FORECLOSURES IN STATES AND METROPOLITAN AREAS William H. Lucy and Jeff Herlitz Department of Urban and Environmental Planning School of Architecture University of Virginia February 2009
Foreclosures in States and Metropolitan Areas Contents 1. Foreclosures in States and Metropolitan Areas text 2. Tables 3. Maps 4. Appendix tables
Foreclosures in States and Metropolitan Areas: Patterns, Forecasts, and Pricing Toxic Assets William H. Lucy and Jeff Herlitz Department of Urban and Environmental Planning School of Architecture University of Virginia February 2009 Copyright William Lucy 2009 Introduction and Executive Summary National housing price declines and foreclosures have not been as severe as some analyses have indicated, and they are not as important as financial manipulations in bringing on the global recession. Most foreclosures have been concentrated in California, Florida, Nevada, and Arizona, and a modest number of metropolitan counties in other states. In fact, 66 percent of potential housing losses in 2008 and subsequent years may be in California, with another 21 percent in Florida, Nevada, and Arizona, for a total of 87 percent of national declines in these four states. California had only 10 percent of the nation s housing units, but it had 34 percent of the foreclosures in 2008. California was vulnerable to foreclosures, because the median value of owneroccupied housing in 2007 was 8.3 times median family income, while the 2007 national average was only 3.2, and in 2000 it was lower still at 2.4. Another vulnerability to foreclosures was seen in the Los Angeles metropolitan area, where more than 20 percent of mortgage holders in each county were paying at least 50 percent of their income in housing related costs. But even in California, enormous variations existed among jurisdictions, such as in the San Francisco metropolitan area, where Solano County had 3.69 percent of housing units in foreclosure in November 2008, while only 0.24 percent of housing units were in foreclosure in the City of San Francisco, a 15 to 1 difference. Potential housing value losses from 2008 foreclosures in 50 states, if values decline to year 2000 levels, were less than one third of the $350 billion that has been provided to banks and insurance companies to cope with losses in mortgage backed securities. Damage to the balance sheets of large banks and AIG occurred not mainly from losses on foreclosed residential mortgages, but because of borrowing short range to buy long range derivatives and from selling credit default swaps insuring derivatives backed by mortgage payments. These financial manipulations had high speed forward gears, but when the housing bubble burst, the banks and AIG discovered they had neglected to create a reverse gear with which they could separate foreclosed properties from some forms of mortgage backed securities. Obstacles to disentangling toxic components of mortgage backed securities magnified many times the actual housing value declines. Although there are pockets of substantial declines, claims that overall housing values have tanked nationwide are exaggerated. In the Washington, D.C. area, for example, prices have barely changed in the District of Columbia, Alexandria, Arlington County, and some parts of Fairfax County Virginia. The largest price declines (more than 30 percent in 2008) have been in Prince William County, but even there, the range of price declines in its six zip codes ranged from 49 percent to only 6 percent. 1
Foreclosures usually were lower in central cities than in some suburban counties, probably due to less demand for housing in those suburbs. Demand for housing declined in some suburban parts of metropolitan areas, usually outer areas, due to shifts in the age distribution in the population. The population segment from age 30 to 44, when the biggest increase in home ownership occurs, has been declining in recent years. Those are prime child rearing years for families, so demand for houses with four or more bedrooms has declined and led to an excess of large houses in some counties. The run up in housing prices from 2000 to the national peak in 2006 has contributed to a 10 months supply of houses for sale, nearly six months more than the norm from 1998 through 2005. But most of the excess supply is either from foreclosed properties for sale in declining areas which constitute 45 percent of total sales during some months in 2008 or they are opportunity sale offerings by owners trying to take profits on the price escalation of recent years. A small portion of the excess housing supply is from construction of new houses. Changes in house value to family income ratios from 2000 to 2007 enable us to estimate potential losses from foreclosed mortgages contained within mortgage backed securities (MBSs). More mortgage backed security losses have been deducted from the balance sheets of major banks and insurance companies than the potential losses in the underlying mortgages if housing prices fall to year 2000 levels. Inability of banks, investors, the Federal Reserve Bank, and the U.S. Treasury to price these so called toxic assets is at the heart of the global financial crisis. Data in this study can help estimate the potential value of these assets. Inability of financial institutions to price them constitutes an enormous private market failure. Remedies for this market failure require reforming mark to market accounting rules. price corrections in a few states and a modest number of counties and metropolitan areas contributed to a national and international financial crisis. The spatial pattern of these foreclosures has received little attention, even though manipulations by financial institutions broadened localized foreclosure problems into an international financial crisis which has begun a global recession. Years before this crisis, income and housing trends within metropolitan areas were altering traditional mobility and settlement patterns. In this study we describe year 2008 foreclosure patterns and 2007 house value and family income patterns in 50 states, 35 large metropolitan areas, and 236 metropolitan counties. Foreclosure patterns update and amend descriptions of socio economic spatial trends and aid forecasts of future variations in income and house value trends in central cities, suburbs, and exurbs. After briefly describing recent trends, patterns, and forecasts and discussing limitations of foreclosure data, this study shows: 1. The geography of foreclosures, first among 50 states and second within 35 large metropolitan areas. 2. market price corrections, housing affordability, and pricing toxic mortgage based assets. 3. Consumer demand prospects and public policy challenges within metropolitan areas. Metropolitan Trends since 1990 Analyses of trends within metropolitan areas since 1990 can aid interpretations of variations in foreclosures and housing prices in 2007 and 2008. Population and income trends within metropolitan areas since 1990 have included apparently contradictory patterns. In 44 large central cities, population 2
downtown increased by 10 percent in the 1990s, including increases from 13 to 24 percent in the 25 to 34 age group (Birch 2005, 1). This may be due to cities having some advantages based on variety and accessibility in attracting jobs filled by knowledgeable workers whom Richard Florida has dubbed the creative class (Florida 2005). Suburban and exurban outward growth rates during the 1990s outpaced rates from the 1980s and were often more pronounced in slower growing northern metropolitan areas than in those of the faster growing south and west (Fulton et al 2001). On the other hand, pre 1940 neighborhoods in the Atlanta, Chicago, Los Angeles, Philadelphia, Richmond, and Washington, D.C. metropolitan areas saw greater increases in residents income than did middle aged neighborhoods, most of which were in suburbs. Moreover, middle aged neighborhoods, developed mainly between 1945 and 1970, often declined in income relative to both new and old parts of cities and suburbs (Lucy and Phillips 2006). Trends since 1990 demonstrate that the connection between suburban sprawl and city decline in some metropolitan areas has been severed. Atlanta, for example, had the fastest central city income increases in the nation during the period after 1990, when its suburban income decline and exurban population sprawl also led the nation (Lucy and Phillips 2008). Arthur Nelson (2006) has argued that demographic changes fewer households with children and more elderly, singles, and empty nesters have reduced demand for large single family detached houses on large lots below the increase in supply. Causes of these income trends since 1990 and demographic changes since 2000 may have contributed to the geographic pattern of foreclosures as well as influenced the rate of foreclosures during 2007 and 2008. Data Sources and Issues Foreclosure data are difficult to compare from one source to another. The foreclosure label may include delinquency notices, formal filings of intent to foreclose, repossessions through foreclosure processes, and property sales via sheriffs auctions. These processes may be interrupted by delinquencies being paid, changes in lenders enforcement policies, or legislation requiring delays in foreclosure proceedings. The same property may be listed multiple times (Olick 2007). Up to date sources, like RealtyTrac.com and foreclosure.com, aim their services at potential buyers of foreclosed properties. RealtyTrac s data for foreclosure proceedings (2.3 million) more than doubled the foreclosure rate of foreclosure.com in 2008. But RealtyTrac reported more than 860,000 properties were actually repossessed by lenders in 2008 (Associated Press 2009). Foreclosure.com s website said home foreclosures jumped 64% to nearly one million homes in 2008. In our study, we used foreclosure.com data for states and counties, usually from November 2008. The U.S. number of foreclosures and preforeclosures in that source was 1,009,485. The U.S. Department of and Urban Development (Capone 1996) has reported that repossession data were not available from the American Mortgage Bankers Association, so HUD developed a method of estimating repossessions from other data. Charles Capone (1996) estimated that 55 to 59 percent of formal foreclosure filings resulted in repossession of single unit residential properties from their owners in the 1980s and 1990s. The HUD study by Capone (1996) was in response to concern in Congress that the foreclosure rate was excessive. Consequently, the foreclosure crisis of 2007 and 2008 was an increase from a substantial level of foreclosures that had become common, a matter explored in depth later in this study. 3
Different data comparisons can yield different impressions. Here we compare foreclosures to housing units to arrive at a foreclosure rate. Comparing foreclosures to mortgages is more common and yields a higher rate as well as leaves out owner occupied housing where mortgages have been paid completely (32 percent of owner occupied dwellings). This method also diminishes the importance of rental housing (32 percent of housing nationwide and 46 percent of housing in central cities) on which there are fewer foreclosures. By comparing foreclosures to housing units we include all housing. This measure, however, understates the burden of delinquent mortgage payments on lenders. With 51 million mortgages in 2007, one million foreclosures would be two percent of all mortgages, a major increase from the previous norm of 0.4 percent of mortgages starting the foreclosure process from 1997 to 2006. We used median family income rather than median household income data. Median family income was 19 percent higher ($50,046 in 2000 to $41,994 for median household income). Median value of owner occupied housing to median family income ratios are lower than comparisons to median household income. A considerably higher percentage of married couple families (more than 80 percent) owned their residence in 2000 than did non family households in 2007 (53 percent) (HUD 2008, 85). For most single unit detached residences, which constitute the majority of owner occupied housing mortgages, families are the predominant occupants. Foreclosure Geography: States Foreclosure rates among states were highly skewed. The 2008 national foreclosure rate was 0.79 percent of 2007 housing units. Only seven states exceeded that rate, with an eighth, Idaho, tying it. The seven states exceeding it had considerably higher rates, led by Nevada 4.10 percent, California 2.57 percent, Arizona 2.26 percent, and Florida 1.99 percent (Table 1). The top 10 foreclosure states were in the West, except for Florida, Illinois, and Connecticut. Foreclosure rates were low in most states in 2008. In three fourths (38) of the 50 states, foreclosure rates were below 0.50 percent (1 in 200). In one half of the states (25), foreclosure rates were below 0.25 percent (1 in 400). And in 11 states, foreclosure rates were below 0.10 percent (1 in 1,000) (Table 2). (U.S. Map about here) The extreme skewing of foreclosure rates has economic, political, business, and public policy implications. The economic implication is that the origins of the foreclosure crisis were geographically limited, even though the financial crisis has spread worldwide. Politically it is difficult to generate public enthusiasm in the Senatorial and Congressional Districts in low foreclosure states to bail out the financial institutions whose questionable manipulations led to a national financial crisis and then a severe recession. Business revival is complicated by the struggle to find a national solution to financial and recession problems whose root causes lie in a small number of state, regional, and local supply, demand, and house cost to income imbalances. Public policies must be crafted that cope with national financial and recession traumas but which leave opportunities for house cost to income ratios to fall to manageable relationships in Nevada, California, Arizona, and Florida. We will expand on these observations later in this study. Announcements of foreclosure increases during 2007 and 2008 tended to be exaggerated. News media accounts emphasized the increase in 2008 above 2007, as with reporting RealtyTrac.com showing an 81 percent increase. But these accounts leave out the longer term norms and trends. From 1997 through 2006, the 10 year average of foreclosures started was 0.42 percent of mortgage loans, 4
according to data gathered by the Mortgage Bankers Association (HUD 2008, 73). In 2007, foreclosure starts increased to 0.71 percent of mortgage loans. If roughly half of foreclosure starts proceed to repossessions by lenders, then the actual foreclosure (repossession) rate would be 0.40 percent or less in 2007. During the first six months of 2008, foreclosure starts slightly exceeded 1.0 percent, which might translate into 0.50 percent repossessions (one out of 200 mortgages). If one million foreclosures proceeded to repossessions in 2008, that would be two percent of 51 million mortgages (one out of 50 mortgages). National and international financial systems are extremely fragile if they are stressed to the breaking point by a moderate foreclosure rate with foreclosures concentrated in a few states. From 2000 through 2007, the relationship between housing values and annual incomes widened. In 2000, the average 50 state ratio of median value of owner occupied housing to median family income was 2.4 to 1. By 2007, this average 50 state ratio had increased to 3.2 to 1 (Table 3). In 12 states, the ratio of house value to income exceeded 4.0 to 1, led by California at an extraordinary 8.3 to 1. The other 11 states exceeding 4.0 to 1 ratios were Hawaii, Nevada, Massachusetts, New York, New Jersey, Rhode Island, Maryland, Arizona, Florida, Oregon, and Washington. These were measures of median values and median income, that is, the middle case. Numerous properties had house value to income ratios much higher than these national and state averages. Many property owners, therefore, would be vulnerable to being unable to pay their mortgages, a fact that would be obvious if lenders had collected accurate income information. A useful indicator of vulnerability to mortgage payment delinquencies and foreclosures is the percentage of household income that mortgage holders paid for housing costs. Sheila Bair, executive director of the Federal Deposit Insurance Corporation (FDIC), has advocated and implemented a mortgage adjustment plan in which owner occupants would pay 31 percent of income for mortgagerelated costs. Traditional lenders and Fannie Mae have required about 30 percent, more or less depending on various factors, of gross income paid for mortgage related costs. Yet, in 2007, 13.6 percent of mortgage holders reported that they spent more than 50 percent of household income on housing costs, up from 9.0 percent in 2000. In high housing cost jurisdictions, such as those in the Los Angeles Metropolitan Area, more than 20 percent of mortgage holders were paying more than 50 percent of income for housing costs in 2007 (U.S. Bureau of the Census 2008, Table B25091). High foreclosure rates were influenced, but not controlled, by population growth. Of the 10 states with the highest foreclosure rates in 2008, six were in the top 10 population growth states from 1990 to 2000 and from 2000 to 2007 (Nevada, Arizona, Colorado, Utah, Idaho, and Florida) (Table 1). California, which was second in its foreclosure rate, was 18 th in population growth rate, but first in the number of new residents. High population growth would lead to high housing prices if supply lagged behind demand. values to income ratios were higher than the national average in each of the top 10 states in foreclosure rates (Table 1). But six states in the top 10 in house value to income ratios (Hawaii, Massachusetts, New York, New Jersey, Rhode Island, and Maryland) were not in the top 10 in foreclosure rates or in population growth rates. These six states also were high household income and family income states, making high housing costs more manageable. Foreclosure Geography: Metropolitan Areas Foreclosure processes in four states California, Florida, Nevada, and Arizona constituted 62 percent of the U.S. total in 2008. Within three of those four states, foreclosures were concentrated in a few metropolitan areas. In Nevada, Clark County, which constitutes the entire Las Vegas Metropolitan 5
Area, contained 88 percent of Nevada s foreclosures but only 72 percent of Nevada s population. The two counties, Maricopa and Pinal, which comprise the entirety of the Phoenix Metropolitan Area, included 91 percent of Arizona s foreclosures and 63 percent of its population. In Florida, the metropolitan areas of Miami, Orlando, and Tampa St. Petersburg contained 62 percent of Florida s foreclosures and 53 percent of its population. In California, foreclosures were more widely dispersed, as the metropolitan areas of Los Angeles, Sacramento, San Diego, and San Francisco contained 81 percent of California s population and only 63 percent of its foreclosures. Within the 35 most populous metropolitan areas, foreclosures were concentrated in a modest numbers of counties. The national average in 2008 was 0.79 percent of housing units were in foreclosure proceedings. In these 35 metropolitan areas, 74 counties had foreclosure rates at or above the national average out of 236 counties with data. Thirty three of these counties were in nine metropolitan areas in California, Florida, Nevada, and Arizona, and foreclosure rates exceeded the national average in 30 of them (91 percent). In the other 203 counties in 26 metropolitan areas, only 44 (21 percent) had higher foreclosure rates than the national rate (0.79 percent). Data for 236 counties in 35 metropolitan areas are in Appendix 1. Twelve of these 35 metropolitan areas included counties with foreclosure rates two or more times the national average (Chicago, Denver, Las Vegas, Miami, Orlando, Phoenix, Sacramento, San Diego, St. Louis, and Tampa St. Petersburg). Each of these metropolitan areas was in one of the four high foreclosure states (California, Florida, Nevada, and Arizona) except for Chicago and St. Louis. In five metropolitan areas (Las Vegas, Orlando, Phoenix, Sacramento, and San Diego) every county had foreclosures at twice or more the national rate. These five metropolitan areas had large counties, however, with a total of 12 counties, so information is limited about the geographic distribution of foreclosures within each metropolitan area in this group. Foreclosures in Central Cities In eight of these metropolitan areas, foreclosures in central cities were available in this data set because the central cities also were counties. They displayed diverse patterns of foreclosure concentrations, but the central city usually had a lower foreclosure rate than one or several counties. The widest disparity was between the City of San Francisco (0.24 percent foreclosure rate) and Solano County (3.69 percent), a 1 to 15 ratio. Each of eight counties in the San Francisco Metropolitan Area had a higher foreclosure rate than the central city, with six counties exceeding the national foreclosure rate. The Washington, D.C. Metropolitan Area had the second greatest disparity between the central city rate (0.12) and the highest county rate (1.27 percent in Prince William County, a 1 to 10 ratio). Twelve of 13 cities and counties had higher foreclosure rates than the District of Columbia. In New York City, the five counties ranged from a foreclosure rate of 0.04 in Manhattan to 0.77 in Richmond (Staten Island), with a metropolitan high of 1.52 in Passaic, New Jersey (Appendix 1). (San Francisco Metropolitan Area map about here) Three central cities had low foreclosure rates that were not much different from the highest rate in other counties (Philadelphia 0.53 percent to 0.59 percent in Camden County, 0.19 percent in Norfolk to 0.24 percent in Suffolk, and 0.16 percent in Baltimore to 0.10 in the next lowest county). In each of these central cities the foreclosure rate was well below the national rate of 0.79 percent. The central city foreclosure rate was higher than the national rate only in Denver (2.23 percent) but the Denver rate was exceeded by Adams County s 3.01 percent) and St. Louis (1.02 percent), but the St. Louis rate was exceeded by St. Clair County, Illinois (1.71 percent) and Madison County, Illinois (1.21 6
percent). In most instances, the central city foreclosure rates were exceeded by the national rate, and in the other instances, where the central city rate exceeded the national rate, suburban counties had higher foreclosure rates than the central city. (St. Louis Metropolitan Area map about here) There is no evidence in these data that foreclosures are concentrated in central cities. On the contrary, some evidence indicates foreclosures are concentrated elsewhere, sometimes in counties far from their central cities. This spatial pattern may reflect demand. In general, demand for owneroccupied housing may have been stronger in central cities relative to supply than in outer counties resulting in lower foreclosure rates in cities. This outcome could occur because housing prices were less inflated relative to family incomes in these central cities. But the opposite was more often the case. In San Francisco, for example, median value of owner occupied housing in 2007 was 9.7 times median family income, yet the foreclosure rate was a mere 0.24 percent. In the District of Columbia, housing values were 6.8 times family income, yet the foreclosure rate was 0.12 percent. And in New York City, housing values were 12.3 times family incomes in Brooklyn (foreclosure rate 0.38), 11.7 times income in Manhattan (foreclosure rate 0.04 percent), and 10.3 times family income in the Bronx (foreclosure rate 0.28 percent). Other central cities lacked such extraordinary house value to income ratios, but in no instance were low foreclosure rates associated with low house value to income ratios (Table 4). Perhaps city residents income capacity is not represented well by median family income. With lower owner occupancy rates in central cities (54 percent) compared with suburbs (76 percent) (HUD 2008, Historical Data Table 28), more home owners in cities may be relatively high on the income scale rather than near the median income. In addition, if demand for city home ownership is high relative to ownership opportunities, households who get in financial trouble paying mortgages may have been able to sell at prices high enough to pay their mortgage holder in full. This prospect was one motivator for the housing bubble the prospect of being able to sell and make a profit even if household income and ability to pay the mortgage diminished. Perhaps selling at a profit has persisted longer and more frequently in central cities than in suburban counties. Value Changes The ratio of median value of owner occupied housing to median family income increased from 2.4 in 2000 to 3.2 in 2007. This increase was strongly influenced by the 12 states above 4.0 in 2007, led by California at housing values 8.3 times family incomes. The average increase of these 12 states was 73 percent between 2000 and 2007. In 2007, 16 states still were at housing values 2.4 or less times family income. The average increase of these 16 states was 12 percent between 2000 and 2007. High house values, and high increases in house values, relative to family income were creating financial imbalances in some states. These imbalances were raw material from which foreclosures could be forged if the housing bubble burst or if recession occurred. When excessive risk stretched borrowers to the breaking point, reductions in earnings, however brief, brought many owners to be delinquent in mortgage payments. When house prices fell below the value of mortgages, which sometimes lacked down payments and owner equity, sales brought additional losses to sellers. Lower values and lower earnings led to a rapid increase in foreclosure proceedings. Just as house value to income imbalances were skewed among states, declines in house values skewed similarly. Standard & Poor s\case Shiller composite index of house values in 20 metropolitan areas is a widely recognized tracker of housing values. Year to year house values fell between October 7
2007 and October 2008 by an average 28.1 percent in the seven metropolitan areas in Nevada, Arizona, California, and Florida (Las Vegas 31.7, Phoenix 31.1, San Francisco 30.9, Los Angeles 27.9, San Diego 26.6, Miami 29.0, and Tampa St. Petersburg 19.8). These four states also accounted for 62 percent of U.S. foreclosure proceedings. In the other 13 metropolitan areas in the Case Shiller index the average housing price decline was 9.9 percent. The Case Shiller index has strengths and weaknesses. It is composed of sales of the same single family houses. Its strength is that it controls for effects of location by comparing same house sales. But this strength also is a weakness, if the goal is an accurate national measure of house value trends. Foreclosed houses, most of which are single family, constituted as much as half the sales in Nevada, Arizona, California, and Florida. Thus, the Case Shiller index captured large price declines in these houses. But the Case Shiller index does not measure prices of condominiums, apartments, or new houses (Standard & Poor s 2008, 5). With seven of its 20 metropolitan areas in high foreclosure states, and including Detroit, which is the most distressed large metropolitan area where house prices declined 20.3 percent, the Case Shiller index leads to exaggerated interpretations of national price changes when foreclosed properties constitute a high proportion of total same house sales. The housing price index calculated by the Federal Finance Agency (formerly the Office of Federal Enterprise Oversight) presented a different national picture. It showed prices down from November 2006 through October 2007 by 0.7 percent and a further decline from November 2007 through October 2008 of 8.7 percent. During this 2007 2008 twelve months, prices declined 22.1 percent in the Pacific region (including California), 11.5 percent in the South Atlantic region (including Florida), and 9.1 percent in the Mountain region (including Nevada and Arizona). In the other six regions, housing prices declined from 1.1 percent to 6.4 percent (Federal Finance Agency 2009). This index is based on same sales of single unit detached houses sold to or guaranteed by Fannie Mae and Freddie Mac. It is not weighted as heavily toward formerly fast rising, and recently fast falling, housing markets as the Case Shiller index. It excludes condominiums, multi family, and rental housing, like Case Shiller. The U.S. Census Bureau tracks sales of new single family housing, which also is excluded from the Case Shiller index, and for the third quarter of 2008 it showed new housing sales in the Northeast had increased to $414,400 per unit from $301,300 in the third quarter of2007 (HUD 2008, Table 8). Price increases in the Northeast could be one explanation for why foreclosure rates in the Northeast were low even though several Northeast states had housing value to family income ratios exceeding 4.0 in 2007. The Case Shiller index does not distinguish one part of a metropolitan area from another. In the San Francisco metropolitan area, the foreclosure ratio ranged from 0.24 percent of housing units in the City of San Francisco to 3.69 percent in Solano County in 2008, a 1 to 15 ratio. Consequently, house prices may have fallen by more than the San Francisco metropolitan average of 30.9 percent in Solano County and may not have declined at all in the City of San Francisco. Similarly, news accounts about the Washington, D.C. metropolitan area described house price declines in Prince William County of more than 30 percent from 2007 to 2008 (Mack 2009), while prices were stable in the District of Columbia (Rucker 2008) and the adjacent jurisdiction Arlington County (Laris 2008). Within the six zip codes of Prince William County, price declines from December 2007 to December 2008 varied widely by the following percentages 49, 39, 33, 26, 14, and 6 percent (Active Rain 2009). One benefit of foreclosures concentrated in a few states is that price declines are rapidly reducing the house value to income imbalances that fed the foreclosure crisis. in these high price markets is becoming more affordable. The National Association of Realtors compiles an existing single family affordability index that includes median prices and median family income. It showed a 2007 affordability index value of 111.8 followed by an average January through September 2008 index value 8
of 127.9, a considerable improvement. If maintained, the 2008 affordability index would show housing affordable to more families than in any year since 2003. The affordability index is influenced by mortgage interest rates, but mortgage rates were lower in 2003 than in 2008 (HUD 2008, Table 11). As foreclosures have risen, the home ownership rate has declined. The home ownership rate peaked at 69.2 percent of households in 2004. In the third quarter of 2008, the home ownership rate was 67.9 percent. The homeowner vacancy rate, despite foreclosures, was only 2.8 percent in the third quarter of 2008, up slightly from 2.7 percent in the third quarter of 2007. The rental vacancy rate was much higher, 9.9 percent in the third quarter of 2008, up from 9.8 percent in the third quarter of 2007 (HUD 2008a, 23). Opportunities for foreclosed households to find rental housing were ample, but perhaps not well located or of appropriate size or quality compared with their owned housing. Problem Scope and Policy Possibilities Rapid increases in housing prices driven by speculation that price increases can go on indefinitely, and rapid price decreases driven by foreclosures and less demand, are difficult to interpret. Diverse causes and motivations occur. Some speculators buy houses with the intention of flipping them by selling them for higher prices without ever occupying them. Some owner occupants buy in hopes that their incomes will rise by the time higher interest rates kick in on their adjustable rate mortgages (ARMs). Some owner occupants buy in fear that their hope of buying a house will become more remote with each passing year as prices rise. Some owners do not understand the extent to which higher interest rates in their ARM will become difficult to afford. And some price increases are driven by easy credit, increasing competition for the houses for sale, creating an impression that supply lags behind demand when demand may be artificially stimulated by easy credit, fear, and speculation. When demand slackens, supply turns out to be excessive rather than insufficient. Then price declines are fueled by over supply as well as by foreclosures. A few states, mainly Nevada, California, Arizona, and Florida, have been engulfed in this boom and bust rhythm. The boom carried these states into unsustainable relationships between house values and family income. Rebalancing house values and income requires prices to fall. Lenders have a choice. They can foreclose and resell at drastically lower prices, or they can negotiate extended terms a longer mortgage and delinquency forgiveness that will limit but not avoid short term losses. Until housing supply comes down to lower levels the national supply has exceeded 10 months with longer supply chains in some states in 2008, house prices will not stabilize. Because foreclosures typically lead to lower resale prices, and because foreclosure processes cost lenders money, lenders seem to have an interest in writing down principal in some instances to keep owners in their homes and to avoid foreclosure costs. If lenders had accurate information about which owners will default, rather than recover from being delinquent in payments, and they could obtain that information inexpensively, more renegotiated terms, including principal write downs would occur. But Kristopher Gerardi and Paul Willen (2008, 20 21) explain that lenders who make mistaken guesses about who will default face larger losses per loan than if they refuse to reduce principal. Lenders also avoid establishing a reputation for writing down principal that may invite more such requests. With housing price declines, affordability will increase and could improve the long term growth prospects for states with excessive housing prices, if those prices approach the national average. If Richard Florida is correct that skilled employees are the knowledge based private sector s most important element of production, then affordable housing prices are an inducement to positive growth and excessive prices impede economic development. High tech Silicon Valley industries in California 9
have understood this relationship for many years and have made affordable housing subsidies for employees a priority (Silicon Valley Leadership Group 2009). Realigning house prices toward a goal of three times family income will enhance the competitiveness of knowledge based businesses in high housing price states. Restoring balance between house prices and incomes is complicated by imbalances between a shortage in supply of dwellings where people prefer to live and an overabundance of dwellings in other locations. Metropolitan areas vary in the range in their political jurisdictions of house value to family income and in foreclosure rates. San Francisco provides an extreme, but clear, example. In 2007 the ratio of house values to family incomes was excessive in each jurisdiction. The lowest house value to family income ratio, 5.7 to 1, was in Solano County which also had the highest foreclosure rate, 3.69 percent of housing units. The house value to income ratio suggests that Solano County on the edge of the metropolitan area had more dwellings relative to demand than other jurisdictions. The high foreclosure rate indicated that buyers capacity to pay mortgages was fragile, and, perhaps, that an accumulation of foreclosures hampered new sales. In contrast, the highest house value to income ratios were in central jurisdictions City of San Francisco, Marin County, and San Mateo County. They had house value to income ratios of 9.7, 8.5, and 8.5 to 1. But their foreclosure rates were the three lowest in the metropolitan area. Perhaps more residents in those jurisdictions had purchased when prices and mortgages were lower. Or, perhaps owners unable to pay mortgage costs were able to sell at acceptable prices because demand was strong (Appendix 1 San Francisco Metropolitan Area). The Chicago Metropolitan Area experienced a less extreme form of the San Francisco pattern. Data for the City of Chicago were included with other Cook County data of which Chicago constituted a majority of residents and housing units. Cook County had a rather high foreclosure rate, 2.00 percent of housing units, and it also had the highest ratio, 4.5 to 1, of median value of owner occupied housing to median family income in the Chicago Metropolitan Area (Appendix 1 Chicago Metropolitan Area). Three outer counties, Kane, Kendall, and Will, had higher foreclosure rates (2.24, 2.62, and 2.29 percent), and lower house value to family income ratios (3.3, 3.0, and 3.0 to 1). The highest foreclosure rates were associated with moderate rather than high house value to family income ratios. (Chicago Metropolitan Area map about here) The Minneapolis St. Paul Metropolitan Area had a flat distribution of house value to family income ratios, with a range of 2.8 to 3.3 to 1. The central city and inner suburb foreclosure rates were moderate, 0.33 percent in Hennepin (including Minneapolis) and 0.83 percent in Ramsey (including St. Paul) with an average of 0.69 percent in 10 metropolitan counties. The highest foreclosure rates, again, were in outer counties, Dakota (1.15 percent) and Wright (1.48 percent) (Appendix 1). (Minneapolis St. Paul Metropolitan Area map about here) Demand and Demographic Changes These foreclosure percentages and house value to family income ratios are consistent with an interpretation that demand was lower relative to supply in outlying counties compared with central cities and inner suburbs. The forecast about housing demand made by Arthur Nelson (2006) also is consistent with these patterns. Based on condominium and single family detached housing price trends, market surveys of consumer preferences, and changes in age cohorts, Nelson (2006, 397) concluded 10
that market demand for new homes through 2025 may be almost exclusively for attached and small lot units. Dowell Myers (2005) has warned that changes in age cohorts may reduce demand for the housing types that the baby boom generation, now moving toward retirement, preferred for the childrearing years. Changes in the number of households in key home buying cohorts from 2000 through 2007 are consistent with an interpretation that demand for large houses on large lots in remote metropolitan area locations may be waning. Numbers of householders in age cohorts from 45 to 54, 55 to 64, and 65 and over expanded each year from 2000 through 2007. But the numbers of householders in the 30 to 34 group decreased in six of these eight years, while the numbers in the 35 to 44 age cohort decreased in seven of eight years (HUD 2008, Table 22). Householder cohorts from 30 to 44 were the ages when home ownership rates increased most rapidly. Home ownership in the age 25 to 29 group was 40.6 percent in 2007, jumping to 54.4 percent in ages 30 to 34 and to 67.8 percent in ages 35 to 44. Older groups had still higher home ownership rates 75.4 to 80.6 percent (HUD 2008, Table 27). These older groups would have more houses to sell as they retire, move, and downsize. Examining age cohort trends before and after 2004 is instructive, because the home ownership rate peaked then at 69.2 percent. In 2004, the home ownership rate in the 25 to 29, 30 to 34, and 35 to 44 year age groups had increased from the 1994 to 2003 average and increased more from 1994. In 1994, the national home ownership rate was 64.0 percent. Ten years later it had increased by 5.0 percent (and by 5.2 percent to the highest quarter in 2004). That 5 percent increase would add 3.2 million more homeowners, based on 63.5 million homeowners in 1995 (HUD 2008, Table 25). That caused a tremendous boost to employment in housing construction, land development, real estate sales, building materials, home furnishing, mortgage initiation, and mortgage lending. Increases in prime home ownership age groups drove demand for housing. In the age groups from 35 to 54, the when large increases occurred in first time home buying and in move up home transitions, an average 793,000 more households existed each year in the U.S. from 1994 through 2003 (Table 5). Thereafter, some erosion occurred. The rate of increase slowed in 2004 and 2005 through 2007 in the age 45 to 54 group. In crucial younger age groups, 30 to 34 and 35 to 44, when the biggest increases in home ownership rates have occurred, the number of households in those age groups decreased in 2004 and during the 2005 to 2007 period. The average annual decrease was 184,000 for ages 30 to 34 and 226,000 for ages 35 to 44 during each of the four years from 2004 through 2007 when the home ownership rate declined to 68.1 percent in 2007 (Table 5). These ages also are prime periods for child rearing, with preferences increasing for larger residences and proximity to satisfactory schools. Reductions in demand for that type of housing in suburban locations may account for some of the high foreclosure rates in outlying counties in many metropolitan areas. Another cause of high foreclosure rates may be the increase in home ownership that occurred in age groups in their 20s. These age groups had the biggest increase in home ownership rates of any age cohort during the 1995 to 2004 period. These ages also are more mobile than older households. They are more likely to be making job changes, less likely to have children at home and in school, and more likely to move to other metropolitan areas. For householders of these ages, adjustable rate mortgages that reset in two or more years are especially attractive, because many such households expect to move in two or three years. If housing prices continue to rise, as they did in most metropolitan areas until 2006, when single family house prices peaked (HUD 2008, Table 9), then finding buyers and moving before ARMs reset to higher interest rates seemed like a smart investment. Moreover, not buying often seemed like an opportunity to make money was being wasted by getting in on rapid price appreciation. In markets with rapid price appreciation, such as California in particular, getting in on a 11
good housing investment opportunity may have look especially attractive, despite the risks that would accompany a downturn in prices (which had not occurred in decades). The demographic changes described above indicate that the raw material to sustain demand for large single unit houses in prime child rearing areas was diminishing. With diminished numbers of replacement homebuyers in the 30 to 44 age groups, demand for large houses in outer metropolitan counties may diminish for demographic reasons, and potentially for other reasons related to accessibility and travel costs. Locations of foreclosures and house value to family income ratios may foreshadow such transitions. Remedies for the foreclosure crisis in some metropolitan areas, therefore, should consider encouraging construction of housing to own and rent in locations and in sizes, configuration, and quality that come closer to meeting market demand. The Urban Land Institute, an organization of large developers, has been making the case for several years that development opportunities increasingly will be in infill, transit oriented development, and other redevelopment sites in central cities and inner suburbs (Urban Land Institute 2006). The research of William Lucy and David Phillips (2006) revealed that demand for housing in old neighborhoods increased from 1990 through 2007, as do the differences in foreclosure rates between central cities and outer suburbs described previously in this study. Supply and Demand Restoring some housing construction related employment is an important dimension of economic recovery. Increasing housing production requires reducing the unsold inventory of houses for sale. During 2008, ten months supply of houses was for sale at prevailing sales rates. From 1998 through 2005, 4.0 to 4.8 months of supply existed as prices rose. In 2006 and 2007, six months, and then eight months, supply existed, even though new housing production declined (Table 6). In 2005, 1.8 million more houses were for sale than in 2003. New houses accounted for 335,000 of this increase. Existing houses accounted for nearly 1.5 million of the increase in inventory of houses for sale. But only 4.8 months supply was available, because sales numbers had increased steadily since 1998, peaking in 2005. This year, 2005, was before foreclosures increased. Much of the increase in the for sale inventory probably constituted a search for opportunity sales. Some sellers of existing homes were attracted by high prices. Due to high prices, some sellers hoped to make substantial profits by selling at the right time. In stock market terms, they were trying to take profits. In 2007, houses available for sale had declined by 822,000 from their peak in 2005. Of this total, the largest reduction was the number of new single family houses available for sale, which, in 2007, had declined by 526,000 from the 2005 level. Consequently, some of the unsold inventory continued to be opportunity sales prospects by owners who did not need to sell. They could keep their houses on the market until they got a good price. Therefore, the 10 months supply prevailing in 2008 was inflated, because it reflected a lower sales rate, an increase in foreclosures, and persistence of opportunity sales prospects. Production of new housing in 2007 had returned to levels that prevailed from 1998 through 2002. This production level may be sustainable. But it is crucial that new housing is provided where demand is high. In 2008, too many foreclosed houses and other new houses for sale were located where demand was low relative to supply. Foreclosure trends described for 35 metropolitan areas in this study (Appendix 1) indicate a partial mismatch has occurred between where housing is available for sale and where 12
households want to live. In most metropolitan areas, foreclosure rates were highest in a few outlying counties. Pricing Toxic Mortgage Assets An obstacle to formulating remedies for the national financial crisis that followed the foreclosure crisis has been difficulty in pricing and accessing so called toxic assets. Assets are referred to as being toxic if they are worth substantially less than their original valuations by lenders or buyers of repackaged mortgages. As mortgages were purchased from lenders and bundled in MBSs (mortgage backed securities), which are various forms of securities paying a given interest rate, mortgages were separated from the original lender and reallocated in forms that were difficult to disentangle. MBSs limited ability of mortgage servicers to renegotiate mortgage terms with delinquent home owners at risk of foreclosure and repossession. Lacking a market for many bundled MBSs, their value was undetermined. If valued at zero, or some small fraction of their original value, these assets were toxic in the sense that they weighed heavily against the reserves banks are required to maintain against liabilities. The absence of a market blocked the federal government from establishing a value for many MBSs backed by delinquent and foreclosed mortgages. But an estimate of the cost of buying these mortgages, if they can be separated from MBSs, is possible. Data in this study for housing values relative to family income can be used. Or, as an alternative, housing values relative to household income could be used. Just as lenders of origin, and Fannie Mae and Freddie Mac, and currently the FDIC, have required that monthly housing costs approximate 30 percent of gross monthly income, or less, the relationship between housing values and family income can be used to calculate how much prices should decline to rebalance house values and income, while returning foreclosure rates to traditional levels. With 62 percent of foreclosures occurring in California, Florida, Nevada, and Arizona, price declines to rebalance housing prices and income can be calculated. Returning California to the 4.0 to 1 ratio of housing values to family income of year 2000, would cut the 2007 median value of owneroccupied housing ($535,700) to $258,252 (four times median family income of $64,563). That would be a price reduction in California of $276,448 per foreclosed house, a cut of 51.6 percent. To accomplish a reduction to the 2007 national average, housing values 3.2 times family income, Florida prices would fall 24.4 percent, Nevada s by 37.6 percent, and Arizona s by 24.6 percent. If all the listed foreclosures and preforeclosures became repossessions, then these value reductions would cost $95 billion in California, $10 billion in Florida, $5 billion in Nevada, and $4 billion in Arizona, a total of $114 billion (Table 7). This estimate overstates the crisis dimension of foreclosures. From 1997 through 2006 the average foreclosure rate was 0.42 percent of mortgage loans, about onethird of the 2008 rate (HUD 2008, 73). It had become the normal cost of being in the mortgage business. Consequently, the foreclosure crisis should be considered, at most, the number and rate of foreclosures above the previous decade s norm. An extreme perspective on pricing mortgage backed toxic assets can be acquired by projecting 2008 foreclosure losses if housing prices decline to year 2000 ratios of housing values to family income. Calculating declines in the 34 states above the year 2000 national ratio of house values to family incomes (2.4) in 2007, the loss from lower house values would be about $143 billion. In all 50 states, the decline to year 2000 house values would be about $145 billion, with 87 percent in four states California $95 billion (66 percent), Florida $18 billion (13 percent), Nevada $6.5 billion (5 percent), and 13
Arizona $5.5 billion (4 percent) (Table 8). Declines of $1 billion or more also would occur in Illinois, New Jersey, New York, Massachusetts, Colorado, and Washington (Table 8). Eight of the 12 states with house value to family income ratios above 4.0 had low foreclosure rates Hawaii, Massachusetts, New York, New Jersey, Rhode Island, Maryland, Oregon, and Washington (Appendix 1). Consequently, the example above based on returning house value to family income ratios in 2000 exaggerates potential toxic asset losses in most states. Private Market Failures Traditional banks and investment banks have incurred losses far in excess of these estimates. By May 2008, banks and insurance companies already had written down more than $300 billion in assetbacked losses (Ferguson 2008, 354). Nouriel Roubini, who apparently had the most extreme prediction in February 2009, foresaw mortgage related lender losses far exceeding $1 trillion (Lohr 2009). Because $145 billion is less than the funds allocated to banks by January 2009 under the TARP (Troubled Assets Relief Program) of the U.S. Treasury, it would be, or would have been, possible to buy up all the toxic mortgages, or to refinance them at lower principal, lower interest rates, or longer terms, with bank funds or TARP funds, if they could be disentangled from MBSs. These cost estimates help interpret causes of the national financial crisis. The financial crisis was triggered by sub prime mortgages, no down payment mortgages, resetting adjustable rate mortgages, and by some low income home buyers being manipulated by unscrupulous mortgage initiators. Herman Schwartz (2009,Chapter 8) identified a 16 percent default rate after nine months on 2007 subprime mortgages as launching the insolvency of several important lenders (including Countrywide and IndyMac) in 2007. In addition, the financial crisis was caused by house value to income imbalances in a few states and a modest number of counties and metropolitan areas, by easy credit to support these imbalances, and by MBSs and subsequently by credit default swaps which ostensibly spread risk and reduced risk, but which actually greatly increased risk. They created an inflexible structure which neither lenders, packagers, central banks, nor national governments were able to access easily to repair the underlying delinquent mortgage payments. Schwartz (2009, Chapter 8) has explained how profitability of banks manipulations of short term borrowing and long term MBSs required annual appreciation of 5 to 10 percent in housing prices. A set of practices and institutions that increased flexibility on the upside were inflexible and damaging on the downside. Some MBSs are financial instruments analogous to an automobile with several forward gears but no reverse gear. They can get you where you want to go most of the time, but when you need to reverse direction they are worse than useless. A problem faced by lenders has been the so called mark to market accounting rule. This rule requires lenders to value assets at current market prices. While seemingly reasonable, this rule overvalues property assets during the bubble period of inflated expectations during housing price increases. Mark to market undervalues properties if the market for them erodes or disappears when housing prices fall. Banks then limit loans to retain enough capital to meet regulatory requirements for reserves relative to liabilities. Lenders and regulators have difficulty determining the value of mortgage based assets that are obscured by packing many mortgages into securities that are resold as MBSs. If lenders retain mortgages in their portfolios, they can rely on their own experience in valuing foreclosed unpaid mortgages and reselling these properties at lower prices. They also can estimate write downs by using data in this 14
analysis for traditional median house value to median family income or median household income for a proportion of their mortgage loans that may default. Estimating the value of MBSs is more difficult. MBSs take many forms with varying proportions of mortgages composing them that are being paid on time and other mortgages that are delinquent, in the foreclosure process, repossessed, or resold. If these MBSs are undervalued because risk is difficult, and costly in time, to calculate, then lenders are left with too many so called toxic assets that have less value in today s market than they may have if held to maturity. Private lenders may need to sell these assets below a reasonable value, or sell more valuable assets, to strengthen their balance sheets and maintain adequate reserves. The U.S. Treasury would have a less severe problem than private banks if these same assets were in its possession. Most of the mortgages underlying the MBSs are being paid on time. Some parts of these MBSs may be delinquent or on their way toward repossession and resale. What would their value be to the U.S. Treasury? We can construct a simple example. If 90 percent of the mortgages were paid on time, then the potential loss to the U.S. Treasury would be 10 percent or less. How much less would depend upon the delinquency, foreclosure, repossession, and resale rates, and the cost of managing these processes. Repossession rates have been much less than 10 percent of all mortgages, although they may be that high or higher for certain categories of recent mortgages. How much foreclosure resales would occur below face amounts of mortgages can be estimated based on recent experience and by traditional house value to family income, as described in this analysis for states, metropolitan areas, and counties. These are approximations, because actual performance will vary within counties (note the example above of Prince William County Virginia where six zip codes had price reductions ranging from 49 percent to 6 percent from December 2007 to December 2008). If the U.S. Treasury purchased the MBSs at a discount, it might not lose any money on the MBSs in the short run and might make some profit later. The discount would not need to be large for most MBSs, since most of them are performing above 90 percent of payments due. And the U.S. Treasury does not need to satisfy regulators that it is valuing the MBS assets by marking them to market. The concept of using a bad bank to buy, manage, hold, and eventually sell MBSs, and other assets, probably embodies concepts like these. This analysis about variations in foreclosure rates, house values, and family income help quantify the potential risk to the U.S. Treasury of such a policy. These calculations indicate that massive private market failures have occurred. Banks and other lenders have claimed losses on their balance sheets far in excess of the actual reduction in value of the houses on which mortgages have been foreclosed. Moreover, the recorded losses are greater than the house value declines that would occur if the foreclosed properties declined in value to year 2000 levels. It is possible that price reductions to year 2000 levels will occur. But such large price declines can occur as a result of deep and prolonged recession, not because of an excess of supply occasioned by the foreclosures themselves which add to the backlog of houses for sale. Thus, market failure has two components. The first is that the value of the underlying mortgages has not been disentangled from the MBSs, leading to excessive undervaluing of the MBSs. The second is that accounting rules, so called mark to market requirements forced MBSs to be valued at what buyers would offer for them today, rather than based on the revenue stream that the underlying mortgages would provide. National Home Ownership Goals 15
This inaccessible financial system was encouraged by home ownership policy goals. Frederick Eggers (2001) described the Clinton Administration goals as follows: the Nation s home ownership rate actually declined in the early 1980s. Between 1985 and 1994, the home ownership rate remained virtually unchanged (at 64 and 65 percent).in late 1994, President Clinton set as a national goal to raise the home ownership rate to 67.5 percent by the end of 2000. Beginning in 1995, the home ownership rate has risen almost steadily until, by the third quarter of 2000, it was 67.7 percent surpassing the President s ambitious goal.hud used its oversight of Fannie Mae and Freddie Mac to encourage those entities to reach out to low income borrowers and areas underserved by the private market. As an important part of his concept of the United States as an Ownership Society, President George W. Bush set a goal in 2002 of increasing home ownership by 5.5 million minority families. We want everybody in America to own their own home, President Bush said in October 2002 (Ferguson 2008, 267). Niall Ferguson (2008, 267) summarized Bush s strategy: Bush signed the American Dream Downpayment Act in 2003, a measure designed to subsidize first time house purchases among lower income groups. Lenders were encouraged by the administration not to press sub prime borrowers for full documentation. Fannie Mae and Freddie Mac also came under pressure from HUD to support the sub prime market. As Bush put it in December 2003: It is in our national interest that more people own their home. Financial manipulations became overly clever and difficult to reverse. But they served public policy goals, which, in general, were supported by successive Democratic and Republican Administrations, members of Congress, federal agencies, and government sponsored entities (Fannie Mae and Freddie Mac). As the home ownership rate descends from its peak of 69.2 percent in 2004, the appropriate home ownership rate or range should be revisited. Based on more than 110 million owneroccupied dwellings in 2008, a four percent reduction to 65 percent home ownership would reduce owner occupants by 3.5 million. The 64 to 65 percent home ownership rate was sustained for two decades without engendering a financial crisis. That experience is one place to look for guidance. Policy Challenges Lenders and public officials have an interest in keeping owners in their homes and making regular mortgage payments. Support for banks that renegotiate mortgage terms to make them more affordable should be an aspect of public policies, those included in dispensing TARP funds and in programs advocated by Sheila Bair, President of the FDIC. While home owners can be helped on the margin, they should not be given unearned gifts worth hundreds of thousands of dollars. In California, in particular, house values grew to such unreasonable multiples of family income (more than eight times incomes in 2007) that write downs through foreclosures of more than $200,000 were needed merely to return to the high cost conditions of 2000, when house values were four times family incomes. For traditional lending practices to work, with down payments, fixed rate mortgages, and incomes verified to be in the range of 30 percent of monthly mortgage costs, very large reductions in house prices became necessary. These price reductions can become positive influences on housing affordability and economic development, after the shock of absorbing large write downs works through the financial systems. Evaluating the severity of the 2007 to 2009 financial crisis, one should remember that the traditional foreclosure start rate from 1997 through 2006 was 0.42 percent of mortgages. In estimating values of MBSs, a foreclosure start rate in this range should be considered normal for the lending business. MBSs with foreclosure rates above that level, as occurred in 2007 and 2008, should be valued in light of this normal range. This value is not zero, and it is not 20 cents on the dollar, except in highly 16
unusual circumstances. As calculations in this study indicate, the cost of mortgage reductions through repossessions and resales in 2007 and 2008 was much less than losses acknowledged by banks and much less than the $700 billion in TARP funds. Establishing values of MBSs is a challenge, one which the U.S. Treasury is much better prepared to achieve than are private banks which must satisfy skeptical regulators administering the mark to market accounting rule. What about California? In 2007, California had only 10.4 percent of the housing units in the United States. In 2008, California had 33.9 percent of the foreclosures in the U.S., and if housing values relative to median family income were to fall to year 2000 ratios of housing values to family income, California would account for 65.6 percent of the reduction in housing values. Moreover, California provided warnings in census data about looming crisis conditions; the American Community Survey revealed that the ratio of median value of owner occupied housing to median family income increased from 4.0 in 2000 to 6.7 in 2004, 7.8 in 2005, and 8.3 in 2006, as well as an 8.3 average for 2005 2007. If national home ownership policies, and private lender policies seeking front end mortgage initiation fees and other fees and interest rate swaps that provided banks and insurance companies with large short term profits caused the foreclosure crisis and the ensuing financial crisis, what caused the house value to income imbalances that fueled these crises to be concentrated in California? And why were so many willing participants in escalating the housing bubble playing their games in California? Were economic and political conditions, business imagination and unethical conduct, and public policies in California contributing causes of the crises, or was California merely an unlucky victim? Does California need special remedies? Does it embody conditions which may launch a new housing bubble? These questions need answers which we do not have. Speculations, however, may be useful. The huge run up in housing prices in California created opportunities for large gains for homebuyers if price increases continued. Thus, more households may have been attracted to potential gains, worried, perhaps, that they would be priced out of the home buying market if they did not act quickly. Some lenders (Countrywide) specializing in subprime, no principal, interest only, and no income check loans got their start in California and focused there. Perhaps the expansion of prime home buying age groups up to 2004 was followed by a decline in these groups in California, on par with or greater than the national demographic transition. Perhaps public policies had some effects, such as hindering infill construction and transit oriented development in the City of San Francisco and other attractive cities and inner suburbs. And perhaps Proposition 13 was influential. Because Proposition 13 limited property tax increases to one and one half per cent per year, home buyers could buy with a low interest ARM, perhaps interest only, for two or more years, pay little more in property taxes in the second and third years as their property value increased, and sell at a substantial profit in two or three years before the reset ARM higher interest rate became too burdensome an attractive opportunity for some young buyers anticipating moving. Whatever the causes, extra high house value to family income ratios in California complicate potential public policies aimed at mitigating the foreclosure crisis. To return stability to housing finance, and to return to a reliable rate of housing construction and resale of existing dwellings, sustainable home ownership levels are required. Lending manipulations which drove the home ownership rate to 69 percent were not sustainable. Longevity of a 65 percent home ownership rate demonstrated it was sustainable. Whether it can be higher, or should be higher, than 65 percent is an important policy question. As the distribution of income has become more skewed, and with recession deepening, retaining a 65 percent home ownership rate may be difficult. 17
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