These days the political consensus seems to be that everyone deserves the American Dream, no matter what the cost. Record-high home ownership rates seem to trump everything. Is there a housing bubble? Who cares, say the cheerleaders, when we're helping more families create wealth through home ownership. Don't worry, they say, house prices have never fallen in the U.S. — at least not on average, and not for the country as a whole. Besides, ever-increasing house prices will keep people from getting in over their heads.
But let's examine that last point. It may not have made the prime-time news, but there have been rising, even record, defaults in a number of cities this year, including Philadelphia, Denver, and Houston. Is this just a local anomaly, or is there something more going on?
At first glance, the overall statistics are somewhat reassuring. In the second quarter of 2005, new foreclosures totaled 0.39% of all loans outstanding, down from the peak of 0.50% three years ago, according to the Mortgage Bankers Association.
But there are some worrisome signs. Even with that dip, the overall foreclosure rate remains higher than at any time prior to 1999. Much of this is concentrated in two areas: FHA and subprime lending. FHA foreclosures occurred at a 0.76% rate in the second quarter, almost twice the overall rate. This rate is down from the record high of 1.06% two quarters earlier, but the improvement looks to be temporary. After a temporary dip in the spring of 2004, the serious delinquency rate on FHA loans has resumed its rise and stands at an all-time high (see chart). The foreclosure rate on subprime loans is even higher at 1.54%.
There are at least three reasons for concern over the possibility of rising foreclosures:
the prevalence of loans that require a low or even no down payment;
the recent widespread use of riskier mortgages; and
the probable end to the rapid price appreciation of recent years.
While FHA and VA have long offered mortgages that require a down payment of 5% or less, such loans are now widely available in the conventional market. In addition, many people are now using equity take-out refinancing or home equity loans to fund consumption that does not increase home value. These borrowers are particularly likely to find themselves “upside down” — having loans higher than the value of their houses.
Recently, there has been a proliferation of creative mortgage products unlike anything since the early 1980s. Then, the problem was record-high mortgage rates. Now, the problem is record-high home prices that make monthly payments unaffordable. But interest-only loans and “option ARMs” increase the risk of default, Fed Chairman Alan Greenspan has noted.
More recently, Federal Reserve Governor Mark Olson pointed out that “households stretching to qualify for loans will be severely challenged if, for example, interest rates rise” — a prospect that is virtually certain, given that the Fed has been tightening monetary policy for 18 months.
Even if you do not believe there is a bubble in house prices, fewer and fewer analysts are ruling out the possibility of at least some price declines in some markets. Freddie Mac CEO Richard Syron even acknowledges that point: “We are prepared to see some retracing of house prices in some of the markets where gains have truly outpaced underlying economic drivers,” says Syron. A dip in house prices, even in areas of substantial price appreciation, could cause foreclosure rates to rise.
Impact of fallout
Why should we care about defaults? They don't just affect borrowers and lenders. Defaults also affect surrounding neighborhoods, local businesses and police and fire departments. These costs are exacerbated in the case of subprime loans, which tend to be more concentrated geographically. A new study details just how costly foreclosures can be — in some cases exceeding $30,000 per property.
In the post-World War II era, the American Dream of home ownership became a reality for the majority of U.S. families. But surely ownership isn't the right housing solution for all families at all times. And surely we aren't doing anyone a favor by pushing home ownership onto families who don't have the ability to sustain it.
Mark Obrinsky serves as the chief economist for the National Multi Housing Council based in Washington, D.C.