If President Obama is to sell his mortgage bailout plan to the public, an important argument will be his claim that preventing foreclosures actually helps all homeowners by preventing housing prices from dropping:
"This plan will not save every home, but it will give millions of families resigned to financial ruin a chance to rebuild," Mr. Obama told a crowd here, in one of the communities hardest hit by the housing crisis. "It will prevent the worst consequences of this crisis from wreaking even greater havoc on the economy. And by bringing down the foreclosure rate, it will help to shore up housing prices for everyone."
The claim that the program helps "shore up housing prices for everyone" has been frequently repeated by administration officials. Housing and Urban Development Secretary Donovan elaborated on the point:
And in all, this will help, as I said, 3 to 4 million families. But let's be clear: This will also help millions of other families, as well. Recent research shows that neighboring homes to foreclosed homes lose as much as 9 percent of their value. So people who are not in danger of foreclosure still are suffering from nearby foreclosures. This will help those families, as well. Our estimates are that the average home -- not the average home in foreclosure, but the average home across the country will gain $6,000 in value relative to had this plan not been put in place.
The 9 percent figure seems to come from a study by three analysts at Fannie Mae in a report titled, Spillover Effects of Foreclosures on Neighborhood Property Values, which was abstracted this way:
We project that the spillover effect of a foreclosure on neighborhood property values depends on two factors: the discount of foreclosure sale and the weight placed on the foreclosed property as a comparable in the valuation. The former is related to housing cycle and the latter varies by time of foreclosure and its distance from the subject property. Empirical results based on a 2006 sample show that this effect is significant within a radius of 0.9 km (roughly 10 blocks) and within 5 years from its liquidation. The most severe impact is an 8.7% discount on neighborhood property values, which gradually drops to anywhere between âˆ’1.2 to âˆ’1.7% for foreclosures liquidated within the past 5 years. These spillover effects vary slightly when the sample selection bias is taken into account. Based on an alternative sample of purchase transactions in 2003, the estimated spillover effects in booming years are reduced by half, confirming on the important role played by housing cycles.
The only problem is that the study doesn't prove what the Obama administration would like to say it does. Some of it is playing with data. For example:
1. It is only "the most severe impact" that is 8.7% -- this is a foreclosure within 0.1 kilometer of a house with the foreclosure occurring within the last two years. A house 1.5 to 2.0 kilometers from a foreclosure that occurred within two years experiences only a 0.7% decrease.
2. The $6,000 gain in value seems unlikely. The National Association of Realtors said that the median sales price of a home in the 4th quarter of 2008 was $180,100. So the administration is assuming the median home in America would fall in price by 3.3 percent due to neighborhood foreclosures. In order for this to occur, according to this study, the foreclosures would have to occur with a half mile of a house. Yet as Alan Reynolds pointed out in the New York Post, foreclosures are overwhelmingly occurring in just five states.
3. Even if true, the impact dissipates quickly. The study shows that a foreclosure within 0.4 to 0.5 kilometers causes a 4.3 percent dip in neighboring home values -- but only for the first two years. Between three and five years, the dip is down to 1.9 percent and after 6 years, only 0.6 percent.
More broadly, the study was not a controlled study in which half the houses in distress were foreclosed on and the other half saved by the government. It is just an analysis of what happened to neighborhood prices when a home got foreclosed on. The study does not even touch on the issue the president and Secretary Donovan attempt to draw from it: What would happen if foreclosures were stopped?
Foreclosures typically occur when real estate prices have not been rising sufficiently to enable someone to sell their house and pay the mortgage off. This happens for a reason. If an auto maker in a small town closes a factory and lays off a lot of workers, the real estate market in that company town will be weak. This means that laid-off factory workers who can't afford their mortgages will be foreclosed on.
Yet the problem in the community is the closing of the auto plant and the subsequent loss of jobs and income. This is the cause of the decline in housing prices. Foreclosures are just a symptom. It simply doesn't follow that when the auto plant closes, if we just don't foreclose, the neighboring houses will stay at their old value. Indeed, the very knowledge that so many people are continuing to live in houses they can't afford might depress the market further due to fear that the homeowners may not be able to keep up the homes or that they may be hesitant to invest in local schools or amenities. Plus the fact that they may be sellers at the first positive move in the market implies a limit to the upward potential of property in that community.
Foreclosures often serve to broadcast clearing market prices. When prices decline in a community, many simply won't sell if they don't have to. Typically the number of transactions goes way down. Foreclosures are one of the situations where the house has to be sold. But the researchers did not establish or even attempt to establish that the pre-foreclosure market price they used to measure price declines was, in fact, a liquid market at which people could actually sell their homes. It is highly likely that the researchers discovered not so much a causal link -- foreclosures cause houses nearby to go down in value -- but a publicizing function -- foreclosures communicate what the values of homes in the area actually are and thus encourage the market to become liquid at a new, lower, price point.
In addition, the study -- all the data is from the Chicago area -- does not distinguish between foreclosures, per se, and the rules of different jurisdictions to require maintenance of vacant properties. There is a national movement, as evidenced in Boston and Miami-Dade County, to make sure that the owners of foreclosed or vacant properties maintain the properties, often using municipal authority under nuisance abatement laws. One suspects that whatever negative effects foreclosures may entail, relate not to the foreclosure itself but, rather, to the negligence of local authorities in enforcing local laws requiring properties be properly maintained.
The president, the administration, and its advocates can promote any mortgage relief plan they choose on whatever basis they wish. But any claims that there is evidence that bailing out the mortgages of particular individuals helps all property owners is simply not supported by any real research and should be viewed with great skepticism.