Thomas N. Edmonds Judith Swisher* Western Michigan University, USA *Corresponding author:

Changes in US Housing Values US Consumers generally expected home values to appreciate over time Average annual increase in housing values of 5.6% for the US from 1980 through 2006 No annual losses for US overall Double digit increases in values from 2004 to 2006, fueled by the low interest rate policies of the US Federal Reserve (Allen and Carletti, 2010) Large increases in value led to euphoria on the part of both lenders and borrowers (Archer and Smith, 2011) 2

Changes in US Housing Values – continued Falling home values from 2007 to 2012 An estimated 5.3 million US households had mortgages with balances at least 20% higher than the value of their homes (First American CoreLogic) An estimated 2.2 million had mortgage balances at least twice the value of their homes (First American CoreLogic) 3

Prior Research Models used to predict default have unstable parameter estimates over time (An, Deng, Rosenblatt and Yao, 2012) Combination of negative equity and low financial resources act as the “dual triggers” of default (Campbell and Cocco, 2015) Default is related to unemployment (Tian, Quercia, and Riley, 2016; Pennington-Cross and Ho, 2010) 4

Prior Research - continued Borrowers seek bankruptcy protection at higher rates in states with stronger garnishment laws and shorter foreclosure timelines (Edmonds, Stevenson and Swisher, 2011) Evidence of strategic default in states without lender recourse (Edmonds, Stevenson and Swisher, 2011) Survey results suggest that borrowers do not default due to an equity shortfall of 10% or less (Guiso, Sapienza, and Zingales, 2009) 5

Data Loan data – percentage past due loans, foreclosure starts and foreclosure inventory Mortgage Bankers Association collects data from its members Data for all loans, prime and subprime loans Housing values – Freddie Mac Home Price Index (FMHPI) Limited to mortgages that do not exceed the maximum “conforming” loan limit (i.e., for most states in 2009, $417,000; high cost states of Alaska & Hawaii in 2009, $625,000) Unemployment data – US Bureau of Labor Statistics web site 6

Annual Change in US Housing Values, Mortgages Past Due, Foreclosure Starts and Foreclosure inventory (%) 7

Default and Foreclosure Across States Loans past due Hurricane Katrina led to loans past due in Louisiana of 20.81% in the 4 th quarter of 2005 Highest rates during housing crisis reported by Nevada: 14.92% and Mississippi: 14.69% in 4 th quarter of 2009 Problems were widespread; 19 states had past due loan levels that exceeded 10% Foreclosure starts Nevada dominates the list of states with highest foreclosure starts, with rates of 2.79% to 3.76% in 2009 and 2010 Florida shows foreclosure starts of 2.79% for the 1 st and 3 rd quarters of 2009 Foreclosure inventory Florida claims highest level with 14.49% in 3 rd quarter of 2011; From 2010 to 2013, Florida tops 10% in 18 quarters, Nevada tops 10% in 3 quarters 8

4 th Quarter Mortgages Past Due, Foreclosure Starts and Foreclosure Inventory by State YearPast Due (%)Foreclosure Starts (%)Foreclosure Inventory (%) MeanMaxMinMeanMaxMinMeanMaxMin

Performance of Prime and Subprime Loans Prime Loans (%) 10 Subprime Loans (%)

Unemployment Unemployment peaked for the US as a whole at 10% in October 2009; large variation among the states Unemployment remained high from 2009 to 2013, with 17 states and 150 state-quarters showing double-digit unemployment during this time Possibly worst hit was Nevada, with double-digit unemployment from 1 st quarter of 2009 through 2 nd quarter 2013, peaking at 13.9% in the 3 rd and 4 th quarters of

4 th Quarter Unemployment Rate by State (%) YearMeanMaxMin

Legal Rights of Borrowers and Lenders by State Recourse: right of lender to require borrower to repay portion of mortgage not covered by proceeds of home sale Recourse favors lender Dummy variable set equal to one (zero otherwise) if recourse allowed 40 states classified as recourse and 10 non-recourse Timeline: optimal number of days to foreclose Shorter timeline favors lender Dummy variable set equal to one (zero otherwise) if the timeline < 180 days 13

Table 5: Hypothesized Relations between Variables 14 Past Due Loans Foreclosure Starts Foreclosure Inventory Panel A: All mortgages Lagged Unemployment+++ ∆ FMHPI─── Big Drop Dummy+++ Recourse?++ Timeline─++ Panel B: Prime mortgages Lagged Unemployment+++ ∆ FMHPI─── Big Drop Dummy+++ Recourse?++ Timeline─++ Panel B: Subprime mortgages Lagged Unemployment+++ ∆ FMHPI─── Big Drop Dummy??? Recourse?++ Timeline─++

Analysis Maximum likelihood logistic regression analysis (1) (2) Where is the proportion of past due loans, foreclosure starts, or foreclosure inventory ∆FMHPI is the year-over-year change in the value of the FMHPI housing index BigDrop is a dummy variable equal to 1 if the annual drop in housing value is greater than 10% Unemployment is the quarterly unemployment rate Recourse is a dummy variable equal to 1 if a state allows recourse to lenders Timeline is a dummy variable equal to 1 if the optimal timeline to foreclosure in a state is less than 180 days 15

Table 6. Maximum Likelihood Logistic Regression Results for Mortgage Defaults and Foreclosures Panel A: US Past Due Loans Foreclosure Starts Foreclosure Inventory Est.P-ValueEst.P-ValueEst.P-Value Intercept-3.394< < <.001 ∆ FMHPI-1.794< < <.001 Unemployment0.108< < <

Table 6. Maximum Likelihood Logistic Regression Results for Mortgage Defaults and Foreclosures Panel B: State Level Data Past Due Loans Foreclosure Starts Foreclosure Inventory Est.P-ValueEst.P-ValueEst.P-Value Intercept < < <.001 ∆ FMHPI < < <.001 Big Drop < < <.001 Unemployment < < <.001 Recourse < < <.001 Timeline < < <

Table 7. Maximum Likelihood Logistic Regression Results For Mortgage Defaults and Foreclosures: Prime and Subprime Past Due Loans Foreclosure Starts Foreclosure Inventory PrimeSubprPrimeSubprPrimeSubpr Intercept ∆ FMHPI Unemployment Big Drop Recourse Timeline

Table 8. Maximum Likelihood Logistic Regression Results For Prime and Subprime Mortgages Combined Past Due Loans Foreclosure Starts Foreclosure Inventory Est.P-ValueEst.P-ValueEst.P-Value Intercept < < <.0001 Subprime < < <.0001 ∆ FMHPI < < <.0001 Unemployment < < <.0001 Unempl*Subprime < < <.0001 Big Drop < < <.0001 BigDrop*Subprime < < <.0001 Recourse < < <.0001 BigDrop*Recourse < < <.0001 Timeline < < <

Summary and Conclusions American households defaulted on their mortgages in record numbers from 2008 to 2013 Evidence shows defaults Negatively related to the changes in housing values Positively related to unemployment Large drops in housing values (proxy for negative equity) associated with higher levels of default and foreclosure Subprime mortgages less sensitive to unemployment than prime mortgages Higher probability of foreclosure in states with recourse Higher probability of foreclosure in states with shorter timelines to foreclosure 20