By James P. Gaines

The downturn in the capital

and mortgage markets has

been far more severe than

originally anticipated. Already

several major financial

organizations — Countrywide,

Fannie Mae, Freddie Mac,

Bear Stearns and Lehman

Brothers — have failed and

required substantial federal

support. Others teeter

dangerously close to the brink.

are the widespread decline in residential property

values from peak levels in 2005–06, the volume

of high-risk home mortgages originated and the worthless

mortgage-backed securities that fueled the boom. Without

question, the home price bubble has burst. The mortgage

delinquency and foreclosure issues have carried over into the

consumer and business credit lines, adding to the mounting

capital market financial pressures.

So far, Texas’ housing markets have fared comparatively well

despite all the turmoil, but the state’s housing sector increasingly

reflects the effects of the general downturn.

The Office of Federal Housing Enterprise Oversight (OFHEO)

reported 22 states had lower home prices in second quarter

2008 compared with first quarter 2007. Other data (the First

American Home Price Index) suggest that as many as 33 states

suffered declining home prices in the second quarter. Falling

home prices appear to be concentrated in major metropolitan

areas (according to the Case-Schiller Index, for one).

Many small and medium-sized metro areas around the

country are still reporting increasing values. So far, Texas is

one of the major states still posting home price increases. Falling

home prices mean delinquent owners and borrowers lose

Prime Fixed 64% 19%

Prime ARM 14% 23%

Subprime Fixed 6% 11%

Subprime ARM 6% 37%

FHA & VA 10% 8%

Source: Mortgage Bankers Association, National Delinquency Survey, March 31,

2008. Estimates by Real Estate Center at Texas A&M University

Source: NAR, OFHEO Y/Y percent change in quarterly estimates.

Source: RealtyTrac Inc. (Data include notices of trustee sales plus notice of

foreclosure sales.)

Texas foreclosures have been moderate

compared to the U.S. trend.

U.S. foreclosures are up 27% YTD 2008;

Texas is down 18% YTD 2008.

the option of refinancing or renegotiating a loan or selling a

property. When properties are “upside down” (the loan amount

exceeds the current value of the property), homeowners get

discouraged and are less likely to keep up their payments,

and lenders have less room to negotiate without sustaining a

significant loss.

The significant drop in home prices that began in 2006 is

depicted in Figure 1. Both OFHEO’s repeat-sales index and the

The current housing market bust is affecting every locale

but appears to be concentrated in several states that experienced

the most rapid price increases. The boom saw housing

prices deviate way out of line with basic market fundamentals

including income, employment, buyer credit histories and

prudent lending practices. In today’s sophisticated, computerconnected

markets no place is immune to the repercussions of

national and even international financial conditions as these

directly affect the cost and availability of credit down to local

levels.

These problems have resulted in solvency questions and

strained liquidity in the banking and capital market sector.

The capital market has lost confidence in bond underwriting

practices. As a result, investors have been forced to reevaluate

risk for all securities previously purchased, which makes

determining the current price of existing bonds and securities

difficult if not impossible. This mess will probably result in

broader government regulatory controls and expanded laws

concerning mortgage lending and origination underwriting, not

to mention commercial banking and Wall Street.

median home price reported

by the National Association

of Realtors (NAR) indicate a

substantial and declining rate

of change, which is bad news

for the market.

10 percent of all homeowners in the United States have

negative equity in their homes and predict that percentage

will increase as prices continue to fall. The major areas

affected by lower home prices are six states: California, Florida,

Nevada, Arizona, Ohio and Michigan. Through first half 2008,

these states accounted for 43 percent of all foreclosures in the

country according to RealtyTrac Inc.

Nationally, the number of foreclosures continues to climb,

but may begin to stabilize in second half 2008 and into 2009.

However, no significant decline in overall foreclosures should

be expected until late 2009 or early 2010 as the number of

adjustable rate mortgage (ARM) resets for both prime and

subprime mortgages will not significantly abate until second

quarter 2009. Texas foreclosures have held fairly stable,

compared with a national

increase of 61 percent to 1.4

million. Based on Notice of

Trustee Sales and Notice

of Foreclosure Sales, Texas

properties posted for foreclosure

during the first half of

2008 totaled 42,705, down

17.7 percent from the same

period in 2007. Foreclosure postings were up 27.3 percent to

462,418 nationally.

account for the majority of foreclosures. Prime and subprime

ARM mortgages represent approximately 20 percent of all

mortgages outstanding, and 60 percent of all foreclosures

started during first quarter 2008 (see Table).

ARM loans plus subprime fixed-rate mortgages account for

26 percent of all mortgages outstanding and 71 percent of all

foreclosures. Clearly, the foreclosure issues facing the country

and Texas will not abate until the majority of ARM mortgages

originated between 2005 and 2007 reset, refinance or are foreclosed.

Most subprime loans were one- or two-year ARMs,

so the vast majority will reset in 2008 and early 2009. Prime

ARM mortgages involved one-, two-, three- and five-year

adjustments and may take well into 2010 before the majority

foreclosure rate is at an all-time high, even exceeding

the Texas foreclosure rate during the oil bust and

depression of the 1980s. Texas’ current foreclosure rate is a

full percentage point less than the national rate and considerably

below the state’s mid-1980s level (Figure 3).

Nearly 2.5 percent of all mortgage loans in the United

States are in foreclosure, compared with 1.45 percent of

Texas mortgages. The foreclosure rate for subprime mortgages

nationally is 11.8 percent compared to Texas’ 5.9

percent (Figures 4 and 5).

It is hardly surprising that subprime loans have a substantially

higher foreclosure rate because they are high-risk

mortgages, a fact that seems to have been ignored by many

investors in subprime mortgage-backed securities. The most

troublesome data depicted in Figures 4 and 5 is the level of

prime loan foreclosures, which is running more than double

the long-term average rate for the nation (1.42 percent vs. 0.5

percent). Texas’ prime loan foreclosure rate is about 20 percent

above its long-term average (0.65 percent vs. 0.5 percent).

slightly declining for the past several years and are expected to

continue that general trend (Figure 2).

In 2007, Texas was one of only six states that reported a

decrease (4.6 percent) in delinquency-foreclosure filings versus

a 75 percent national increase, according to RealtyTrac. During

first half 2008, Texas’ filings totaled 70,180, up 1 percent,

So far, Texas has avoided high foreclosure levels. The housing

market continues relatively strong though sales and

new construction are down considerably from 2006–07. A

stronger-than-national-average economy with fairly low unemployment

and continued population growth continues to

fuel demand for housing, but not at the unsustainable levels

of the boom years.

A common thread in these figures is that foreclosure activity

tends to be cyclical, following the ups and downs of the general

economy. Nationally, foreclosures for all loans declined during

the late 1990s and accelerated during and just after the 2001 recession.

Because that recession was quite mild, the impact on

foreclosures was not as pronounced, though the rate increased

nearly 50 percent, rising from 1.03 in second quarter 2000 to a

high of 1.51 percent in first quarter 2002.

Subprime-mortgage foreclosures,

although not nearly

as numerous as they would

later become, soared from 5.5

percent to 9.2 percent (a 68

percent increase) during the

same time. Interestingly, and

subsequently disastrously,

subprime-backed securities

investors failed to notice how

much more magnified subprime

foreclosures became

during even a slight economic

decline.

The pattern of change in

Texas foreclosure rates followed

the national pattern,

although the 2001 national

recession did not affect Texas

until 2002. Nevertheless, Texas’ prime-mortgage foreclosure

rate trended upward in late 2002 and into 2003 but not to an

alarming level.

The subprime-mortgage foreclosure rate during the time

spiked at a little over 7 percent in fourth quarter 2002. During

the housing boom in Texas, which was somewhat shorter

than nationally, both foreclosure rates dipped to near “normal”

levels or below.

Since second quarter 2006, foreclosure rates have increased,

though not nearly as much as the national rates. The primemortgage

foreclosure rate is up 44 percent from 0.43 percent to

0.65 percent, and the subprime-mortgage foreclosure rate rose

54 percent from 3.81 percent to 5.89 percent.

According to the U.S. Census Bureau’s American Community

Survey, of Texas’ roughly 5.3 million owner-occupied

homes, approximately 3.4 million (64 percent) have a mortgage

and 1.9 million have no debt (36 percent). Of the homes with a

mortgage, about three million (89 percent) have a first loan and

slightly more than 400,000 homes (11 percent) have some type

of second financing. Approximately 173,300 Texas homes (5

percent) have a second mortgage, nearly 200,000 (6 percent) have

a home equity loan and about 11,500 (0.3 percent) have both.

Home debt financing nationally exceeds Texas levels, with

slightly more than 68 percent of all owner-occupied homes

having some type of debt. Of the homes with debt, 73.5 percent

have only a first loan and 26.5 percent have some type of secondary

financing. Almost ten million homes nationally carry

a home equity loan or home

equity line of credit (HELOC),

representing more than 19

percent of all homes with a

mortgage. Secondary financing

is most common in the highest

home-price states where

buyers are forced to obtain

greater financing to cover the

higher acquisition costs.

Little delinquency-foreclosure

data are available on

second loans or home equity

loans. First American’s

subsidiary company, LoanPerformance,

publishes regular

reports on delinquencies and

foreclosures for loans held in

its sizeable portfolio. According

to its data as of June 2008, the states with the most significant

home equity and HELOC serious delinquencies were

Florida, Nevada and Mississippi. Texas ranked as the third-best

state with a 0.67 percent serious delinquency rate.

Texas should continue to weather the current storm well so

long as there is not a major falloff in statewide employment

and the liquidity problems plaguing mortgage lenders do not

result in a major cutoff of funding.

Real Estate Center.

D. Marc McDougal, Lubbock, chairman; Ronald C. Wakefield, San Antonio, vice chairman; James Michael Boyd, Houston; Catarina Gonzales Cron, Houston;

David E. Dalzell, Abilene; Tom H. Gann, Lufkin; Jacquelyn K. Hawkins, Austin; Barbara A. Russell, Denton; Douglas A. Schwartz, El Paso;

and John D. Eckstrum, Conroe, ex-officio representing the Texas Real Estate Commission.

are free to Texas real estate licensees. Other subscribers, $20 per year. Views expressed are those of the authors and do not imply endorsement by the

Real Estate Center, Mays Business School or Texas A&M University. The Texas A&M University System serves people of all ages, regardless of