Mortgage risks underestimated, economists conclude

Oct 22, 2012 by James Devitt
Mortgage risks underestimated, economists conclude
The Federal Housing Authority (FHA) underestimates the risks of defaulted mortgages, NYU economist Andrew Caplin concludes in a new study co-authored with economists at the Federal Reserve Bank of New York. @iStockPhoto.com/Kaan Tanman

(Phys.org)—The Federal Housing Authority (FHA) underestimates the risks of defaulted mortgages, NYU economist Andrew Caplin concludes in a new study co-authored with economists at the Federal Reserve Bank of New York.

Their research, which examined granted by the FHA, finds that the federally banked lenders miscalculate the risks of default because their assessments are based on mortgages rather than on individuals. That is, it counts refinanced mortgages as paid off, even though the same individuals still hold these mortgages and many of these homeowners remain at risk of defaulting on their home loans. Moreover, many of these homes, even after refinancing, are "underwater"—the value of the home is worth less than the amount of the loan.

"Since many of the FHA borrowers refinancing are underwater, it will be difficult for them to exit the FHA system by either selling the house or refinancing into a non-FHA mortgage," the authors write. "As such, these borrowers may remain at risk of default for many years."

The study's other co-authors were Anna Cororaton, an at the of New York, and Joseph Tracy, an executive vice president at the bank.

The authors point out that FHA mortgages that undergo an internal refinance are treated no differently than FHA mortgages that are fully paid off by the borrower, which removes any further credit risk to the FHA.

"So a borrower who defaults after internally refinancing is treated by the FHA as creating one success (termination of the first mortgage) and one failure (default of the second mortgage)," they write. "In fact, the borrower has nothing to show for their 'success' in refinancing, and taxpayers face a large bill."

Caplin and his colleagues conclude that "the current mortgage-based approach is inappropriate for the study of . Instead, one must focus on the borrower. Specifically, one must construct the borrower experiences by linking together strings of consecutive mortgages taken out by the same borrower and secured on the same property."

In assessing the borrower's likelihood of default, they examined FHA loans refinanced by the federal authority, then tracked the likelihood of default and prepayment—in which the loan is paid off earlier than the original life of the mortgage. This measure allowed the researchers to track multiple mortgages under a single borrower.

Their results indicated that only 6.4 percent of borrowers under FHA loans since 2007 have successfully paid off their mortgages. They also found than 15 percent of these borrowers have already been 90 days or more delinquent on their loans.

These findings stand in stark contrast to FHA's results, which track only mortgages, not their borrowers. Using that metric, the payoff rate is three times as high at 19.4 percent, reflecting the fact that a majority of terminated mortgages have immediately been refinanced back into new FHA mortgages.

"The FHA uses an outmoded econometric model that leads it to underestimate delinquency risk to and financial risks to taxpayers," the authors write. "Fannie Mae and Freddie Mac use this same outmoded model. More accurate estimates would serve the cause of transparency and help policy-makers to determine these organizations' appropriate roles in the U.S. housing finance markets of the future."

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peterpalms
not rated yet Oct 22, 2012
The U.S. Housing Bust has saddled the country with an "extraordinary" level of abandoned properties, inflicting heavy costs on the wider community which may warrant to ease the problem, a top US central banker said on Friday.
"In order to see the robust economic recovery we all want, we need to deal effectively with the large volume of vacant and distressed properties throughout the country," said Federal Reserve Board Governor Elizabeth Duke. QE3

Now the banks OWN your house. When the dollar collapses the government will no longer have the collateral of these houses and the banks will have paid nothing for them. Here is what will come next. If you do not pay your real estate taxes on time you home will become the banks property. One of the first industries to feel the raw power of "emergency measures" was the home industry. During the early stages of inflation, people were applying their increasingly worthless dollars to pay down their mortgages. That was devastating to the lenders.
peterpalms
not rated yet Oct 22, 2012
They were being paid back in dollars that were worth only a fraction of the ones they had lent out. The banking crisis had caused the disappearance of savings and investment capital, so they were unable to issue new loans to replace the old. Besides, people were afraid to sell their homes under such chaotic times and, if they did, very few were willing to buy with interest rates that high. Old loans were being paid off, and new loans were not replacing them. The S&Ls, which in the 1980s had been in trouble because home prices were falling, now were going broke because prices were rising.
Congress applied the expected political fix by bailing them out and taking them over. But that did not stop the losses. It merely transferred them to the taxpayers. To put an end to the losses, Congress passed the Housing Fairness and Reform Act (HFRA). It converted all Bancor-denominated contracts to a new unit of value—called the "Fairness Value"— which is determined by the National Average Price Ind
rwinners
not rated yet Oct 22, 2012
"Since many of the FHA borrowers refinancing are underwater, it will be difficult for them to exit the FHA system by either selling the house or refinancing into a non-FHA mortgage," the authors write. "As such, these borrowers may remain at risk of default for many years."

Of course they will. There are people who can still their mortgages and love their homes. Many people. Refinancing continues to help them.
But most important, the effects of all the work arounds that have been and will be offered to current home owners has been most beneficial in avoiding the abrupt defaults that would have happened during the past 4 years and spreads the damage over time.
Eventually, the government will begin rewriting these loans to accurately reflect the current value of the underlying assets.
And, eventually, a massive reflation of the housing market similar to what happened in the '70s will occur and all will be good again in our housing market.