The Housing Market Since the Great Recession

photo by Robert J Heath

CoreLogic has posted a special report on Evaluating the Housing Market Since the Great Recession. It opens,

From December 2007 to June 2009, the U.S. economy lost over 8.7 million jobs. In the months after the recession began, the unemployment rate peaked at 10 percent, reaching double digits for the first time since September 1982, and American households lost over $16 trillion in net worth.

After a number of economic stimulus measures, the economy began to grow in 2010. GDP grew 19 percent from 2010 to 2017; the economy added jobs for 88 consecutive months – the longest period on record – and as of December 2017, unemployment was down to 4 percent.

The economy has widely recovered and so, too, has the housing market. After falling 33 percent during the recession, housing prices have returned to peak levels, growing 51 percent since hitting the bottom of the market. The average house price is now 1 percent higher than it was at the peak in 2006, and the average annual equity gain was $14,888 in the third quarter of 2017.

However, in some states – including Illinois, Nevada, Arizona, and Florida – housing prices have failed to reach pre-recession levels, and today nearly 2.5 million residential properties with a mortgage are still in negative equity. (4, footnotes omitted)

By the end of 2017, ” the most populated metro areas in the U.S. remained at an almost even split between markets that are undervalued, overvalued and at value, indicating that while housing markets have recovered, many homes have surpassed the at-value [supported by local market fundamentals] price.” (10) This even split between undervalued and overvalued metro areas is hiding all sorts of ups and downs in what looks like a stable national average.  You can get a sense of this by comparing the current situation to what existing at the beginning of 2000, when 87% of metro areas were at-value.

And what does this all mean for housing finance reform? I think it means that we should not get complacent about the state of our housing markets just because the national average looks okay. Congress should continue working on a bipartisan fix for a broken system.


The Miraculous Continuous Workout Mortgage

Professor Robert Shiller

Nobel Prize winner Robert Shiller et al. have posted Continuous Workout Mortgages: Efficient Pricing and Systemic Implications to SSRN. The paper opens,

The ad hoc measures taken to resolve the subprime crisis involved expending financial resources to bail out banks without addressing the wave of foreclosures. These short-term amendments negate parts of mortgage contracts and question the disciplining mechanism of finance. Moreover, the increase in volatility of house prices in recent years exacerbated the crisis. In contrast to ad hoc approaches, we propose a mortgage contract, the Continuous Workout Mortgage (CWM), which is robust to downturns. We demonstrate how CWMs can be offered to homeowners as an ex ante solution to non-anticipated real estate price declines.

The Continuous Workout Mortgage (CWM, Shiller (2008b)) is a two-in-one product: a fixed rate home loan coupled with negative equity insurance. More importantly its payments are linked to home prices and adjusted downward when necessary to prevent negative equity. CWMs eliminate the expensive workout of defaulting on a plain vanilla mortgage. This subsequently reduces the risk exposure of financial institutions and thus the government to bailouts. CWMs share the price risk of a home with the lender and thus provide automatic adjustments for changes in home prices. This feature eliminates the rational incentive to exercise the costly option to default which is embedded in the loan contract. Despite sharing the underlying risk, the lender continues to receive an uninterrupted stream of monthly payments. Moreover, this can occur without multiple and costly negotiations. (1, references omitted)

If it is not obvious, this is a radical idea.  It was not even contemplated before the financial crisis. That being said, it is pretty brilliant financial innovation, one that should not just be discussed by academics. The paper provides a lot more detail about the proposal for those who are interested. And if you want to avoid taxpayer bailouts of the housing market in the future, you should be interested.

Thursday’s Advocacy & Think Tank Round-Up

  • The Center for American Progress has released a report The Uneven Housing Recovery which includes an interactive map the report analyzes the problem of negative equity, which grew out of the financial crisis and concludes that the lack of recovery in some areas, mostly non-metropolitan and rural, creates a risk of foreclosure and threatens to exacerbate the rental affordability crisis.
  • Corelogic has released its latest Home Price Index it shows that there has been a 4.7% increase in home prices in September.
  • HOME Coalition has released a report Building HOME which highlights the success of the HOME Investment Partnership Program by analyzing its impact in all 50 states, it also includes over 100 success stories. Enterprise Community Partners is hosting webinars in their effort to #saveHOME.
  • MakeRoom’s November Living Room Concert was hosted in the home of Devin Hallford in Denver, Colorado, where rent has increased 50% since 2010.  Devin is an aspiring artist and restaurant worker struggling to find an affordable place to live and pay back student loans.  American Author’s performed a concert in Devin’s cramped living space to draw attention to the affordable housing crisis. MakeRoom has also released an interactive map which illustrated the rising trend of Millenials living with roommates later in life.

Loose Credit. Plummeting Prices.

"Durdach Bros Miller Lite pic4" by MobiusDaXter

Christopher Palmer has posted Why Did So Many Subprime Borrowers Default During the Crisis: Loose Credit or Plummeting Prices? to SSRN. While this is a technical paper, it is clear from the title that it addresses an important question. If it can help us get to the root causes of the foreclosure crisis, it is worth considering. The abstract reads,

The surge in subprime mortgage defaults during the Great Recession triggered trillions of dollars of losses in the financial sector and accounted for more than 50% of foreclosures at the height of the crisis. In particular, subprime mortgages originated in 2006-2007 were three times more likely to default within three years than mortgages originated in 2003-2004.

In the ensuing years of debate, many have argued that this pattern across cohorts represents a deterioration in lending standards over time. I confirm this important channel empirically and quantify the relative importance of an alternative hypothesis: later cohorts defaulted at higher rates in large part because house price declines left them more likely to have negative equity.

Using comprehensive loan-level data that includes much of the recovery period, I find that changing borrower and loan characteristics can explain up to 40% of the difference in cohort default rates, with the remaining heterogeneity across cohorts caused by local house-price declines. To account for the endogeneity of prices — especially that price declines themselves could have been caused by subprime lending — I instrument for house price changes with long-run regional variation in house-price cyclicality.

Control-function results confirm that price declines unrelated to the credit expansion causally explain the majority of the disparity in cohort performance. Counterfactual simulations show that if 2006 borrowers had faced the price paths that the average 2003 borrower did, their annual default rate would have dropped from 12% to 5.6%.

Ok, ok — this is hyper-technical! The implications, however, are important: “These results imply that a) tighter subprime lending standards would have muted the increase in defaults, but b) even the relatively “responsible” subprime mortgages of 2003–2004 were sensitive to significant property value declines.” (40) It concludes that, “In reality, cohort outcomes are driven by both vintage effects (i.e. characteristics bottled into the contracts at origination) and path dependency in that exposure to economic conditions affect cohorts differently depending on their history.” (40)

So, the bottom line is that loose credit and plummeting prices were both causes of the defaults during the crisis. Mortgage underwriters and policymakers are on notice that they need to account for both of them in order to be prepared for the next crisis. This paper’s contribution is that it has quantified the relative impact of each of those causes.



Wednesday’s Academic Roundup

The Prime Crisis

Ben Franklin, Founder of the University of Pennsylvania

Fernando Ferreira and Joseph Gyourko, both at Penn’s Wharton School, have posted A New Look at the U.S. Foreclosure Crisis: Panel Data Evidence of Prime and Subprime Borrowers from 1997 to 2012 to SSRN. Unfortunately it is behind a National Bureau of Economic Research paywall. The paper makes the case for “a reinterpretation of the U.S. foreclosure crisis as more of a prime, rather than a subprime, borrower issue.” (1) The authors conclude,

The housing bust and its consequences are among the defining economic events of the past quarter century. Constructing and analyzing new and very large micro data spanning the cycle and all sectors of the mortgage market leads us to reinterpret the ensuing foreclosure crisis as something much more than a subprime sector issue. Many more homes were lost by prime mortgage borrowers, and their loss rates not only increased relatively early in the crisis, but stayed high through 2012. This new characterization of the crisis motivates a very different empirical strategy from previous research on this topic. Rather than focus solely on the subprime sector and subprime traits, we turn to the traditional home mortgage default literature that explains outcomes in terms of common factors such as negative equity and borrower illiquidity.

The key empirical finding is that negative equity conditions can explain virtually all of the difference in foreclosure and short sale outcomes of Prime borrowers compared to all Cash owners. This is true on average, over time (including the spike in their foreclosure rate beginning in 2009), and across metropolitan areas. Given the predominance of this group in terms of foreclosures and short sales, this is tantamount to explaining the crisis itself. We can explain much, but not all, of the variation in Subprime borrower outcomes in terms of negative equity or borrower illiquidity conditions, so something potentially ‘special’ about the subprime sector still is unaccounted for. That said, it also could be that a less noisy measure of borrower illiquidity would be able to account for this residual variation. That remains for future research.

None of the other ‘usual suspects’ raised by previous research or public commentators change this conclusion. Housing quality traits, household demographics (race or gender), buyer income, and speculator status do not have a material influence on outcomes across borrower types. Certain loan-related attributes such as initial LTV, whether a refinancing occurred or a second mortgage was taken on, and loan cohort origination quarter do have some independent influence, but they are much weaker than that of current LTV. (27)

I will have to leave it to other empiricists to evaluate whether this sure-to-be-controversial study is methodologically sound, but I sure did find their policy conclusion to be interesting:

We are not able to provide a definitive recommendation one way or another, but we can rule out one noteworthy reason offered for not aiding homeowners—namely, that the crisis was mostly about irresponsible subprime sector actors (both lenders and borrowers) who were undeserving of transfers. Of course, this is not to say that there was no such behavior. The evidence from other research and serious journalists is that there was. However, it is clear from the passage of time (and the accumulation and analysis of new data that provides) that the problem was much more widespread and systemic.  (28)

Hopefully, this is a lesson that we can take with us into the next (inevitable) housing crisis so we lay the foundation for policy solutions based on facts and not rely on moral judgments about borrowers that are built on shaky ground.

Thursday’s Advocacy & Think Tank Round-Up

  • On June 23, at 2pm the Urban Land Institute, John D. and Catherine T. MacArthur Foundation, and Hart Research are hosting a Virtual Conversation entitled: Housing, Communities, & Messaging that Resonates: Results from Three New Polls (RSVP Here).
    • Americans’ housing and community preferences in this rapidly changing landscape,
    • where and how Millennials want to live,
    • overall satisfaction with government’s prioritization of housing affordability, and
    • the most persuasive messaging about affordable housing.
  • Corelogic’s Equity Report finds that 245,000 properties regained equity in the first quarter of 2015 – over 90% of properties have positive equity and the percentage of “underwater” mortgages decreased by over 19% year-over year.