I've been looking at some more foreclosure statistics, this time divided between defaults on types of mortgages, and I want to raise a question in the abstract. Which is worse: refinance defaults or home purchase defaults?
Defaulted mortgage can be divided into purchase v. refinance mortgages. In the former case, you get a loan in order to buy a house. In the latter, you already own the house and you get a new mortgage.
In turn, refis can be divided conceptually into ones where the homeowners makes the likelihood of default lower (e.g., you have a fixed mortgage at 9 percent interest rate and, when interest rates drop, you refinance with a mortgage of the same length and size but with a 6 percent interest rate), ones where the refinance makes the likelihood of default higher (e.g., you switch from a prime to a subprime mortgage in order to take out $100,000 in cash to scratch your Vegas itch), or all sorts of complicated combinations of the two.
Leaving aside the no-brainer case where the only motivation of the refinance is to get a lower interest rate, what's worse: defaulting on a refi or a home purchase? From a moral standpoint, I'd be inclined toward the refi case.
But from a systemic standpoint of understanding cause and effect in the Housing Bubble and Bust, I think cash-out refis were mostly an effect of rising home prices. The more important question is what caused the increase demand for houses that drove up prices, right? And dubious purchase mortgages were the main engine of prices rising above what could be paid off out of income. Does that make sense?
But from a systemic standpoint of understanding cause and effect in the Housing Bubble and Bust, I think cash-out refis were mostly an effect of rising home prices. The more important question is what caused the increase demand for houses that drove up prices, right? And dubious purchase mortgages were the main engine of prices rising above what could be paid off out of income. Does that make sense?
Falling interest rates partially drove up prices. Very few people (in a normal market) buy a house in cash. So the "real" price is the monthly payment. As interest rates fall, the total sale price that a given monthly payment can support goes up.
ReplyDeleteDevelopment restrictions also drive up prices. There was a craze in the 90s and early 00s for "urban limit lines" in places like California, etc., and those limits may have been reached in the mid 00s, but jurisdictions beyond the reach of those limits were often happy to allow development. Similar causes (tax preferences, etc.) were operating long before 2000, and are unlikely to have led to constricted supply.
I'm a little confused by what you mean by worse. I think what you're asking is which came first the chicken or the egg?
ReplyDeleteIn that regard, maybe you're right: you need purchases to drive the comps to get the appraisals to pull money out on a refi.
In theory it could be all coordinated at the appraisers' level, and there were certainly a lot of shenanigans among the appraisers, but by and large they really are the tail of the dog. Owners would defect and sell if they know their appraisals are completely bogus.
But I think you're splitting hairs. Ultimately, it takes willful ignorance on the part of the bank delivering the loan. First and foremost economic bubbles are _financing_ phenomenon. Without credit, the average person doesn't have enough surplus cash to fuel the flames to any remarkable extent. You need leverage, and that only comes from financing. That the banks get to sell the mortgages they originate, formerly to MBS investors, now to the Govt via FHA, FNMA, et al, is what makes the whole thing possible.
Yes, it makes a lot of sense.
ReplyDeleteThe ease of getting a loan ("liar loans", etc.) helped drive up demand, which drove up prices.
We need to go back to sensible regulation.
Risto
I hope there is a way to separate out reverse mortgages. When the mortgagee dies, often the house has lost value and the heirs find that they have no equity. If one of the kids or grandkids has any attachment to the house, they just live in it until evicted.
ReplyDeleteWhat we have witnessed in housing is an asset bubble. An asset bubble can theoretically happen for any asset class (e.g., tulip bulbs).
ReplyDeleteOur debt-money system feeds asset bubbles because whenever a bank writes a new loan, money is created out of nothing to fund it. The bank merely makes an accounting entry in a borrower's checking account and the money is there. Freshly-created money from borrowing thus stokes the growth of asset bubbles.
Which kind of default is worse? To me they are the same. A default is a default. Perhaps the borrower is somewhat less culpable if he has been the victim of deception, and perhaps that would tend to let him off the hook more for the purchase mortgage than the re-fi mortgage (by the time of the re-fi, one would assume he had wised up).
Don't forget options to fold in existing debt into a mortgage. There were constant adds about the advantages of using your equity because of the tax deduction.
ReplyDeleteWhich makes me think we aught to rethink the whole tax deduction for mortgage interest.
Speak for your self Buddy about "bad" purchase loan defaults and "worse" refi defaults. I would not have been able to buy a house for about 50% less the the previous price if it were not for defaults. Nor would I have the security of knowing I can cash in some of my gains since with a home equity loan, including some sweat equity.
ReplyDeleteAs for the people who defaulted, I am glad most of them did. I don't want to see my neighbors here or nearby stuck in virtual poverty paying back massive debt to some faceless billionaire buyer of securitized mortgages.
What lead to the increase in home prices?
ReplyDeleteI would point you to the capital gains tax exemption for homesteads. I would also point you to the collapse of the internet stock bubble, people decided, I think, into real estate instead.
Also I would point you to the Basel accords on banking regulation. Those accords drive banks toward a certain type of security. When the banks want a certain security, there arises a machine to produce them. The Crimson Reach can point you in the right direction on this matter.
The media never talks about this distinction, but as I said in the other thread I think it's a very important one. Within the housing crisis reporting, the first-time buyer who put 20% down, had a low debt-to-income ratio and bought at the peak is viewed the same as the guy who owned for 20 years and pulled out his equity for cash. Since they have both defaulted, and since housing is seen as a fundamental need (or even right), we are asked to feel the same compassion for these two individuals. But they acted in much different ways, and to group them together confuses the political dialog about What To Do about the housing crisis.
ReplyDelete(Note a straight refi, with no cash out, doesn't really apply here since it doesn't affect the borrower's equity)
The Federal Reserve has been buying mortgage bonds for the last four years containing these cash-out mortgages. Those bonds will never be sold, and the banks and borrowers will get a break at the expense of the US taxpayer/dollar-holder.
One big difference is that first mortgages in many states are non-recourse loans, while refi's are almost always recourse loans. You can think of a nonrecourse loan as a recourse loan plus some insurance bought by the borrower to protect his other assets. The cost of that insurance is surely factored into the offering terms by the lender.
ReplyDeleteIf a default happens, it's just a contingency that the contract anticipated. Why is this any different from a mortgage default by the operator of an office building who can't find enough tenants? Nobody calls that immoral, it's just business.
I think your analysis is correct.
ReplyDeleteIt's worth noting that banks generally have (and had) higher standards for borrowers taking cash-out refis (as opposed to normal refis to take advantage of lower rates or initial purchases).