Obama on Foreclosures

http://www.futureofcapitalism.com/2009/06/obama-on-foreclosures

President Obama, trying to explain his economic policies to the Wall Street Journal, claimed that mortgages that were too expensive for borrowers to begin with have led to the foreclosure crisis:

If you find yourself able on a $30,000-a-year income to buy a $400,000 house with no money down, then you are much more vulnerable to the inducements that are out there than a generation ago…. he problem is, is that when you start seeing the entire housing market collapse because of foreclosures, or banks and other financial institutions requiring extraordinary support from taxpayers because they've greatly overextended themselves, this is not just a problem for one individual consumer; this is a problem for the economy as a whole.

In talking about a borrower's $400,000 debt and $30,000 income, Mr. Obama is invoking what is known as a DTI ratio, or "debt-to-income" ratio. The only catch is, as this paper by four economists says and demonstrates, "the DTI ratio at the time of origination is not a strong predictor of future mortgage default." Says the paper, "Ultimately, the importance of affordability at origination is an empirical question and the data show scant evidence of its importance."

The paper explains:

The fact that origination DTI explains so few foreclosures should not surprise economists, given the mountain of economic research on the sources and magnitude of income variation among U.S. residents. The substantial degree of churning in the labor market, combined with the trial-and-error path that workers typically follow to find good job matches, suggests that income today is an imperfect predictor of income tomorrow. Consequently, a mortgage that is affordable at origination may be substantially less so later on, and vice versa.

It should not surprise economists, but it looks like it might surprise Mr. Obama. The paper says that other factors, such as the unemployment rate and changes in house prices, are more important contributors to the likelihood of foreclosure than is the DTI ratio at the loan's origination. None of this is to deny that some lenders did make loans to borrowers who could not afford them by any reasonable standard pretty much at the outset, or to defend such practices. But the economics paper suggests that, contrary to Mr. Obama's comments, such practices are not the primary cause of the current problems.

In the same interview, Mr. Obama responds to the "socialism" question with essentially the same tactic that he used here and that his aide Lawrence Summers used here: citing the policies of his predecessor, President Bush: "essentially every step we're taking really involves cleaning up the mess that we found when we arrived here at 1600 Pennsylvania Avenue… The reason we stepped in was because when we arrived $10 billion had already been provided to the auto companies with essentially no strings attached."

by Editor  |  Jun 17, 2009 at 7:19 am Related Topics:  Housing receive the latest by email: subscribe to the free futureofcapitalism.com mailing list