[Becca/FL]

From The Wall Street Examiner

What causes foreclosures?

Before even debating the details of Henry Paulson’s new plan to prevent foreclosures, I think it would be logical to first ask the question:

What causes foreclosures?

Your gut instinct may tell you it is not being able to make the mortgage payments. Even though we have been inundated with media coverage about this (i.e. impact of rate resets on ARMs), the truth is:

This is not the primary reason for foreclosures at all.

The main driver of foreclosures is the change in real estate prices.

Excerpt from Boston Globe article:

The recent spike in home foreclosures in Massachusetts is caused by falling home prices, and not by rising mortgage payments, according to research released yesterday by the Federal Reserve Bank of Boston.

The contrarian report suggests the common understanding of the foreclosure crisis is somewhat mistaken. Unaffordable loans don’t cause foreclosures directly. Even as subprime lending became more common, even when people fell behind on mortgage payments - during the economic downturn in 2001, for example - foreclosures were rare because house prices continued to rise.

In part, people were able to escape trouble by selling their homes at prices high enough to cover their debts. But the research also suggests that troubled borrowers tried harder to make the necessary payments, in the expectation they would profit eventually.

Conversely, when prices started falling, people struggling to make payments had less incentive to find the money. And the value of the home could drop below the outstanding debt, making it impossible to sell. Over the last two years, the number of foreclosures exploded.

Housing price movement “plays a dominant role in generating foreclosures,” the report concluded.

One implication of the report is that current attempts by local and federal officials to help borrowers may be ineffective.

US Treasury Secretary Henry Paulson is negotiating a deal to freeze monthly mortgage payments on some subprime loans by delaying scheduled interest rate increases. Paulson reiterated yesterday the plan could be announced this week.


This proves that the Paulson plan is a phony PR stunt because it does not address the primary cause of the foreclosure problem. Foreclosures are mostly driven by declining homeowner equity—especially negative equity.

Now that this has been established, let’s talk about the actual details of the Paulson plan to see if it would even effectively address the secondary factor (interest rate resets):

Excerpt from Bloomberg article:

U.S. Treasury Secretary Henry Paulson’s negotiations with banks to freeze payments on certain subprime home loans will offer little aid to borrowers, Barclays Plc and UBS AG bond analysts say.

Few homeowners may qualify for the proposed aid and many are likely to default even before rates reset higher, Barclays analysts wrote in a report today.

Only 12 percent of all securitized subprime adjustable-rate loans in California would qualify for fixed payments under a similar agreement between the state and four mortgage servicers last month, the Barclays analysts wrote, based on an announcement saying the deal applies to borrowers who occupy homes, have been making on-time payments and can’t afford higher rates.

Assuming that half of subprime balances default or are repaid before rate resets, another 30 percent of borrowers don’t qualify because they’ve missed payments and 20 percent of modified loans eventually default anyway, the Paulson plan only eliminates losses of 60 cents per $100 of subprime loans, versus a total that may be as high as $18 to $20, they wrote.

The extent of home price declines and economic conditions will have a “far greater impact” on the rates of loan modifications and foreclosures, wrote UBS’s Zimmerman, who is also based in New York.


Finally, to gain a better understanding of the US real estate market, I would like to draw your attention to an excellent report that I just discovered.

The report was published by the General Accounting Office on behalf of the Congressional Committee on Financial Services (released on October 16, 2007). It is 61 pages long, but it is very readable.

I must say that this is by far the most educational document I have read about the real estate market and about what happened to it over the past several years. I don’t think you will find a better source of information about this on the Internet. There has been little/no reference to this report in the media. There are certain things mentioned that many of you may already know about, but it really provides a comprehensive understanding of “what happened”.

By the way, this report cited a recent study that showed three-quarters of the increase in mortgage delinquency over the past two years was driven by the change in home prices.

How about the change in interest rates? How much did that account for?

Answer: Six percent

So Paulson’s “rescue” plan will save a small fraction of people that account for a small fraction of the foreclosure problem. A fraction of a fraction.

What a joke. The entire leadership should resign immediately.

This was written by Bernard Ducalion. Posted on Tuesday, December 4, 2007, at 10:03 am.