Changes in Foreclosure and Unemployment across States
The most recent recession has left deep scars on both the housing and labor markets, with the unemployment rate more than doubling and the foreclosure start rate roughly tripling from pre-recession levels. However, the timing of the movements of the two series differs somewhat over the cycle. The overall foreclosure start rate began to rise sharply before the unemployment rate rose and well before the onset of the recession in December of 2007. This likely reflects a number of forces that were at work preceding the recession, including the decline in home prices and the weakening of loan quality, which occurred earlier in the decade.
For traditional prime, fixed-rate mortgages, the rise in the foreclosure start rate moved later in the cycle and more closely in step with the rise in the unemployment rate. These loans represent about 53 percent of first-lien mortgages prior to the start of the housing crisis. For this group of loans, loan quality is generally higher, and the subsequent rise in the foreclosure start rate is more closely linked to economic weakness and job loss. Indeed, recent statistics from the Making Home Affordable Program indicate that 60 percent of the program’s permanent mortgage loan modifications are the result of the loss of income. The joint movement of foreclosure starts and unemployment rates is particularly evident in this cycle.
The obvious corollary is that the foreclosure start rate for loans other than prime, fixed rate mortgages, including subprime loans, led the cycle. The foreclosure start rate in this all-other-mortgage category is much higher than that for prime, fixed-rate loans, and it began rising well before we saw a significant rise in the start rate on prime, fixed rate loans or the unemployment rate.
The positive relationship between unemployment and foreclosure can be seen across the 50 states. Looking at the change in unemployment rates and the change in foreclosure start rates in the three-year period from 2007:Q1 to 2010:Q1, we see that states that experienced large increases in their unemployment rates tended to experience relatively large increases in foreclosure start rates. The pattern is largely similar for both all mortgage types and for prime, fixed-rate mortgages, though the correlation is a bit stronger for the latter.
To be sure, there is considerable dispersion in rates across states. For example, Ohio and Arizona have had similar rises in unemployment rates over the recession but very different changes in foreclosure start rates. Arizona has felt the full force of the housing boom-bust cycle, with very high increases in foreclosure start rates. On the other hand, Ohio already had a relatively high foreclosure start rate well before the recession began, and it has had a more modest increase thereafter. Florida and Nevada (as well as Arizona in terms of foreclosure starts) are the clear outliers, experiencing the highest increases in both foreclosure starts and unemployment rates.
This relationship between foreclosure starts and unemployment at the state level is not seen in every cycle. In the early 1980s, when the U.S. economy experienced a double-dip recession and unemployment rates also above 10 percent, changes in state foreclosure and unemployment rates are basically uncorrelated. Alternatively, the correlation in the 2007:Q1–2010:Q1 period using all mortgage products is 0.55, indicating a reasonably strong, positive relationship. This highlights the fact that the key elements of this housing cycle—falling home prices and generally weaker loan quality—have interacted with job and income losses to reinforce the severity of foreclosures.
What should we think about the path of the foreclosure starts and unemployment going forward? With respect to unemployment rates, many commentators think that unemployment will fall slowly, as structural adjustments in the labor force take time [for example, see this Commentary]. Alternatively, if history is any guide, high foreclosure start rates are likely to persist, as well. This conjecture is based on the observation that states that experienced boom-bust housing cycles in the past (such as Texas, Oklahoma, Massachusetts, and California) had elevated foreclosure starts for years after the peak in foreclosure starts and inventory, and these previous boom-bust cycles were small in comparison to the current cycle.