Economics

Bogus Unemployment/Default Connection Is Bogusly Bogus

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HousingWire.com finds an interesting point buried in recent testimony at the House Financial Services Committee by Laurie Goodman, senior managing director at Amherst Securities:

Goodman also took on the widespread, but mistaken notion that unemployment is the primary driver of delinquency, default and home loss. (Indeed, a committee member set her up for a dunk ball, by stating "there is no better foreclosure mitigation plan than a job." I should clarify, he was using his three minutes to grandstand against the Administration's stimulus, spending and tax programs as "job crushing" disincentives to job providers, not demonstrating his—or even his staff's—understanding of the dimensions of the foreclosure crisis.)

This movie is called Time Out (l'Emploi du Temps), and is worth seeing.

Drawing on her recent report, "Negative Equity Trumps Unemployment in Predicting Defaults," (covered by HousingWire.com at publication: Read here), Goodman made three key points:

1. The total ratio of mortgage debt to home value (CLTV) is critical. In areas with low unemployment, defaults rates of Prime and Alt-A loans were at least 4 times greater for borrowers underwater by 20% than for borrowers with at least 20% equity in their homes.
2. Comparing loan performance and unemployment rates at the local level (as can be done with loan level data), Goodman found all borrowers with positive equity performed similarly regardless of the local rate of unemployment.
3. When borrowers have negative equity—as measured by CLTV, to include second mortgages—unemployment plays a role, but a minor one compared to negative equity. For example, borrowers with CLTV greater than 120%, default rates were 50% to 100% higher in a high unemployment area than in a low unemployment area.

Goodman's argument is not innocent. By cutting through the job-loss argument, she is trying to lay the groundwork for steep haircuts for mortgage deadbeats. But it's important to clear away the pettifoggery around what's actually causing—and continuing to cause—the collapse of the housing debt market. It's not unemployment. And of course, you read it here first.

Speaking of people who need to lose their jobs before the economy can recover, you may have heard about Ben Bernanke's exploding option ARM the other day. Calculated Risk turns up a wonderful fisking (do people still do fiskings?) of Bernanke's own mortgage:

Bernanke bought in May 2004 for $839,000. He had a 5/1 ARM for $671,200 at 4.125% that adjusted to 12 month Libor in June of each year after his fixed period ended. To calculate his rate you take 12 month Libor on that date and add 2.250%, it can't adjust more than 2% in any one year due to restrictions on the note. He also had a purchase money second $83,900 but for some reason I can't find the interest rate on that one, nor do I see an ARM rider for it so it could very well be fixed. Both notes indicate they are amortizing loans.

Bernanke bawls like a twist because he's a pansy.

So what does this all mean? Well according to the terms I see for Bernanke's first and the little information on historic LIBOR I can find (here)… his rate actually went down. So if his rate went down on his first and his second is fixed (an assumption on my part since I see no ARM rider on the second) then ask yourself why refinance now? You would only do so if you expect rates to rise in the future or you don't think fixed rates will ever be this good again. Winter time is a low demand time for mortgages so rates drop to encourage activity, also the Fed is ending it's MBS purchases so rates are expected to rise.

Based on his actions I think Bernanke does not expect rates to get better than this at the very least. One can't read how much worse he might think rates might get based on his refinance but he clearly fixed his rates now so the risk for lower rates in the future based on his personal financial decision is low. I was a little doubtful that the Fed would actually end their MBS purchases since the housing market is only this "good" due to the artificially low rates caused by those purchases. But now I am much more convinced that the Fed will at least let the MBS portion of the market to stand on its own two feet in the near future. They could always jump back in if rates jump higher than they want.

I'm shocked that the Effective Demand blogger implies Bernanke is trading on his insider knowledge of Fed policy to lock in a good interest rate. This is Ben Bernanke for God's sake, Time's man of the year, a being motivated solely by sound judgment and selfless patriotism. But if you're making plans, keep in mind that even in Bernankeworld negative interest rates can't go on forever.

NEXT: Recycling Material in Copenhagen

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  1. Interesting post.

    I don’t think watching fed chairs and members personal habits is all that new in making expected inflation/deflation determinations. I’ve heard about it more than once.

    There’s going to be a lot of really kool data and derived information from this recent fiasco. Fire up the SAS and let the regressions commence.

  2. do people still do fiskings?

    I hope not.

    1. The President misspoke.

      He does still have hope, especially for a better America.

      He meant to say that there are some who would use nitpicking in a mean-spirited attempt to derail necessary progress.

  3. think…disinformation

  4. Japan has had near zero interest rates for 20 years. Not forever yet, but getting close.

    1. Japan is also quickly turning into the nation size equivalent of a ghost town.

      Debt to GDP ratios that are stunningly bad and make us look responsible. Low interest rates that have only been maintainable because of a cultural quirk whereby its populace chooses to buy government bonds rather than all those cool gadgets they produce. And a large portion of said populace now entering retirement age, meaning that they will have to consume those savings to live on rather than buying government debt. Oh, and negative population growth and increased competition from China, meaning no prospects of sufficient economic growth to pay down the mountain of debt (unless they get that robotics program started soon).

      There’s more, but screw the Japanese anyway.

  5. “This is Ben Bernanke for God’s sake, Time’s man of the year, a being motivated solely by sound judgment and selfless patriotism.”
    Hard to decide here. The man is in a position that requires both omnipotence and perfect disinterest; neither of which are possible.
    But given that ‘talk is cheap’ is axiomatic in econ, I think I’ll act on his activities rather than his talk.

  6. Silly Ben… He should have just got a Friends of Angelo loan.

  7. Nice post Tim. I agree that the unemployment / default relationship is incorrect. It is all about negative equity.

    Regarding option ARM blow-ups in 2010 & 2011: many option ARMS were written with negative amortization and 1% interest-only payments for a period of time. When those loans adjust in 2010 & 2011, the mortgagor must must pay market interest (certain to go up from 1%) AND principal amortization. If the mortgagor ‘stretched’ to get into those loans, then you can expect them to simply walk when they have to pay real interest rates and principal reduction on an under-water loan.

    The banks will still be dealing with write-offs, and foreclosures, for another 1 – 2 years.

    1. I’ve been out of that biz for a few years, but when I was in it neg am loans were huge in California but not significant in most other markets. IndyMac was big into those.

      1. My wife, still connected to the mortgage industry, just pointed that an awful lot of loans were backed into being neg am loans. It’s funny and true.

  8. You’re doing it wrong. It’s called Bernankeland.

  9. If one has a ARM tied to the LIBOR, this is a good time to refinance to a fixed rate regardless of who you are

    http://www.moneycafe.com/library/libor.htm

    1. They won’t b able 2.

      Chances r that these people qualified for a loan then but will NOT qualify now. The standards r much tougher.

      1. If by standards you mean possessing any equity in the home, having two pennies to rub together to put down or being able to prove that they have an income stream capable of handing payments.

        For a good chunk of “these people” the above did not apply before and it still does not apply.

        Why we should bail them out completely perplexes me – suppose I go out and by a Bently on loan and then when payments are do I can’t pay it. What the hell is the difference

        1. suppose I go out and by a Bently on loan and then when payments are do I can’t pay it. What the hell is the difference

          I suppose “The American Dream” does not involve owning your own Bentley.

          Something built by GM, OTOH, …

  10. I’ll stay tuned for her next report entitled “Being a Moron That Takes on More Debt than They Can Pay Back Trumps Negative Equity in Predicting Defaults.”

    Anyone who was watching during the boom years saw that people were borrowing more than they could pay back and basically betting on housing prices. The true cause of defaults, it seems to me, is that people can’t pay the true cost of the house. Negative equity is an indicator that their bets on the market went bad, but it’s not the cause of their defaults. Negative equity doesn’t cause you to lose to ability to pay the loan back. If the borrower didn’t bet on ever rising prices (for example taking out a 30yr fixed) they probably aren’t defaulting at the same rate.

    I’d like to see a study comparing the defaults rates on those with negative equity broken down by the type of loan. It’s probably out there, but I’m too lazy to find it.

    1. Negative equity doesn’t cause you to lose to ability to pay the loan back.

      True.

      Negative equity is an indicator that their bets on the market went bad, but it’s not the cause of their defaults.

      That doesn’t follow, which I think is the point. The WSJ has had several articles recently on people that walk away from their mortgages because they’re underwater, and not because of any particular financial difficulty. That’s anecdotal evidence, but it appears to be backed up by the data.

      My recollection is that default rates are higher on ARMs than on long-term fixed rate mortgages, but I don’t remember whether that’s true after controlling for other factors (credit score, doc type, LTV, etc.)

  11. Wow, is anyone really surprised b this?? LOL

    Jess
    http://www.anonymous-web.cz.tc

  12. We’re either going to create jobs while raising taxes and energy prices… or we’re going to convince you we managed to do so.

    Either way, you’re going to like it, because I said so.

  13. Anybody who thinks people default on mortgages just because they’ve lost their incomes and jobs hasn’t learned to reason like a libertarian.

    1. Edward, here’s Mr. Allin with a response that’s on your intellectual level.

  14. I’m sorry, but if you owe more money on something than it is worth, you do not own it.

    People who put little or no money down, with ARMs or interest-only loans such that they barely put a dent in the principal, are NOT homeowners and it is ridiculous to insist that taxpayers, banks, or anyone else make concessions to keep them in “their” home.

  15. Maybe I need to look at that bit about Bernanke’s situation again a little deeper, but my quick read of it makes me think that the fisker doesn’t have a very deep understanding of the subject.

  16. Too much weight is given to home prices. Wages are depressed by the “free market”, housing prices are artificially inflated because of regressive taxation which then enables gross income inequality and the false inflation of commodities – whose values have no relation to real wages anymore. Good economics is simple: empower wage gains, and the rest will take care of itself – no bubbles, no ARMS needed. And another quaint idea – that of owning a home just because one needs a reasonable place in which to live – what happened to that? That concept too was twisted by overblown financial markets who want to indenture the average consumer in every way possible. All of the fancy positing about LIBOR, interest rates, employment or unemployment – have nothing to do with what is really going on – which is that housing prices are purposefully blown far out of proportion to median and under-median incomes and that is the biggest problem here. That – along with the sophistry we are forced to endure from dubious supply side and regressive taxation advocacy – is the cause of this meltdown. Until we build an economy from the bottom up, via rising wages (and not encouraging consumer debt), we will not have the prosperity nor the stability that occurs in well run and fair economies.

  17. you’re right that Time Out is worth seeing – a fine film w/great performance by the protagonist. The director’s 2 movies since haven’t been at the same level, but Time Out is a film i’d be proud of having directed.

  18. Nothing new here, they’ve been doing this for a while. Even since BEFORE Obama was elected. Are you just barely catching on?

    You see they don’t count certain groups of people who are still unemployed, like those collecting social security, the retired, and those who aren’t registered with an unemployment agency. They don’t factor in the fact that many people who are employed are only employed part-time, or that they were laid off from a high-paying job but got a job flipping burgers. They’re employed, but they aren’t making nearly as much as they once were (therefor they aren’t paying as many taxes).

    This was going on during the Bush years and even before then. It’s all an illusion meant to boost confidence in our country and our economic system so people don’t fly into a panic when they realize we’re showing depression-era numbers. The fact that you’re trying to blame this on Obama only shows your ignorance and blind hatred for the man.
    Seo Company | Car Leasing

  19. Nothing new here, they’ve been doing this for a while. Even since BEFORE Obama was elected. Are you just barely catching on?

    You see they don’t count certain groups of people who are still unemployed, like those collecting social security, the retired, and those who aren’t registered with an unemployment agency. They don’t factor in the fact that many people who are employed are only employed part-time, or that they were laid off from a high-paying job but got a job flipping burgers. They’re employed, but they aren’t making nearly as much as they once were (therefor they aren’t paying as many taxes).

    This was going on during the Bush years and even before then. It’s all an illusion meant to boost confidence in our country and our economic system so people don’t fly into a panic when they realize we’re showing depression-era numbers. The fact that you’re trying to blame this on Obama only shows your ignorance and blind hatred for the man.
    seo company

  20. Nothing new here, they’ve been doing this for a while. Even since BEFORE Obama was elected. Are you just barely catching on?

    You see they don’t count certain groups of people who are still unemployed, like those collecting social security, the retired, and those who aren’t registered with an unemployment agency. They don’t factor in the fact that many people who are employed are only employed part-time, or that they were laid off from a high-paying job but got a job flipping burgers. They’re employed, but they aren’t making nearly as much as they once were (therefor they aren’t paying as many taxes).

    This was going on during the Bush years and even before then. It’s all an illusion meant to boost confidence in our country and our economic system so people don’t fly into a panic when they realize we’re showing depression-era numbers. The fact that you’re trying to blame this on Obama only shows your ignorance and blind hatred for the man.
    seo company Thank you

  21. Nothing new here, they’ve been doing this for a while. Even since BEFORE Obama was elected. Are you just barely catching on?

    You see they don’t count certain groups of people who are still unemployed, like those collecting social security, the retired, and those who aren’t registered with an unemployment agency. They don’t factor in the fact that many people who are employed are only employed part-time, or that they were laid off from a high-paying job but got a job flipping burgers. They’re employed, but they aren’t making nearly as much as they once were (therefor they aren’t paying as many taxes).

    This was going on during the Bush years and even before then. It’s all an illusion meant to boost confidence in our country and our economic system so people don’t fly into a panic when they realize we’re showing depression-era numbers. The fact that you’re trying to blame this on Obama only shows your ignorance and blind hatred for the man.
    seo company Thank you

  22. hi,
    everybody, take your time and a little bit.shrtjhw

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