The Mortgage Crisis

Todd J. Zywicki

Professor of Law

George Mason University

The Housing Boom

• Low Interest Rates

• Fannie & Freddie

• Weakened Underwriting Standards

• Speculation

Housing was Cheap

HUD Composite Affordability Index

60

7080

90

100110

120

130140

150

Aff

ord

abil

ity

Ind

ex

Homeownership Rose

Homeownership Rates

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63

64

65

66

67

68

69

70

Perc

en

tag

e o

f H

ou

seh

old

s O

wn

ing

Ho

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Minorities Benefited

Homeownership by Race

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40

45

50

55

60

65

70

75

80

Per

cen

tag

e H

ou

seh

old

s

White

Other

Black

Hispanic

Young Benefited

Homeownership by Age

0

10

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Per

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e H

ou

seh

old

s 65 and Over

55-64

45-54

35-44

30-34

25-29

Less than 25

Housing Bust: Foreclosures

Foreclosures

0

0.2

0.4

0.6

0.8

1

1.2

Theories of Foreclosure

• Local Macroeconomic Problems

• Payment Shock and ARMs

• Negative Equity and the “Put” Option

Macroeconomic Problems

• Michigan, Ohio, Indiana

• Post-Natural Disasters

• Historically foreclosures rise a bit in recessions

Monetary Policy

Mortgage Interest Rates

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

30 Year Fixed

Adjustable

Rise In ARMs

Market Share of Fixed v. Adjustable Rate Mortgages

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100

Per

cen

tag

e

PercentFixedRate

PercentAdjustableRate

ARMs Follow Spread

ARMs and Interest Rate Spread

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10

20

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80

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

Percent ARM

Spread

Subprime ARM Resets

Foreclosures: Subprime Mortgages

0

1

2

3

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5

6

7

Per

cen

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ore

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tart

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Subprime ARM

Subprime All

Subprime FRM

Prime ARM Resets

Foreclosures: Prime Mortgages

00.20.40.60.8

11.21.41.61.8

2

Per

cen

t F

ore

clo

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s S

tart

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Prime ARM

Prime All

Prime FRM

Are ARMs the Problem?

• Consumers Respond to Interest Rate spread: Problem was monetary policy, not necessarily ARMs per se

• 2Q2008: increase in prime ARM foreclosure starts > increase in all subprime starts

• Home buyers self-select for ARMs: Risk aversion

• Consumers with ARMs benefited a lot between 2000-2004

• Very Common in Rest of World

Real Home Prices

Real Home Prices

50000

60000

70000

80000

90000

100000

1983

Do

llar

s

Factors Affecting Option Value

• Speculator v. Non-Speculator: Continuum

• State Antideficiency/Nonrecourse Law– California– Arizona

• Downpayment, “Piggyback Loans,” “Skin in the Game”

Foreclosure “Hotspots”• Michigan, Ohio, Indiana• California, Florida, Arizona, Nevada (1Q2008)

– Calif: 109,000, Fla: 77,000– Texas, Mich, Ohio: Next 3 with 20,000-24,000 each

• 43 states below national average of 6.32% foreclosure start rate• 20 states had drops in foreclosures between 4Q2007 and 1Q2008• Prime ARM

– 62% of all prime ARM foreclosures started– 84% of increase in prime ARM foreclosures started

• Subprime ARM– 49% of subprime ARM foreclosures– 93% of increase in subprime ARM foreclosures

• Prime FRM foreclosures– 29% of prime FRM foreclosures– 60% of increase

• Subprime FRM– 25% of subprime FRM– 53% of increase

Foreclosure “Hotspots”

• 2Q2008 v. 1Q2008• Majority of states stayed constant• Texas, Mass., Maryland improved• 42 states below national average• Cla, Fla: 58% of prime foreclosure starts• 78% of increase in prime foreclosure starts• Foreclosure starts on prime ARM:

– 2.47% Cal– 3.20 Fla– National Average 1.06– Foreclosure start rates subprime ARM Cal & Fla >9%, double

national median rate

What Next?

• Not Just One Cause

• Not Just One Solution

• Some Solutions May be Counterproductive: E.g., Foreclosure Moratorium

• What About Speculators?

• Not Just a Prime v. Subprime Problem

Resources

• “The Law and Economics of Subprime Lending,” http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1106907

• Todd Zywicki, Consumer Bankruptcy and Consumer Credit in the 21st Century (Yale University Press, Forthcoming 2009)