The recent spike in home foreclosures in Massachusetts is caused primarily by falling housing prices, and not by rising mortgage payments, according to research released yesterday by the Federal Reserve Bank of Boston.
The contrarian report suggests the common understanding of the foreclosure crisis is somewhat mistaken. Unaffordable loans don't cause foreclosures directly. Even as subprime lending became more common, even when people fell behind on mortgage payments - during the economic downturn in 2001, for example - foreclosures were rare because house prices continued to rise.
In part, people were able to escape trouble by selling their homes at prices high enough to cover their debts. But the research also suggests that troubled borrowers tried harder to make the necessary payments, in the expectation they would profit eventually.
Conversely, when prices started falling, people struggling to make payments had less incentive to find the money. And the value of the home could drop below the outstanding debt, making it impossible to sell. Over the last two years, the number of foreclosures exploded.
Housing price movement "plays a dominant role in generating foreclosures," the report concluded.
One implication of the report is that current attempts by local and federal officials to help borrowers may be ineffective.
US Treasury Secretary Henry Paulson is negotiating a deal to freeze monthly mortgage payments on some subprime loans by delaying scheduled interest rate increases. Paulson reiterated yesterday the plan could be announced this week.
Meanwhile, states including Massachusetts have introduced programs to refinance troubled borrowers into more affordable loans. Those programs have struggled as most of the applicants are unable to qualify.
But government efforts to make payments more affordable may not matter to borrowers mostly concerned about home values.
Instead, the number of foreclosures will be determined mostly by "how far housing prices fall," said Boston Fed president Eric Rosengren, who introduced the report yesterday during a speech to the Massachusetts Institute for a New Commonwealth.
Rosengren nonetheless endorsed government efforts to help subprime borrowers.
Subprime borrowers are particularly likely to face foreclosure, because their grip on ownership is more tenuous. They pay more, they own less of the home, and they have fewer resources. The Boston Fed found subprime borrowers are about six times more likely to face foreclosure than conventional borrowers.
Many subprime borrowers now face increased mortgage payments, as the interest rates on their adjustable loans reset to higher levels. Analysts predict widespread foreclosures will follow.
"Getting people into other products may be much more straightforward and much less costly than helping people once they're already in trouble," Rosengren said in an interview.
The Fed found one-quarter of subprime borrowers in New England are good candidates for more affordable loans. The evaluation is based primarily on these borrowers having sufficiently good credit, and that their homes are worth more than what they owe on their mortgages.
The list of lenders serving subprime borrowers has diminished dramatically. Eight of the 10 companies that made the most subprime loans in Massachusetts over the last decade have stopped making loans. But Rosengren said he was hopeful other companies, including local banks, would step forward.
Freezing the rates on subprime loans would also help, he said.
Critics of the plan have questioned whether investors who own the rights to collect the mortgage payments will agree to forego a portion of those payments.
Rosengren highlighted a reason for optimism. On a typical subprime loan, the interest rate increases after the second year. Historically, most borrowers either sell or refinance before the rate resets. Rosengren said investors were never counting on a long-term income stream.
"It's not like they expected the borrowers to be there for 30 years," he said.
Binyamin Appelbaum can be reached at email@example.com.