.

Anonymous said...

They were looking at Los Altos, where a million dollar house is a 1500 sq ft rancher that's also a fixer. A typical buyer there would be an engineer, maybe married to a high income spouse with a combined income in low six figures. They didn't have much wealth but did have a lot of income. They stretched to buy at 5X or 6X gross income.

One of them lost their job and with that sort of mortgage burn rate it's curtains pretty fast. They were never wealthy, they just had a high income at that moment in time.

Why pay such high prices? It gets them into the Los Altos school district, or one of the other nice school districts like Palo Alto or Cupertino, and away from the schools in San Jose.

ben tillman said...

I was just searching to see where I had heard the name Streitfeld before. And I stand by my earlier comment. Your analysis was really sharp.