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The Journal of Real Estate Finance and Economics

Erschienen in:

01.02.2013

Residential Mortgage Default: The Roles of House Price Volatility, Euphoria and the Borrower’s Put Option

verfasst von: Wayne R. Archer, Brent C. Smith

Erschienen in: The Journal of Real Estate Finance and Economics | Ausgabe 2/2013

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Abstract

House price volatility; lender and borrower perception of price trends, loan and property features; and the borrower’s put option are integrated in a model of residential mortgage default. These dimensions of the default problem have, to our knowledge, not previously been considered altogether within the same investigation framework. We rely on a sample of individual mortgage loans for 20 counties in Florida, over the period 2001 through 2008, third quarter, with housing price performance obtained from repeat sales analysis of individual transactions. The results from the analysis strongly confirm the significance of the borrower’s put as an operative factor in default. At the same time, the results provide convincing evidence that the experience in Florida is in part driven by lenders and purchasers exhibiting euphoric behavior such that in markets with higher price appreciation there is a willingness to accept recent prior performance as an indicator of future risk. This connection illustrates a familiar moral hazard in the housing market due to the limited information about future prices.

Vorheriger Artikel Exploring the Foreclosure Contagion Effect Using Agent-Based Modeling

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For example, see Demyanyk and Van Hemert 2008.

According to Robert Shiller (2005) the term “irrational exuberance” derives from some words that Alan Greenspan, the then Chairman of the Federal Reserve Board in Washington, used in a black-tie dinner speech entitled “ The Challenge of Central Banking in a Democratic Society” before the American Enterprise Institute at the Washington Hilton Hotel December 5, 1996.

See Baker and Wurgler 2007, page 129.

See, for example, Stan Liebowitz, “New Evidence on the Foreclosure Crisis,” Wall Street Journal, page A13, July 3–5, 2009.

The main research to date on mortgage default risk has been cross-sectional in nature. This includes linear discriminant analysis, cross sectional regression models and hazard models.

Foote, Gerardi and Willen (2008) conclude as long as the value of housing services derived from a house exceeds the amount of the monthly cost the borrower will seek to avoid default, even with "negative equity" so long as wealth and income permit.

See the bibliography in Shiller, Irrational Exuberance, 2 ^nd Edition, (2005) for extensive references to the work of both Case and Shiller.

Note also, the related study of Foote et al. (2008), mentioned previously. For further related studies see Smith (2009).

Short selling in this context refers to the financial reference and not the current use of the term in residential real estate, selling at a price below the mortgage balance.

The economic characteristics of housing accord well in several respects with the types of securities that finance researchers regard as likely to be affected by “sentiment,” in pricing; they are economically small, heterogeneous, and thinly traded.

Some dependent variables among the seven estimating equations are also used as explanatory variables in other of the equations. Thus it can be argued that there is simultaneity among the equations, implying the need to use instrumental variables. The coefficients of potentially simultaneous variables are, however, being estimated simply as controls. Since the focus here is on the time trend (i.e. the quarterly indicators from each equation) and we are not attempting to interpret the other coefficient estimates, we believe it is appropriate to disregard any potential biases from endogeneity.

Due to truncated data, FHFA (formerly OFHEO) MSA price indices were used for these counties: Collier, Manatee, Pasco and Palm Beach.

The data are made available via a research affiliation between one of the authors and the Federal Reserve Bank of Richmond providing an access agreement between that author and LPS Analytics, Inc.

We expect valid euphoria indicators to be related to house price changes. However, our regressions of the euphoria variables are not on changes but on house price levels. This is because the house price indices for each county begin at a value of one for the initial quarter (1999 Q1). Thus, the level of the index is, in effect, a complete summary of lagged appreciation rates over the study period. This provides more information about past house price movements than we would obtain using quarterly appreciation rates.

We made extensive efforts to identify all second mortgages in the larger data set to match them as much as possible with first mortgages. Our estimated loan-to-value ratios include these second mortgages wherever possible.

To be consistent with the estimation of our euphoria equations (Eqs. 1A–7A), we restrict the sample to observations having original loan-to-value ratios between 50 and 125%. However in tests using the full available sample, which is about 20% larger, we found very little change in results. Our primary coefficients of interest—euphoria proxies and put coefficients—never differed by more than 7%, with an average difference of less than 2%.

Because a large portion of the sample of loans lack a debt-to-income ratio we also employ a statistical device sometimes referred to as modified zero order regression. (See Maddala 1977, p. 202) This variable allows use of the incomplete variable without loss of sample size.

We deleted from the estimation any case with a loan-to-value ratio exceeding 4 due to the likelihood of recording error. This eliminated 117 observations out of 963,163 available.

To estimate the distribution shift we use the derivative of LTV with respect to house value, which is –LTV/V.

See, for example, “Monetary Policy and the Housing Bubble,” a speech of Chairman Ben Bernanke at the Annual Meeting of the American Economics Association, Atlanta, January 3, 2010.

Where a “piggy-back” second mortgage (simultaneous second) was identifiable, its value was added to the first mortgage.

We assume that loans with an original LTV above 125% are likely to have erroneous data. We expect loans with an original LTV below 50% to reflect different clienteles and different behavior from those above that level.

Abraham, J. M., & Hendershott, P. H. (1992). Bubbles in metropolitan housing markets, NBER Working Paper No. W4774.

Ambrose, B. W., & Buttimer, R. J. (2000). Embedded options in the mortgage contract. Journal of Real Estate Finance and Economics, 21(2), 95–111.CrossRef

Baker, M., & Wurgler, J. (2007). Investor sentiment in the stock market. Journal of Economic Perspectives, 21(2), 129–151.CrossRef

Capozza, D. R., & Seguin, P. J. (1996). Expectations, efficiency, and euphoria in the housing market. Regional Science and Urban Economics, 26, 369–386.CrossRef

Case, K. E., & Shiller, R. J. (1988). The behavior of home buyers in boom and post-boom markets. New England Economic Review, November-December, pp 29–46.

Demyanyk, Y., & Van Hemert, O. (2008). Understanding the subprime mortgage crisis. Working Paper, Federal Reserve Bank of St. Louis.

Foote, C., Gerardi, K., & Willen, P. (2008). Negative equity and foreclosure: theory and evidence. Journal of Urban Economics, 6(2), 234–245.CrossRef

Gerardi, K., Shapiro, A., & Willen, P. (2007). Subprime outcomes: Risky mortgages, homeownership experiences, and foreclosures. Working Paper 07−15, Federal Reserve Bank of Boston.

Goetzmann, W. N., Peng, L., & Yen, J. (2009). The subprime crisis and house price appreciation. Unpublished paper.

Maddala, G. S. (1977). Econometrics. New York: McGraw-Hill Inc.

Ong, S. E., Neo, P. H., & Spieler, A. C. (2006). Price premium and foreclosure risk. Real Estate Economics, 34(2), 211–242.CrossRef

Quercia, R. G., Stegman, M. A., & Davis, W. R. (2005). The impact of predatory loan terms on subprime foreclosures: The special case of prepayment penalties and balloon payments, center for community capitalism, Kenan Institute for Private Enterprise. University of North Carolina at Chapel Hill, January 25.

Shiller, R. J. (2005). Irrational exuberance (2nd ed.). Princeton: Princeton University Press.

Smith, B. C. (2009). The Subprime Mortgage Market, a Review and Compilation of Research and Commentary, forthcoming in the Journal of Housing Research.

Titel: Residential Mortgage Default: The Roles of House Price Volatility, Euphoria and the Borrower’s Put Option
verfasst von: Wayne R. Archer
Brent C. Smith
Publikationsdatum: 01.02.2013
Verlag: Springer US
Erschienen in: The Journal of Real Estate Finance and Economics / Ausgabe 2/2013
Print ISSN: 0895-5638
Elektronische ISSN: 1573-045X
DOI: https://doi.org/10.1007/s11146-011-9335-y

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