Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

A Regional Look at the Role of House Prices and Labor Market Conditions in Mortgage Default

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

A Regional Look at the Role of House Prices and Labor Market Conditions in Mortgage Default

Article excerpt

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In the past fewyears, communities across the United States have witnessed unprecedented growth in the number of homeowners facing mortgage foreclosure. In this article, we take a closer look at default rates in the Fifth District. We use a linear fixed effects model to better understand the role of house price movements and local labor market conditions on prime and subprime foreclosure rates in the metropolitan areas of the Fifth Federal Reserve District.1 We find that our simple model does a remarkable job of capturing variation in foreclosure rates, and suggests that deteriorating labor and housing conditions explain most of the rising default in our region. Prime foreclosure is particularly well explained in our model, mostly because of the elevated importance of labor conditions in explaining prime default. We also study the regional variation in foreclosure rates by taking a closer look at two localities in our district: PrinceWilliam County, Virginia, and Charlotte, North Carolina. Through this analysis, it is easy to see how default rates-and changes in default rates-vary among localities despite the common causes of foreclosure that underlie rising rates across our region and our nation.

Although our region has not seen the staggering foreclosure rates of areas in states like Florida, Arizona, or California, we have not been immune to the national "crisis" of foreclosure. From 1979-2006, the rate of serious delinquency2 in the Fifth District averaged 1.9 percent; by the fourth quarter of 2009, 8.7 percent of all mortgages in the Fifth District were seriously delinquent (compared to 9.7 percent in the nation).3 Within the Fifth District, conditions vary significantly among states and localities. At the state level, the District of Columbia, Maryland, and Virginia default rates started to rise steeply along with the national rate in 2007, while North and South Carolina default rates lagged about one year. Within states, foreclosure rates are considerably higher, for example, in the Washington, D.C., metropolitan statistical area (MSA) and certain coastal zones in Virginia, North Carolina, and South Carolina, while other localities have maintained consistently lower rates of default.

Theoretical and empirical research has found that house price movements and local economic conditions (in addition to underwriting standards and certain borrower characteristics) affect foreclosure rates in significant ways. There is reason to believe, however, that the causes of foreclosure are different across states and regions. Some areas of the Fifth District-the Washington, D.C., metropolitan area, for example-experienced a boom and bust in house prices that was even greater than that of the nation as a whole. Other areas, like much of North and South Carolina, experienced considerably more muted house price movements. Conversely, Maryland and Virginia labor markets maintained low and relatively steady unemployment rates compared to other parts of the country while the unemployment rates in North and South Carolina have been some of the highest in the nation in recent years.

In addition, although the national rise in foreclosure was initially concentrated in riskier, subprime loans, defaults have become increasingly common among prime borrowers. In the fourth quarter of 2007, 37 percent of all U.S. mortgages in foreclosure were prime loans. That number jumped to 54 percent by the fourth quarter of 2009 and has since increased further. In the Fifth District, prime foreclosures made up 52 percent of the foreclosure inventory by the end of 2009. Although earlier research has examined the factors that lead to subprime default, fewhave looked carefully at howprime default might differ.

The article is organized as follows. Section 1 provides a brief reviewof the literature on the theory and empirics of mortgage default. Section 2 describes the data, presents the model, and offers the results of the model. …

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