Posted: 23 Feb 2011 02:30 AM PST
The academic paper i am reviewing today attempts -- and fails -- to accurately define and describe a relationship between foreclosures and the economy.
Irvine Home Address ... 12 SANTA RIDA Irvine, CA 92606
Academic writing is the only endeavor that you can take common sense, mathematically measure it, statistically analyze it, pompously write about it, and still get it completely wrong. The academic article featured today attempts to take a common sense idea -- foreclosures impact house prices and the economy -- and try to find some relationships that may have predictive power. They failed. They failed because they didn't properly identify causation.
Correlation is not causation
Have you heard the term post hoc ergo propter hoc? It means that just because something follows an event doesn't mean the first event caused the other. The error the authors make today is rooted in the same problem.
These authors have identified foreclosures as a causal event or circumstance which leads to other economic woes. If fact, foreclosures are another symptom of the same underlying problems -- excessive debt, toxic mortgages and borrower insolvency. Foreclosures do not cause indebtedness. But excessive indebtedness is the cause of all our economic problems including foreclosures.
The bubonic plague analogy
Let's say we are doctors examining the circumstances and conditions surrounding bubonic plague, also known as the black death. Doctors noticed bulbous lesions called buboes patients often displayed before becoming very ill and dying. It would be reasonable to postulate that the buboes were the cause of death. They weren't. The nasty black buboes are merely another symptom of the disease.
in the same way, foreclosures are the cause of anything. People taking on excessive debts under terms with onerous and sometimes escalating payments is the root cause of all the woes in the housing market. Lenders created more debt than current incomes can support under stable terms. When the system collapsed, many borrowers became financially distressed and stopped making their mortgage payments. Mortgage delinquency is at the core of our economic problems.
Mortgage delinquency can be caused by excessive debt or borrower distress. The excessive debts of the Ponzis would have taken out the housing market even if the collapse didn't spill over into other areas of the economy. However, the implosion of the Ponzis did cause widespread economic pain because the loss of consumer spending and the dramatic decline in the demand for real estate. Therefore, the excessive debt distressed an entire class of borrowers who may or may not have been as irresponsible as the Ponzis.
Mortgage delinquency may or may not cause a foreclosure. A certain amount of mortgage distress is always present in the market. Usually, when people get into financial trouble, they simply sell their house, pocket the equity, and go on with their lives. No foreclosure. However, once prices start to fall, people submerge beneath the surface of their debts, and they can no longer sell into a rising market. With resale not being an option, many more foreclosures occur.
Since mortgage delinquency is the real problem, and since foreclosures are an incidental byproduct that only occurs when market conditions are bad, foreclosures are not the direct cause of anything. Also, not all delinquent borrowers have become foreclosures as lenders are building a huge shadow inventory of delinquent mortgage squatters, and not all foreclosures make their way onto the MLS immediately as lenders often take their REO off the market hoping for better days.
Distressed resales lower prices, and foreclosures often become distressed resales. This relationship is direct. Lenders know this, so they are withholding inventory from the market to prevent prices from going any lower. Further, lower prices prompts more of the marginally distressed loan owners into default creating an indirect impact and a self-reinforcing downward spiral.
Notice that foreclosures, though a big part of the story, are not a direct causal factor for much of anything. Keep the plague analogy in mind as you sift through the academic formalities.
Atif Mian, Amir Sufi, Francesco Trebbi
To the first point i say, "duh!" forced sale of any good means taking the highest offer no matter how low that offer is. Of course that pushes prices down.
To the second point, if an entire industry is geared toward the production of the asset crashing in price, it stands to reason that a significant economic decline will ensue.
These two points are not where i differ with their findings. It's when we dive into the details of causation that a disagreement arises.
These authors don't mention the effect of HELOC abuse -- because they probably don't realize how important or widespread it really was. People spending their homes is where the action was at. The lack of mortgage equity withdrawal is also why the economy is in the doldrums.
You don't because they aren't.
No, what they are really doing is looking for correlations and hoping they find some causal link. In this instance, they picked the wrong causal factor.
I would love to see a study on mortgage delinquency as the casual factor. Of course, with amend-extend-pretend and shadow inventory, the direct relationship which exists probably breaks down in early 2008. However, mortgage delinquency starts the chain of events the caused this national catastrophe.
Nice map of the judicial versus non-judicial states. It may tells us something about how long it takes a property to go through foreclosure, but it provides little else of value.
What they have found is a correlation without direct causation.
I wish I were smart enough to understand how their study manages to isolate the impact of foreclosures above and beyond the delinquency that caused the foreclosure. I don't think it can be done because the causation does not exist.
That paragraph as loaded with some serious jargon (and bullshit). It would be interesting to see a study of judicial versus non-judicial foreclosure in a market where the substitution effect across boundaries came into play, perhaps Alexandria, Virginia versus some nearby Maryland zip codes.
Again, their results are wrong because they have identified the wrong causal factor.
Think about what they are saying logically. Wouldn't it make more sense that residential investment would decline when prices crashed? How are homebuilders supposed to run their businesses when the sale price of their product was in freefall? Who were they going to sell those homes to? The foreclosures didn't cause the homebuilders to pull back on new construction. A lack of sales did that.
Mortgage delinquencies and distressed sales -- many of which were foreclosures -- did cause prices to go down which in turn created the circumstances where builders were not incentivized to spend on residential investment. The decisions of homebuilders lowered residential investment. Foreclosures were only part of the mix that occurred in the same time period -- correlation without causation.
That is a shame. This is the main reason foreclosures are a good thing. If the market were allowed to follow its natural course, we would have seen a violent drop in prices followed by a sustained recovery. As it stands, we abbreviated the fall and now we will endure a longer and slower drop.
I think we have seen plenty of government support.
Yes, since mortgage delinquency is the real root cause, the foreclosures are not necessary to make prices go down. In fact, with the amend-extend-pretend policy at the banks, we have not seen near as many foreclosures as we should have given the high level of mortgage delinquency.
IMO, due to the extensive shadow inventory, the speed of judicial processing is not a big deal. Lenders don't want to process foreclosures quickly. They want to buy their heads in the sand
The fix is in
Whenever I see a property priced under market go pending in a single day, I am suspicious. Did the seller really get the highest and best price? Or did a shady listing agent steer the sale to a favored buyer in exchange for a kickback? I have no idea if anything nefarious happened with this property, but the transaction does look rather strange.
The owner of today's featured property paid $978,000 back on 6/1/2004. The owner used a $782,400 first mortgage, a $100,000 second mortgage, and a $95,600 down payment. On 9/30/2005 he opened a $176,100 HELOC. Since this HELOC matches the loss on the sale after commissions, the negotiations between the second mortgage holder and the borrower are at the forefront of this transaction.
Fast forward nearly seven years, and this house is now selling for a 15% loss. Not to worry, the owner hasn't make a payment in nearly two years, and the bank doesn't seem to be in a hurry to foreclose. Realistically, even if the deal is shady, the bank is probably better off than going through foreclosure and recovering even less.
Irvine Home Address ... 12 SANTA RIDA Irvine, CA 92606
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