It’s the loan-to-value ratio, stupid!

Robert Aalberts

Fri, Nov 20, 2009 (3 a.m.)

With apologies to James Carville for corrupting his famous and prescient 1992 presidential campaign battle cry, I think it’s important to discuss what some real estate experts think triggered the residential property debacle. The conventional wisdom has long been that subprime loans caused it. However, a number of prominent economists have crunched the numbers and are discovering otherwise.

They maintain that high loan-to-value ratios among homeowners, much of which was caused by too little money being put down to purchase homes, depreciating prices, plus laws that enabled homeowners to get out of their indebtedness too easily, are more to blame.

Stanley Leibowitz, a professor at the University of Texas-Dallas, offers compelling evidence. Consider this: Fifty-one percent of all foreclosed homes in 2007 were secured by prime mortgages, and foreclosure rates on these notes grew by a whopping 488 percent. Subprime foreclosure rates, on the other hand, grew “only” 200 percent. More importantly, his 2008 data demonstrated that while only 12 percent of homes at that time had negative equity — those homes worth less than the mortgage note — they were involved in 47 percent of all foreclosures. Thus, the bottom line appears to be: How much skin borrowers had in the game best predicts if they are still even in the game, whether subprime mortgages were used or not.

Many of Leibowitz’s findings and recommendations are echoed by another economist, Martin Feldstein. Feldstein, once Ronald Reagan’s chairman of the Council of Economic Advisers, feels that borrowers can only survive if they also put down more to avoid negative-equity scenarios and furthermore must be subjected to more risk. This will create the best bet for deterring future foreclosures. He also strongly recommends that recourse notes — mortgage notes in which the lender can pursue the homeowner after a foreclosure if the home sells for less than the amount still owned — should be federalized by congressional fiat. Currently, 13 states, including Nevada, Arizona and California, actually outlaw recourse notes on homes. Feldstein argues that those who may consider defaulting on their mortgage note that added risks are lurking, in addition to losing their homes.

Leibowitz’s and Feldstein’s ideas have sound economic underpinnings. Their ideas may be politically weak and unrealistic, however. It’s true that Washington has generally been successful in federalizing and therefore creating uniformity across the country in regulating and providing financing for real estate. But foreclosure-related laws are different. The states have historically enjoyed great independence and leeway in formulating these laws. Moreover, these laws differ for a variety of often complicated reasons and are steeped in the fabric of a state’s social, political and economic history. For example, the political clout of a state’s banking sector and the populist reaction to it and even whether the state has influential agricultural, energy, retirement and, yes, gaming sectors, in its economy, can all influence a state’s portfolio of real estate foreclosure laws.

That’s why the idea of federal lawmakers imposing uniform laws across the country that are inimical to such a complex environment will be difficult, at best, and quite likely impossible. In fact, the trend among the states may be the reverse of the policies the two economists are proposing. For example, in this time of economic distress, more states than ever are reacting to their citizens’ cries for help.

Nevada is a prime case in point. As stated earlier, our lawmakers passed a very pro-homeowner law this past session that became effective Oct. 1. The new statute dictates that notes used to finance the purchase of a person’s home must be nonrecourse. This effectively eliminates a lender’s right to pursue homeowners for more money even if the foreclosure sale doesn’t cover the note.

Leibowitz and Feldstein would not be pleased.

Robert Aalberts is Lied Professor of Legal Studies at UNLV.