What Causes Foreclosures?
Research for Online Investors

by John Dalt

7/07/2009

The Wall Street Journal had a great article on the housing foreclosure crisis last week.  Thanks to reader Alan M. for bringing it to my attention.  Stan Liebowitz, professor of economics at the University of Texas breaks down the statistics of the mortgage market to reveal the real problems.

We all marveled at the creative financing that was done.  Only in America could you find a zero down, adjustable, interest only, low documentation loan.  It takes a special kind of marketing department to dream up these kinds of financial instruments.

It takes a congress to encourage this kind of stupidity.  Professor Liebowitz digs into millions of individual loans and discovers “the single most important factor is….negative equity in a house.”

Subprime did not cause the mortgage crisis, according to Professor Liebowitz, because people don’t walk away from a home if they have some “skin in the game.”  Fifty-one percent of loans in foreclosure had prime loans, a 488% increase over normal according to the Mortgage Bankers Association.  Subprime foreclosures only increased 200% over norm.

Professor Liebowitz sites analysis of 30 million mortgages compiled by McDash Analytics, 35% of the defaults were caused by negative equity, 18% subprime, and 7.5% interest rate reset.  The loss of a job caused 23% of the foreclosures, and low down payments accounted for 16%.

If you combine the negative equity and low down payment loans, the combination accounts for 51% of foreclosures.

The fact that a homeowner has no equity in the home does not affect ability to make payments, rather it influences the willingness to make mortgage payments.  Barney Frank is pushing to reduce underwriting standards, again.  He believes that high down payments are too onerous for people that desire to own their own home.  So, the cycle begins again.

It appears that common sense agrees with the statistics.  The level of compliance with contract law is directly correlated with the punishment one feels by violating the contract.  This will be news to some on Capitol Hill.  When has common sense been displayed in the halls of Congress?

Are you thinking of investing in China?  Rio Tinto (RTP) is in negotiations with the Chinese on iron ore prices.  Their contracts expired last week; China thinks RTP wants too much for iron ore.

RTP rejected an increased ownership position by Chinalco (ACH) earlier this year.  Now four of RTP’s employees are under arrest in China, after negotiations bogged down.  China wants a 40% cut from last year’s prices; RTP is offering to reduce prices by 28 to 33 percent.  These prices have been negotiated with Japan and S. Korea.  China is RTP’s largest market for iron ore.

Michael Jackson is dead.  The market rolled over early and landed on support at 888 on the S&P 500.  We sat there most of the day waiting on something to happen.  Yesterday the market rallied the last hour, today it sold off.  We closed at 881 on the S&P500.  We are looking for more down days ahead.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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