Introduction.
Keynesian theory argues that, in short term, total output is determined by total spending, which mostly consists of investment and consumption, this is the reality for any economy in the world but it doesn’t hold all the time as its subject to alterations caused by microeconomic factors particularly inflation which brings about increased interests rates raising the cost of production and unemployment as firms layoff some workers in order to reduce their cost of production.
During the 2008 crisis which was one of the worst worldwide economic downturn one on the worst hit sector was the housing sector and in this paper the united states of America will be used as a reference point in explaining what happened earlier during and after the crisis. The three attributes associated with were associated with the housing are:
- foreclosure rates
- decreasing housing prices
- home equity
These factors will be analyzed independently before, during and after the 2008 crisis and also how they are related.
Foreclosure rates-this is the legal process in which a lender seeks to have an asset that is issued as collateral liquefied in order to cater for the unpaid amount of the real amount he/she have not paid. mostly such exists in the mortgage where the mortgagor or borrower obtains a loan to purchase a house and then issues the house as a collateral in case the borrower stops to pay the due amount of the mortgagor the lender which is a financial institution and specifically commercial banks move in to have the house/collateral and the borrower is left without a home.
When the lender obtains the home issued as collateral he can sell it to cater for the payment of the mortgage or deed of trust and other legal expenses, when the lender adopts such a strategy its said he/she have foreclosed the mortgage and in case the amount realise is not enough to cover the said amount then the lender can apply for claim of deficient payment which is liable to the borrower.
Different types of foreclosure exist whereby the process takes different forms which are
- The judicial foreclosure, in this the lender files a lawsuit against the borrow or mortgagor whereby the courts arbitrates the process whereby the amount realised upon sale are first used to settle the remainder of unpaid mortgage, then other legal expenses while the remainder if any goes to borrower.
- The non judicial foreclosure in which the borrower disposes the collateral and settles the remainder of unpaid borrowed amount and then keeps the excess if any.
Foreclosure rates during the 2008 crisis
Before the 2008 crisis there were few cases of foreclosure in the United States of America and many individuals were securing homes using the mortgage as thus the market of houses was enjoying favourable sales since per every unit of house output there was a willing buyer.
With many individuals in employment and having certainty of continued working in the foreseeable future a majority opted to take mortgages to secure homes with a majority of those who took them mortgages were low income earners who secured them at subprime high rates.this is supported by a report following a study in 2008 by the Local Initiatives Support Corporation (LISC) which indicated that the defaults on mortgages have more to do with the loan type rather than income level (Jackson 2008). This same study claims that only one third of subprime mortgages were made in areas that had high rates of poverty (Jackson 2008).
During the soaring economic times in the year 2008 most of the individuals lost their jobs and therefore they were not in a capacity to service their mortgages and the banks deemed them as defaulters and therefore opted to take up the homes which were used as securities for the mortgages and this caused the rise of foreclosure rates during the year.
Foreclosure is caused by a number of factors with reference to the 2008 crisis before the crisis occurred there was existed a high demand for houses and since most of the individual were comfortably in an employment and hoped to remain in the employment in the foreseeable future they decide to buy a home by mortgage and therefore a loan is advance to them to acquire the house and in return issue the same house as collateral and in case of default the house will be recovered sold to cover up the defaulted amount. With increased number of individual wanting a home the interest rates on mortgage went high as more individuals took the mortgage when the crisis came along and unemployment was on the rise individual lost their jobs and could no longer afford to repay the due amount, principal and accruing interest rates and therefore the banks moved in to claim their amount or the collateral and obviously without the capacity to have an income the people sacrificed their home and in the process there was an increased rate of homelessness as well as increased supply of houses. This situation of homelessness and increased supply of homes was what predominated during the 2008 crisis
According to a report issued by the Kansas City Federal Reserve Bank in 2009 discussing the rising foreclosure rate among higher income neighbourhoods, this contradicted an earlier study in Florida which showed that foreclosure rate was high among the low income earner and no the high income earner then what could have caused such a move? As discussed above as individual moved out of their homes which were sold to recover the defaulted amount the supply of homes was on the rise and therefore the forces of supply predominated and with such high supply the prices of homes went down and going the rationally behaviour of human being the high earning individual though having the capacity to service their mortgage defaulted because they did not see the sense of paying more a similar home that would be going for far much less price in the neighbourhood and therefore it was better to default and acquire a similar home at a cheaper price.(frame 2010) summarised that price declines and foreclosure had a robust relationship.
Another notable factor was that the rate of foreclosure was high among the persons who had taken the mortgage at an adjustable basis where the rates of interest were subject to alteration depending on the prevailing economic conditions and since an economic crisis had loomed in the rates were so high making foreclosure the best alternative, this was not the case for those who had taken the mortgage on a fixed interest basis since the rate remained constant regardless of the economic conditions prevail and thus foreclosure rate to in this category was motivated solely by loss of employment or existence of cheap houses in the neighbourhood.
Another notable thing was that with increased hard times those who defaulted moved out but since there were no equal number of individuals willing to take up the vacated house the banks had no one to sell the house to and thus they incurred huge losses and this almost led to extinction of many banks which had issued mortgage.
This significantly affected the real estate’s sector in which they could no longer build more homes since there was no one willing to acquire a home and even if they existed they would only pay too little for the homes according to the prevailing market rates.
After the 2008 crisis the supply of homes was at the peak and with many individuals recovering their employments and wanting to secure their homes the rates of interest were still high the individual were not willing to take mortgages and thus as john Keynes said an invisible hand works to bring the interests low and thus the cost of mortgage was low but it increased overtime as individual scrabbled to acquire the homes, at this time the foreclosure rate has declined but its effects were still predominant
Foreclosure is largely caused by high subprime rates on mortgages which Duda et al (2005) referred to as blind underwriting standards as banks did advance high rated loans to low income who become the majority in loan defaulting thus making the rate of foreclosure to rise exponentially.
Other factors summarised in the table as shown below also caused foreclosure but their impact was not as much as that caused by high subprime rates.
Other factors that did cause increased foreclosure were:
- neighbourhood behaviour, individual were following a wave of defaulting by their counterpart making the foreclosure rate rise, more so existence of cheap houses in the neighbourhood made individual who had the capacity to pay for their mortgages vacate their current homes for new cheap ones vacated by their neighbour thus making the foreclosure rate rise.
- Race Africa Americans experienced a higher rate of foreclosure
- Unemployment with increased rate of unemployment individual lacked reliable source of income to continue servicing their loan and thus ended up in foreclosures
- Geographical location individual living in urban areas were experiencing a higher rate of foreclosure due to the fact that relied on employment which was nowhere and thus ended up in defaulting making those in urban areas experience higher rate of foreclosure .its’ from this circumstances that multiple linear regression to explain foreclosure was formulated using these factors above the variable parameters and foreclosure as the dependent variable.
- Poverty/income levels poor people are obvious unable to pay for their loans and their conditions being worsened by the 2008 economic crisis the rate of foreclosure was at the peak among the poor persons. Low income earners are always regard as the poor in the society, their income was not enough to meet their very basic needs such as food and servicing their mortgages and thus ended up in the foreclosure.
Another felt effect in the 2008 crisis was the decreasing housing prices,
This could simply be associated to the working together with foreclosure but which precedes the other? Certainly price change predetermines the decrease in price of housing; to start with unemployment caused default creating a room for default and subsequent claim of house by lenders which led to increase in supply of house and therefore decrease in prices of houses, there it can be argued that before the 2008 crisis the prices of housing were high and thus the rate of foreclosure were very low and there were little house for sale and therefore individuals opted to pay for their homes since they could not have defaulted to look for cheap homes which did not exist and therefore the situation was quite good for the money lenders but when the crisis brought about unemployment many individual were incapacitated to pay their mortgages and thus ended up in a foreclosure .
With increased foreclosures there was excessive supply of houses and the theory of supply teaches us an increase in supply of a commodity leads to decrease in the commodities price and thus the pieces of house went down since there were no persons taking up the excess supply.
Before the 2008 crisis the prices were high but during the continued 2008 crisis the prices went down to point of rendering the market of the houses non-operational since there was too much supply with very insignificant buyers who were offering to little to the houses they wanted .
Continued foreclosure during the crisis led to decreasing prices of the property include the house as Data from the Cleveland Federal Reserve asserted the property values of single family homes decline about 1.6% within a 250 foot radius for every foreclosure auction held in the previous 12 months (Hartley 2010). The decline was 1.4% within a 250 foot radius per foreclosure filing (Hartley 2010). This reveals a strong negative relationship between foreclosure and pricing of houses, as foreclosure increased the pricing of house and property went down this captured in and graph as indicated below
Years 2007-2011 foreclosure rate/certificates of titles issued and Tampa Price Index.
As seen from the graph as number of certificates issued for foreclosure increased the prices were going low since there was a continued supply of houses which were not being taken up in fact it was a case of dumping.
Housing prices was also as a result of unemployment as was unveiled in a study in Tampa area although he two had a significant negative correlation of -0.9491 while the coefficient of determination showed a strength of 90%and therefore there were grounds to believe that unemployment had a significant impact on pricing of house but how? Unemployment is a leading indicator of price index in the housing sector around mid 2008 crisis unemployment had risen by a tune of 360% and the rate of housing price index declined with a margin of 45%. This was summarised as indicated below.
As depicted from the graph above at high rate of unemployment the price index is at its minimum level and thus it can be qualified that unemployment causes the prices to go down.
This is true because with no income and no savings individual will only be concerned with feeding themselves and thus the excess supply of homes will be in low demand while the supply is very high and thus the invisible hand will try to equilibrate the demand and supply and a s result the price index of housing will go down and thus it can be said with certainty that during the crisis price of housing were on a recession.
What happened after the 2008 crisis? It’s obvious that a movement from a crisis is never a random process rather it’s a slow process and so is the recovery of the economy and employment. Therefore as unemployment decreased the price of houses increased reason being individuals were starting to have a reliable source of income and required better homes to live in and thus the demand was on the rise and so is the prices and thus the process continued.
However it obvious that where unemployment is low demand for some commodities will be low and in case there is continued supply of the same commodity which is not being absorbed the commodities price will eventually decline till employment opportunities arise and the individuals will have sufficient income to afford and actually purchase the commodity which would see the demand rise and so is the price and since the supply will remain fixed the demand will shoot up at a greater pace until to a price individuals will starts being rebellious against such prices and this is what happened after the crisis and since individual were fearing to take mortgages they preferred to save till they would get enough to purchase a house for cash and not get back to the vicious cycle of borrowing and ending up in a foreclosure.
Another significant issue that arose is that that of home equity which is the difference between the current market value of a home and the unpaid amount of mortgage on the home and is equivalently equal to the amount paid by the owner as principal to the mortgage and the accruing interests rates.
How was this affected by the 2008 crisis before during and after? before the crisis there was an equilibrium in the home equity since the borrower was honouring the debt liable to him or her but when the crisis came along the and unemployment was predominating and certainly no saving to clear the debt the debt remained unpaid and thus the home equity was at disequilibrium with the borrower at a deficit and as a matter of business the lender moved in to claim his dues and thus the home was taken over with the borrower remaining with either the surplus of the disposal amount which could not in either way be equal to the previous equity and thus becomes the loser in the whole process.
Home equity exists in two different forms one which is the traditional mortgage also known as second mortgage in which the amount lend out must be paid in lump sum on fixed period of time, this doesn’t exist in the modern money markets of the world. This type of home equity starts earning interest immediately the principal has been disbursed to the borrower while the second type of home equity is the home line equity credit in which the borrower gets accredit card from the lender in which he obtains the home equity with this starts to earn interest the moment the its used to purchase a home equity otherwise there is no interest that is accruing this is the most prevailing form of home equity in the modern money markets of the world.
Home equity exist to a borrower as long as he or she continues to pay the due principal and the accrued interest and he/she forfeits he/she risks losing the home equity to the lender, he can only own the home equity if he clears the loan and the accrued interest, otherwise he/she is regarded as having possession but not ownership of the home equity.
Home equity prior the crisis is the possession of the borrower but in the ownership of the lender and since the crisis came in and the borrower was unable to pay all the due the lender exercised the right of lien and thus the borrower lost the home equity which could not be reversed even after the crisis and the only way to recover a home equity after the crisis is to take another mortgage.
It can be summarised that home equity was as a result of being unable to pay due to lack of funds and thus it can be traced that unemployment cause loss of home equity but more directly is the act of foreclosure in which the property is forfeited by the lender to recover his/her dues and thus it can be said that as foreclosure id on the rise the loss of home equity is also on the rise and thus there is appositive relation between the two, whether the relationship is a strong one or a weak one this can be statistically confirmed by use of ordinary least square method to finds the coefficient of correlation and coefficient of determination and make an informed inference.
Running a linear regression on the relationship between unemployment and the rate of foreclosure, using the data from the United States of America the following regression as shown on the graph was obtained. As discussed above there exists a strong linear relationship between fore closure and unemployment, but why does this positive strong linear exists? Its obvious that with high rate of unemployment there is no income to meet the due obligations such as repaying of the mortgage and certainly no saving or using t little savings on food an individual is forced to circumstances of letting go of his home equity in his possession to repay the unpaid mortgage and accrued interests.
How do we relate the fluctuation of housing value, the rate of foreclosure and their direct impact on the household net asset and the overall indirect impact of the latter on the consumption of housing?
With an understanding of foreclosure, and how it causes an increase in supply of homes after money lenders take such homes issued as collateral, and with a majority of individuals unable to secure employment the demand for homes goes low since individual don’t have the capacity to buy new homes. With an increased trend of foreclosure due to unemployment causing inability to service the mortgages the value of houses went down and in fear of more losses the lenders disposed such collateralized homes at a low price pushing the prices of homes downwards. This was a form of hedging against huge losses due to decrease prices of homes.
Such downward fluctuations in prices cause the value of homes to decrease and thus negatively impacting on the equity worth of the household.
Homes are a major component of household wealth, and the Collapse of home prices severely damaged the household balance sheets causing consumers to cut back dramatically on spending on housing. This makes one to wonder on the question of what caused the housing bubble to inflate, and why did it deflate? What is the connection between fluctuating housing prices and consumption?
With a closer reference on what happened in united states the puzzles behind such relationship between foreclosure, housing prices household net assets and they impact on consumption of houses is resolved is solved.
With flow of excess credit into United States of America some of it found its way into the real estate market and embodied itself in lower lending standards and an increase in homeowner leverage. The resulting rise in loan-to-value ratios (LTVs) on newly extended mortgages fuelled an increase in housing price this could be directly linked to the financial sector in what can be referred to as the financial accelerator mechanism through the interaction of rising housing prices and loan to asset value (LTV),which rejuvenated this cycle. In most states of America like, California, Arizona and Florida, house prices more up with more than double between 2000 and 2006. Eventually, however, rising housing prices increased the cost of home ownership, and expectations began reverting back towards the real estate framework.
Consequently, the financial accelerator mechanism, this time operating in the opposite direction, caused the balance on the mortgage to exceed that of the Market value of the house and hence the loan to asset value decreased worsening the position of the mortgagors.
Following the failure of several subprime loans in early 2007, the crisis, fed by fears of even more
Subprime losses and heightened by the lack of transparency in lending banking system engulfed most of the U.S. financial sector. This led to a 30 percent drop in the national Composite index of housing prices, tightening of lending standards and a corresponding decline in the availability of credit. According to the U.S. Department of the Treasury, almost 2.8 million homes were foreclosed upon by the end of 2010, with another more than 2 million in the waiting for foreclosure.
With this high rates of foreclosure which lend to increase in number of houses out for sale and with many individual not in a capacity to afford a home, consumption of houses drastically went down since individual who had defaulted could not access loans to purchase homes due to being blacklisted as defaulters, the consumption of housing decreased significantly more so the real estate market also went down since there was no one willing to purchase their products regardless of output being in plenty due to lack of finances to spend!
One thing to be noted in running this model is that since unemployment cannot fall to zero level its automatic that we can never have a definite regression equation but on assumption we can analyze the coefficient of correlation and determination to show that for sure there exists a strong positive linear relationship between the two variable but one thing that be remembered that the two parameter, correlation of coefficient and coefficient of determination don’t mean causation rather indicate how strong the variable vary together .
In order to show that different lead times have been used in running the model.
This was derived from the following rates of unemployment in from year 2006 to year 2010
The rates of certificates issues which indicated the rates of foreclosure during the entire period under study are matched against such rates of unemployment as were recorded by Labour Force Statistics from the Current Population Survey.
Fig a from year 2005-2010 Unemployment rate against rate of Foreclosures: without lead time.
b)
Fig b. 2007-2011 Unemployment rate against rate ofForeclosureswitha lead time of 1 Month
And therefore it can be affirmed with certainty that unemployment is a leading indicator of foreclosure and thus can be relied in saying that as unemployment increases the rates of foreclosure increases to but this is up to a given limit since we seen that even those in employment also expose them to foreclosure not because of unemployment but due to neighbourhood influence.
It can be summarised that the two variable together in the same direction with one which is unemployment denoting the coming of the other which id the foreclosure and therefore its crystal clear that unemployment will always lead to defaulting in repayment of the mortgage which will always lead to foreclosure.
Conclusion
Its clear that the three variables behaved different during the 2008 crisis with unemployment being a leading indicator of what was to happen in term of foreclosure and loss of home equity and housing prices.
More so housing price was also predetermined by inflation rates household disposable income, as well as those slow shifts in demographic patterns as well as cost of land and construction input materials which were all subject to change during the 2008 crisis.
In a nut shell the 2008 impacted negatively to the three variables mostly during and after the crisis but it had no significant impact before.
References
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Jacob,s.(2008).Building wealth buying foreclosure.London. John Wiley &sons Inc.
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