Foreclosure Crisis — Too Early to Define the Solution?

Another day — another study.  Stan Liebowitz, professor of economics and director of the Center for the Analysis of Property Rights and Innovation at the University of Texas, writes in an op-ed piece that “the most important factor related to foreclosures is the extent to which the homeowner how has or ever had positive equity in a home.”  He says that his analysis of foreclosure data shows that subprime loans, upward resets, and so-called “liar loans” were not the primary cause of the current foreclosure crisis, and hence current government programs are “misdirected.”

It is interesting to note that Professor Liebowitz’ analysis concludes that 51% of all foreclosed homes had prime loans.  He reports that his analysis of foreclosures during the second half of 2008 shows that while 12% of the homes had negative equity, they accounted for 47% of all foreclosures.  Professor Liebowitz’ reasons that negative equity, by itself, is not an indicator of a foreclosure, but it implies that the borrower is more likely to walk away from the loan.  He argues that current government programs (i.e., Making Home Affordable), and federal efforts to keep interest rate low, are misdirected.  Driving mortgate payments down to 31% of income will not have much of an effect, since his study showed that those with higher (38%) ratios were not more likely to face foreclosure.  Reducing interest rates induce refinancing, not home purchases.  Professor Liebowitz calls for stronger underwriting standards, higher down payments, and clarifying the consequences for homeowners who simply choose to “walk away.” The good news, according to Professor Liebowitz, is that housing prices are approaching a long-term, pre-bubble levels and equilibrium.  He singles out Barney Frank for criticism for efforts to artificially increase homeownership levels, which would delay the return to equilibrium levels.

Professor Liebowitz’ analysis is one of many that will be conducted as the data becomes available, and it will be interesting to see more precisely what will actually work.  Empirical evidence suggests that while we’re still headed downhill, and the forecasts for continuing foreclosures are dramatic, it is probably too soon to know more precisely what the actual causes of the crisis were, thus too premature to fashion a realistic solution.  We know that many of the investors currently holding the notes are largely unwilling to make significant concessions in terms of rates or payments, let alone reduce principal.  We know that rising unemployment will continue to threaten the pace of recovery — if we’re even in the recovery phase at this stage.  We know that lenders aren’t lending, despite billions of dollars already spent by the Federal Government.  And, we’re starting to see the first real wave of the crisis hitting the commercial property markets, where it will be difficult to scapegoat any single demographic factor as a cause.

Professor Liebowitz is correct when he says that “Understanding the causes of the foreclosure explosion is required if we wish to avoid a replay of recent painful events.”  That goes without saying.  But we just finished the first half of 2009, and studies of what happened during the last half of 2008 may — or may not — tell us all that we need to know.  We really need more analysis, more action, and less knee-jerk legislation.  Private lending has the potential to fill the gap left by the credit crunch, but there is room for mischief and abuse, and the banking industry lobby is fighting hard to protect its grip on the supply.  Ultimately, Americans have proven to be resourceful, creative and most importantly, survivors.  The current rush of legislation at the Federal and State levels are based on old data, driven by special interests, and may cause more harm than help.  We need to be a bit more patient and get better data before we inadvertently make the situation worse.