The Determinants Of State Foreclosure Rates: Investigating The Case Of .

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Economic DevelopmentThe Determinants of State ForeclosureRates: Investigating the Case of Indianaby Leslie McGranahanForeclosure rates are defined asmortgages in the foreclosure processas a percentage of all mortgages. Theserates vary fairly dramatically acrossstates. While the average foreclosurerate in the 50 states and the District ofColumbia in the second quarter of 2007was 1.25 percent, these rates rangedfrom a high of 3.60 percent in Ohio to alow of 0.44 percent in Wyoming. Onestate that has exhibited high foreclosurerates over the past decade is Indiana.Indiana ranked second highest afterOhio in the second quarter of 2007with a foreclosure rate of 3.01 percent.The goal of this article is to look at thedeterminants of state foreclosure rateswith particular attention to the set offactors referred to in discussions ofIndiana’s high rates. Three primaryfactors have been responsible forIndiana’s high foreclosure rates: thepoor performance of the housingmarket and economy, the high levels ofsubprime and FHA borrowing in thestate, and the relatively long durationof Indiana foreclosures. However, evenafter taking these factors into account,Indiana’s foreclosure rates are higherthan would be anticipated.Indiana ForeclosuresIn every quarter since the firstquarter of 1991, the foreclosure rate inIndiana has exceeded that in thenation as a whole. Since the end of2004, Indiana’s foreclosure rate hasbeen more than double the nationallevel. In conjunction with this, mortgages30, 60, and 90 days past due have alsovastly exceeded the national level. Figure1 depicts the Indiana and nationalforeclosure rates from 1979 to 2007.The number of properties beginning theforeclosure process, foreclosure starts,has followed a similar pattern, withforeclosure starts exceeding thenational level in every quarter since thethird quarter of 1998.Introducing RegressionTo investigate the high levels offoreclosure in Indiana, the determinantsof foreclosure rates are examinedacross the 50 states and Washington,DC, between 1989 and 2006 usingregression analysis. This time framewas chosen because of issues of dataavailability. The means and standarddeviations of the variables included inthe regressions as potential factorsinfluencing foreclosure rates, andProfitwise News and ViewsDecember 2007

foreclosure starts are presented inTable 1. The final column of the tableshows the mean for the state of Indianaover the time period.Five sets of variables are analyzed:measures of the state economy; attributesof the state population; measures offeatures of the portfolio of mortgage loansin the state; classifications of the legalforeclosure environment; and a measure ofstate property tax revenues. Each of thevariable groups is evaluatedin detail below.All of the variables are available for1989 through 2006 with two exceptions:property tax data is not available after2004, and data on percentages ofsubprime loans are only availablestarting in 1998. Profitwise News and ViewsRegression results are presented inTable 2. Each column represents theresults for a different regression. Thedifferent regressions cover differenttime periods. The first column includesthe entire data set from 1989 to 2006.The second column adds property taxdivided into two separate time periods,1989-1997 and 1998-2006. The finalcolumn adds a variable on subprimemortgages that is only available for thelater dates. The coefficients indicatehow a one-unit change in theunderlying variable influences the.states with higher unemployment, lower medianincome growth, and lower home price appreciationhave experienced higher foreclosure rates.information excluding 2005 and 2006as local property tax – data has notbeen released for those years. In thethird and fourth columns, the sample isDecember 2007foreclosure rate. An asterisk on acoefficient demonstrates whether theestimated coefficient is statisticallysignificantly different from zero. All of

the regressions include year fixedeffects, which control for differencesover time in the national economy andother factors. In addition, standarderrors are clustered by state, whichassumes that unmeasured attributes of astate are similar over time.Economic VariablesTo measure the effect of the stateeconomy on foreclosures, fourmeasures of the economic situation areincluded – house price appreciation (asmeasured by the Office of FederalHousing Enterprise Oversight) andgrowth in median income over theprevious five years, the stateunemployment rate, and the percent ofthe workforce in manufacturing. Thesemeasures capture the ability ofhomeowners to earn enough money topay their mortgages. Low home priceappreciation may limit the ability ofhomeowners to take out additionalequity from their homes in order tomake a mortgage payment during adifficult period.1 Individuals may havebought more costly houses than theycould afford in hopes that their incomewould grow sufficiently to coverpayments, especially once teaser rateshad expired. Measures of medianincome growth capture the likelihoodthat income growth kept up with thesemortgage obligations. A bad labormarket, as measured by theunemployment rate, may influence theability of a homeowner to find a new jobfollowing job loss. The ability to find ajob with a comparable wage followingjob loss may be particularly challengingin states with a high concentration inmanufacturing. To capture this, ameasure of the percent of the workforcein manufacturing is included.The regressions indicate that stateswith higher unemployment, lowermedian income growth, and lower homeprice appreciation have experiencedhigher foreclosure rates. Also, a greaterjob concentration in manufacturingincreased foreclosures between 1989and 2006. Overall, these measures ofthe economy have had a substantialinfluence on state foreclosure rates.Profitwise News and ViewsDecember 2007

the homeownership rate. Education ismeasured as the percent of thepopulation with at least a BA. It hasbeen hypothesized that states with amore educated workforce would havelower foreclosures because workerswith more education and who earn highincomes have an easier time finding jobsand sustaining their income. Additionally,more educated individuals may be moreinformed about the functioning of themortgage market and less likely toselect mortgage products poorly suitedto their needs. High homeownershiprates are thought to contribute toforeclosures because the marginalborrowers in areas with high levels ofhomeownership are more fragile andmay be more prone to economicdislocations. Neither of these variablesbehaves as predicted. Controlling for theother variables, homeownership ratesare uncorrelated with foreclosures, whilestates with a higher proportion ofcollege educated residents haveexperienced higher foreclosure rates.Based on this result, Indiana’s lowproportion of college educated workershas served to reduce foreclosures.However, it seems likely that the percentof workers with a BA is picking up anomitted characteristic of the populationthat is correlated with both foreclosuresand educational attainment. Individuallevel data would be useful to fullyinvestigate the link between educationand foreclosures.Loan AttributesThese measures have had mixedeffects in Indiana. As can be seen inTable 1, while Indiana has experiencedlower house price appreciation and hashigher manufacturing employment thanthe nation as a whole, Indiana has hadlower unemployment than the nationand median income growth in line withnational levels. Based on these factorsand year fixed effects alone, one would Profitwise News and Viewsestimate an average foreclosure rate of1.03 percent in Indiana between 1989and 2006, compared to 1.02 percent forthe nation as a whole. 2Population CharacteristicsTwo population characteristics thathave been discussed potentiallycontribute to foreclosures – theeducation of the state population andDecember 2007The next set of variables capturesattributes of mortgage loans. Theyinclude measuring the percent ofconventional loans with adjustable rates,the loan to price ratio of the averageloan, the percent of mortgages insuredby the FHA, and (in 1998-2006)percent of mortgages that are subprime.ARMs, FHA, and subprime loans allhave higher foreclosure rates thanconventional fixed rate prime loans, sohigher percents of these loans shouldincrease foreclosures. Similarly, loanswith a higher loan to price ratio indicate

rate would be if Indiana’s foreclosurerates within loan category were fixed,but Indiana mimicked the nationaldistribution of loans by type.Alternatively we could explore whatIndiana’s foreclosure rate would be if wetake Indiana’s distribution of loans, butapply national foreclosure rates. Thesenumbers are graphed in Figure 2 (forthe years where data is available). Thisgraph shows that the higher foreclosurerates within category are the primarydrivers of the high foreclosure rate,because foreclosures remain high whenthe U.S. loan distribution is used.Foreclosure Processthat the borrower has less equity in thehome and is less able to sell the houseto payoff an existing loan and thereforemore likely to default. All of thesevariables have the predicted signs andthe loan to price ratio for the entiresample and the FHA percent andpercent subprime in 1998-2006 havestatistically significant effects onforeclosures. Indiana has had higherlevels of all of these variables duringthe time period under investigation.Table 3 shows the number and percentof loans by type for Indiana relative tothe U.S., as well as associatedforeclosure rates for first quarter of2007. These patterns have beenrelatively consistent over time. A lowerpercentage of Indiana’s loans are in thecategories with the lowest foreclosurerates, particularly in prime ARMs.These loan-based variablescombined with year-fixed effects leadto a prediction of a foreclosure rate of1.05 percent for Indiana from 1989 to2006 as compared to a nationalThe next two variables measureattributes of the legal foreclosureprocess. The first variable measureswhether foreclosures in the state areprimarily judicial or nonjudicial. Thesecond variable measures the averagenumber of days to process a foreclosure.In general, judicial foreclosures are morecumbersome than nonjudicialforeclosures. As a result it may be morecostly for lenders to initiate foreclosurein judicial foreclosure states. Judicialforeclosures may take longer thannonjudicial foreclosures. According, Indiana’s process periodIn general, judicial foreclosures are morecumbersome than nonjudicial foreclosures. As aresult it may be more costly for lenders to initiateforeclosure in judicial foreclosure states.average of 1.02 percent, and aforeclosure rate of 1.40 percent from1998 to 2006 as compared to anational average of 1.17 twice as long as the 51 jurisdictionaverage. The regression results showthat both of these variables serve toincrease the level of foreclosures.Indiana has a relatively long judicialAnother way to investigate theforeclosure process, so these legalcontributions of greater numbers ofattributes partially explain the highsubprime and FHA loans on theforeclosure rate in Indiana. Theaggregate state foreclosure rate is topredict what Indiana’s overall foreclosure foreclosure outcome measure used isProfitwise News and ViewsDecember 2007

the stock of foreclosures at a given time,so the longer foreclosure processmeans that each foreclosure contributesto the stock for a longer period. Onemay be concerned both about thenumber of homes in the foreclosureprocess at a given point and the numberof homes entering foreclosure (the flow).Table 4 reflects the same regressionanalysis as Table 2, but with foreclosurestarts as the dependent variable. Theseresults are broadly similar to the previousresults with the exception that the variablesmeasuring the foreclosure process are nolonger statistically significant. This patternwould occur if the legal conditions extendthe duration of foreclosures rather thanincrease the number of homes enteringinto foreclosure.Property TaxesThe final variable in the regressionsmeasures combined state and local percapita property tax revenue in thestate. High property taxes may diverthomeowner resources away frommortgage payments leading to higherlevels of default. State and localproperty tax revenue data is onlyavailable through 2004, so theregression including property taxinformation covers a shorter span oftime. The regression shows thatproperty tax revenues have no effecton foreclosures. In addition, the pointestimate has the opposite sign fromthat predicted, with higher propertytaxes correlated with lower levels offoreclosure. If we substitute thepercent change in per capita propertytaxes to capture unanticipated propertytax increased, there is still astatistically insignificant effect onforeclosures (with a negativecoefficient). Property taxes have beengetting a great deal of press in Indianaas a result of a court orderedreassessment of property. While theregression does not point to a largerole for property taxes by state,changes within the state may beinfluencing foreclosures in certainmarkets. Property tax rates have goneup dramatically in some areas inIndiana. 3 Further analysis at the countyor individual loan level may find arelationship between property taxesand foreclosures.Based on all of the variables includedin the regressions, Indiana’s estimatedaverage foreclosure rate is 1.19 percent.This is higher than the national average,but substantially lower than Indiana’sactual average value of 1.55 percent.Figure 3 is a graph of the forecast levelsof foreclosures based on the regressionin Column 5 of Table 2 compared to thedata on foreclosures for 2006. States Profitwise News and ViewsDecember 2007

listed above the 45 degree line haveexperienced foreclosures higher thanare predicted by the regression modelwhile states below this line haveexperienced lower foreclosures. Themodel does a very good job predictingforeclosure rates for most states exceptfor Indiana and Ohio, which aresubstantially above the 45 degree line.Two factors not adequately controlledfor in the model may be influencing thisoutcome. First, mortgage fraud may behigher in these markets. It is verydifficult to measure the incidence ofmortgage fraud and, therefore, nomeasure is included in the regressions.The Mortgage Asset Research Institutedoes develop some state rankings offraudulent activities based on lenderreports. Indiana was ranked second inthe Mortgage Fraud Index in 2003 and2004, but dropped out of the top 10 in2006. Ohio was also not in the top 10in 2006. Both Indiana and Ohio were inthe top 10 for subprime fraud in 2006(Sharick et al. 2007). The FBI’smeasure of “Mortgage Fraud HotSpots” for 2006 includes Indiana andOhio, but neither state was on the FBI’slist in 2003 or 2004 (FBI 2005; 2006).It is difficult to rule out mortgage fraudas part of the issue in Indiana, but it islikely to be a small contributor. Tatom(2007) calculates that the total numberof “suspicious” reports is less than 5percent of total foreclosures.The second factor that may beinfluencing high foreclosure rates inIndiana and Ohio are nonlinearities inthe effects of house prices onforeclosure rates. The effect ofparticularly low home priceappreciation may be especially large.The linear regression frameworkassumes that the difference between 5and 10 percent home priceappreciation on foreclosures is thesame as the difference between 25and 30 percent home priceappreciation. This assumption may beincorrect. Figure 4 graphs foreclosurerates versus five-year home priceappreciation for 2006. The three stateswith the lowest house price appreciation– Indiana, Ohio, and Michigan, had thehighest foreclosure rates.NOTES1 Causality may also be reversed withhigher foreclosure rates affecting houseprice appreciation.Conclusion2 Another potential culprit is the role ofthe auto sector in the state economy.In this article, variation in foreclosureAuto employment is not included in therates were investigated across statesregressions, because data is onlyover the past 18 years, to attempt toavailable for half of the states. Inexplain reasons for the high rate ofaddition, as is discussed in Tatomforeclosures in the state of Indiana.(2007), the problems with foreclosuresEconomic conditions, foreclosurein Indiana predate the declines in theprocesses, and loan characteristics allauto sector.explain some of the differences inforeclosure rates. In addition, some3 Desiree Hatcher and Harry Fordvariables hypothesized to contribute toprovided useful insight into property taxforeclosure rates do not appear to dopatterns across the state of, including high homeownership rates,low levels of educational attainment,and property taxes. Based on theREFERENCESfactors that impact foreclosuresnationally, Indiana is predicted to haveTatom, John A., “Why is the Foreclosurehigher foreclosure rates than theRate So High in Indiana,” Networksnational average, but not levels as highFinancial Institute at Indiana Stateas those experienced.University, NFI Report, August 2007.Sharick, Merle, Jennifer Butts, MichelleDonahue, Nick Larson, D. James Croft,“Ninth Periodic Mortgage Fraud CaseReport to Mortgage BankersAssociation,” Mortgage Asset ResearchInstitute, LLC, April 2007.Federal Bureau of Investigation, “FBI2006 Mortgage Fraud Report” Availableat fraud06.htm. May 2007.Federal Bureau of Investigation,“Operation Quick Flip Stats,”available at er 2005.Profitwise News and ViewsDecember 2007

foreclosure process, foreclosure starts, has followed a similar pattern, with foreclosure starts exceeding the national level in every quarter since the third quarter of 1998. Introducing Regression To investigate the high levels of foreclosure in Indiana, the determinants of foreclosure rates are examined across the 50 states and Washington,

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