Foreclosure and bankruptcy

by John Quiggin on September 2, 2007

A few weeks ago, I noticed this piece saying that the mortgage problem in the UK might be worse than that in the US. The reason given (also applicable to Australia) is that the UK boom or bubble in house prices has been much more dramatic than in the US. One statistic quoted in the piece was that there were 14 000 foreclosures in the first half of 2007 a statistic that, as the author notes, makes grim reading. It’s striking then, to read this piece in the NYTimes, predicting 2 million foreclosures in the US this year (since most mortgages are taken out by couples, many with children, the number of people affected is probably more like 4 million). Even allowing for the larger population in the US, this is a huge difference. It now appears that foreclosure has taken over from bankruptcy as the primary mode of financial catastrophe. (Bankruptcy rates plummeted after the “reform” of 2005, but seem certain to rebound in coming months).

{ 18 comments }

1

Danny Yee 09.02.07 at 11:22 am

Have Australian lenders been more careful, or is that just what everyone here is claiming? Like the UK, we have rising interest rates, but unlike the UK house prices have been flattish (outside Perth) for nearly four years now. No sign of massive numbers of foreclosures yet, though…

2

Srini Sitaraman 09.02.07 at 2:21 pm

The inventory of unsold homes is expected to reach 4 million homes in the United States that would affect new home construction, average prices of the existing homes, and the ability of mortgage-capable families to sell homes at a fair price and relocate. Importantly, the failure of mortgage based securities will have an echo-effect on pension funds and bonds. Wow, another fiasco in the making.

3

P O'Neill 09.02.07 at 3:25 pm

Aren’t foreclosure and bankruptcy substitutes in the US? i.e. the home occupant stops foreclosure by declaring bankruptcy or allows foreclosure by not declaring bankruptcy and walking away from the house debt free. Other countries don’t allow the walk-away option, which makes a big difference in terms of debt hangover issues.

4

James Wimberley 09.02.07 at 3:29 pm

Link to NYT piece is missing. Heres another to a McClatchy story also citing the figure.

Thanks, James. I’ve added the link now

5

Martin Bento 09.02.07 at 4:53 pm

Mr. O’Neil, I think the walk-away option you mentioned varies from state to state. It’s not true everywhere.

It’s the upper-middle class who are going to get unexpectedly screwed on this (the poor are expectedly screwed). The new bankruptcy law lessens protection for those who make above the median income for their state. Telecommuters from California who bought in Texas or Florida better hope they can keep up the payments. They could’ve bought cheap, but many bought big instead.

6

abb1 09.02.07 at 5:16 pm

Maybe you can stop foreclosure by declaring bankruptcy, but I don’t think it’s a substitute. It probably stops it temporarily until all the claims have been sorted out.

7

a 09.02.07 at 5:18 pm

A hit to the financial markets, and smaller bonuses to the hedgies, should send the UK market down.

8

stuart 09.02.07 at 5:23 pm

I wonder if the lack of excess housing being built in the UK compared to the US might have a significant impact in how it all unravels in each country.

9

Thomas 09.02.07 at 6:58 pm

The reference is to “foreclosure filings”, not foreclosures. The number last year was around 800,000, so the increase is significant, but it isn’t as if anyone noticed the 800,000 foreclosure filings last year.

A WSJ article discussing defaults in the prime market suggests that defaults (and presumably foreclosure filings as well) are disproportionately concentrated among real estate speculators.

10

Tim Worstall 09.02.07 at 8:36 pm

“Other countries don’t allow the walk-away option, which makes a big difference in terms of debt hangover issues.”

As noted before, D2 and I asked Dean Baker about this. Depends upon the State but “generally” a first mortgage allows that, a second or more (equity release etc) does not.

11

John Quiggin 09.02.07 at 8:43 pm

Actually, thomas, I suspect at least 800000 people noticed.

12

Thomas 09.02.07 at 11:36 pm

Yes, John. But you didn’t.

13

Slocum 09.03.07 at 3:26 pm

It now appears that foreclosure has taken over from bankruptcy as the primary mode of financial catastrophe.

For many of these people, foreclosure will be a form of financial salvation rather than catastrophe. What I mean is, when you’re in a house that’s no longer worth what you paid for it, (when, in fact, your equity is negative due to depreciation and a low down payment), and when the mortgage payment has ballooned due to an interest rate adjustment, you are probably much better off walking away than killing yourself (working two jobs for years, perhaps) to keep making inflated payments on a deflated house. If you keep making the payments, you are the one who absorbs all the losses, if you walk away, the mortgage holder (which probably means owners of shares in some equity tranche) take the bath.

But there will be serious damage to your credit rating. And in some states, it won’t be possible to just walk away (particularly from second mortgages), but given the fact that the lender really doesn’t want the house back, borrowers facing foreclosure do have significant negotiating power.

In general, foreclosure in the U.S. doesn’t have to mean bankruptcy, and, on the contrary, it may mean getting out of a huge mortgage payment and into a lower rent payment for a comparable house.

14

Ginger Yellow 09.03.07 at 5:27 pm

That Bloomberg piece is pretty poor. It argues that mortgages will become (even more) unaffordable because house prices are going to rise by another 40%, then says that everything will be fine so long as house prices continue to rise. It seems to argue that the fact that housing supply is constrained in the UK is a weakness, rather than a prop. Also:

The net result is that even as payment problems mount, people will carry on taking out bigger mortgages. What choice do they have?

How about selling up and renting? Not ideal, but not a disaster either.

I’m not saying that there are no problems with the UK mortgage market – far from it. Underwriting standards have slipped and rising interest rates and resets will indeed put pressure on borrowers. But the structural differences between the UK and the US are almost all in the UK’s favour. Moreover the UK economy is nowhere near as dependent on construction as the US one has been since 2000/2001, so the wider impact of reduced house buying, if that is what happens, should be less.

15

Ginger Yellow 09.03.07 at 5:33 pm

“Have Australian lenders been more careful, or is that just what everyone here is claiming?”

By and large, yes. There are non-conforming (subprime) lenders in Australia, but they make up a far smaller proportion of lending than in the US or even the UK. And even in that sector performance is better – average delinquencies are about 6.5%, compared with 12% in the UK. The big banks doing prime lending are pretty conservative. There is a fair bit of self-certified mortgage lending going on, but any loans (self-cert or otherwise) with loan to value ratios over 80% are insured, and any prime loans that get securitised are also insured. Delinquencies and defaults are extremely low in Australia – always have been. That said, Australian mortgage lenders have traditionally been big users of securitisation and are having difficulty getting funding, so they are likely to hike their prices and cut back origination.

16

a 09.03.07 at 9:00 pm

#15: Despite all the finger pointing at sub-primes, the real problem with the American housing market is that prices went up too much; it was a bubble. I think Australia has exactly the same problem of elevated prices; if it indeed doesn’t have many subprimes, its bubble will simply deflate in a different way than the US’.

17

Ginger Yellow 09.03.07 at 11:50 pm

Oh, there’s no doubt that the US housing market was in an enormous bubble. You only have to look at the graph of real new-build house prices over time to see that. After fluctuating in a clearly defined range for most of the last century, they shot off the scale in this one. But the wider repercussions of the US downturn were caused by a combination of hugely irresponsible lending practices and spreading that risk throughout the global financial system through securitisation. I don’t know enough about the underlying Australian housing market to know if it’s in a bubble or not, but I’m confident that unless there were a catastrophic crash, the repercussions would be contained and the big four banks and the more conservative non-bank lenders would be more or less fine.

18

Peter 09.04.07 at 9:21 pm

I’m not sure that UK foreclosures can touch the US levels. I’d be willing to bet that lenders in the UK never went in for “no doc” (or “stated income”) loans to the degree that US lenders did. Many of these were also called NINJA loans (No Income, No Job, no Assets). Likewise, I don’t think the British have come anywhere near the degree of fraud present in the current bubble in the US. Calculated Risk has been covering much of the US meltdown.

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