Where are the foreclosures?

Alan Reynolds:

When President Obama discusses his $275 billion mortgage bailout, he talks as if it was a national problem, caused by a national decline in home prices. "We must stem the spread of foreclosures and falling home values for all Americans," he says. But there is no national market for homes and no national price for homes. Instead, most of the United States will pay for the folly of few.

The beneficiaries of taxpayer charity will be highly concentrated in just five states - California, Nevada, Arizona, Florida and Michigan. That is not because the subsidized homeowners are poor (Californians with $700,000 mortgages are not poor), but because they took on too much debt, often by refinancing in risky ways to "cash out" thousands more than the original loan. Nearly all subprime loans were for refinancing, not buying a home.

It turns out that the five states with by far the highest foreclosure rates have some things in common with each other, but very little in common with most other states.

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As of the third quarter of 2008, OFHEO home prices were still higher than a year before in 18 states, and down less than 2% in a dozen others. Double-digit declines in home prices were confined to just four states - surprise, every one of the Foreclosure Five except Michigan.

Even though California home prices fell 20.8% over the year ending in the fall of 2008, however, they were still 50% higher than they were just five years ago. In Florida and Nevada too, the bust in home prices obviously followed a speculative boom. Back in April 6, 2008, a New York Times graph showed that default rates on only the riskiest subprime mortgages had already reached 21% in Merced and Stockton, California, and ranged from 19% to 24% in Fort Myers and Naples, Florida.

So what's happening now? By looking at sales, you can see the free market is working very well. Sales of existing homes over the past year have soared in four states where home prices fell the most. Reducing the inventory of unsold homes, foreclosed or not, makes it easier to sell remaining homes and thereby works to arrest falling home prices. Falling home prices are not the problem, they're the solution.

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Looking at the Foreclosure Five, you find another consistency - unemployment rates far above the national average (half the states were below 5.9% in December).

The exception is Arizona, where unemployment is a more reasonable 6.9%. Stephen Miller of the University of Nevada and Rangan Gupta of the University of Pretoria explained the apparent anomaly by explaining that migration and the market for second homes make Phoenix housing dependent on economic conditions in Los Angeles and Las Vegas. Miller and Gupta found that "Los Angeles housing prices cause housing prices in Las Vegas (directly) and Phoenix (indirectly). In addition, Las Vegas housing prices cause housing prices in Phoenix" to rise or fall in step.

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Except for Michigan all of the Foreclosure Five are states where there is a significant number of second homes owned by people elsewhere. It is reasonable to assume that in a down turn they would be the first to be given back to the lender. Michigan is a state that has suffered under liberalism and unionism that people are abandoning along with their homes. I don't have high expectations for Obama's underwater mortgage plan.