On Friday, an interesting opinion piece was featured in the Wall Street Journal. Professor Stan Liebowitz, an economics professor at University of Texas, Dallas explains that the mortgage crisis can't really be blamed on subprime borrowers. Instead, he blames mortgage products where borrowers had little, or even negative, equity in their homes. I partially agree.
Let's start with a great chart that Liebowitz includes:
I went ahead and put that same data in pie format, because I think it's more meaningful that way, given Liebowitz's claims:
From this data, he concludes:
The analysis indicates that, by far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home. The accompanying figure shows how important negative equity or a low Loan-To-Value ratio is in explaining foreclosures (homes in foreclosure during December of 2008 generally entered foreclosure in the second half of 2008). A simple statistic can help make the point: although only 12% of homes had negative equity, they comprised 47% of all foreclosures.
From the chart that I created based on the data, it's pretty clear that the red and purple pieces make up about 55% -- more than half. Those are, in fact, the two pieces that specifically show low or negative equity. It seems that Liebowitz is right.
Moreover, subprime mortgages make up a measly 19% of those foreclosures. I think that makes sense, as subprime mortgages, though more widespread than ever before, were still not that widespread. This point becomes more dramatic by recreating this chart one more time. This time, I remove unemployment-based foreclosures, as those are less attributable to poor mortgage underwriting practices.
It's clear that, really, it's the other wacky mortgage products -- not just the subprime mortgage products -- that were the bigger problem. They account for more than 75% of this pie. That was the same impression that I had back in 2005 when I I visited the major mortgage companies as a consultant. I never found the subprime mortgages as troubling as the other risky mortgage products that were being created. That includes the negative equity, very low equity and adjustable rate mortgage products.
So I would call Liebowitz's point about the importance of equity and raise him an adjustable-rate and subprime mortgage. While those latter products only account for 34% of the bad underwriting pie, one-third is not insignificant. The larger point is that mortgage originators lost sight of reality, deviated from tradition and began writing stupid mortgage products that only a deluded mind would have thought would be okay.
Sure, equity is important. But common sense is more important. These mortgage originators should never have given into the ridiculous ideas that mortgages would survive after payments suddenly shot up due to higher interest rates or when held by borrowers with very poor credit histories, just like they should have demanded greater equity.
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