Sunday, July 5, 2009

“Evidence” on the Foreclosure Crisis

Stan Liebowitz, an economics professor at University of Texas, Dallas, has an op ed piece in the Wall Street Journal touting the results of research he has done using “a huge national database containing millions of individual loans”. His conclusion:

The analysis indicates that, by far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home.

My first reaction was, like Barry Ritholtz, “Duh”. If you have equity in your home and can’t pay your mortgage, you sell the home, pay the loan off and pocket the equity. Equity = No Foreclosure.

But, (as Barry also notes), the piece is weird:

A simple statistic can help make the point: although only 12% of homes had negative equity, they comprised 47% of all foreclosures.

Time out; that means 53% of all foreclosures are on homes that have equity. Does that sound right to you?

The accompanying figure shows how important negative equity or a low Loan-To-Value ratio is in explaining foreclosures (homes in foreclosure during December of 2008 generally entered foreclosure in the second half of 2008).


I think these are all legitimate contributing factors, but I question some of the conclusions Liebowitz draws. For example:

To be sure, many other variables -- such as FICO scores (a measure of creditworthiness), income levels, unemployment rates and whether the house was purchased for speculation -- are related to foreclosures. But liar loans and loans with initial teaser rates had virtually no impact on foreclosures, in spite of the dubious nature of these financial instruments.

Anyone involved in the crisis can tell you the liar loans and low teaser rate loans were the first to default. You wouldn’t expect to see many of them left by the second half of 2008 (survivorship bias at work).

Also, this a very mixed bag of contributing factors. Negative equity is a factor at the time of default (do I sell the property or allow it to be foreclosed?). A low down payment and a low FICO score are factors at origination. The unemployment increase in 2008 and rate resets happen after origination and before foreclosure. If I’m a low FICO score borrower with a low down payment, a rate reset, no equity, and I lost my job, what caused my foreclosure? Regression analysis can parse out the first four variables if done correctly, but how does the fifth variable enter into the equation? I suspect Liebowitz’s analysis is flawed, especially since he concludes more than half of foreclosed properties have equity.

Hoping for some answers, I checked out Liebowitz’s home page. There’s no reference to this research, and precious little on real estate at all (mostly copyright stuff). If one uses the word “evidence” in one’s title, shouldn’t the evidence be available?

I agree with many of Liebowitz’s conclusions, but it would be nice if they were coherently supported. Also, it’s depressing that some many bloggers have uncritically endorsed the piece without question.