Risk is in the eye of the beholder

Trying to predict what's going to happen next in a single housing market -- let alone 381 metropolitan areas where more than 9 out of 10 Americans live -- is not easy these days.

The slowdown in sales has bloated inventories, and so have foreclosures, short sales, and cancellations of new home purchases. How do you factor in the impact of tightened lending standards and regulations? What about economic factors like unemployment and interest rates? And then there's the all important wild card, consumer sentiment/buyer psychology. When will people come to believe that -- to paraphrase the National Association of Realtors -- "It's not a crazy time to buy a home?"

So hats off to the folks at PMI Mortgage Insurance Co., First American CoreLogic, and others who are crunching numbers like mad in an attempt to answer that question. And a word of caution to those who would take them as gospel.

First American CoreLogic just released its quarterly Core Mortgage Risk Index (see Inman News story), which found home prices are falling or not keeping pace with inflation in 247 of 381 markets. Prices are actually falling in 88 markets, and appreciating at less then 3 percent -- about what inflation has been averaging -- in 159 others. So homeowners in those markets may be seeing their house values declining in real terms.

That's not necessarily a big deal, First American CoreLogic's chief economist, Mark Fleming, told me -- it was only during the housing boom that the rate of appreciation raced past inflation, like the hare speeding past the tortoise.

But the other thing that struck me about First American CoreLogic's report was that four of the markets it identified as being at the lowest risk for delinquencies -- West Palm Beach, Orlando, Ft. Lauderdale and Phoenix -- were recently singled out by PMI Mortgage Insurance Co. as markets at the greatest risk for price decline in the next two years (see story).

These reports are looking at two different things -- First American CoreLogic is assessing the risk of mortgage delinquencies in the next six to 12 months, and PMI the risk of price declines in the next two years.

But as Fleming acknowledged, price declines can raise the risk of delinquencies and foreclosures, because homeowners may lose the equity they have in their homes, and be unable to refinance an ARM loan or recoup what they owe on their mortgage by selling their home.

While it's easy to understand how First American CoreLogic and PMI might not agree on what the riskiest or lowest risk markets are, it seems highly improbable that markets that are at the lowest risk for delinquencies in the next 6 to 12 months could also be among those at the highest risk of price declines in the next two years.

So who's right?

Fleming said the Core Mortgage Risk Index emphasizes economic issues like employment and wage growth over home-price appreciation. An event like job loss or a divorce is still the most likely trigger for delinquency, he said, and foreclosures are often a combination of economic stresses and negative equity positions that can result from price declines.

PMI also looks at economic issues, but its report puts more emphasis on factors like home-price appreciation, price volatility, and affordability.

Cities in California and Florida dominate the list of markets where PMI predicts home price declines are most likely in the next two years. That's because of the rapid and sustained price appreciation these markets saw during the boom, the analysts who put that report together told me.

Eight of First American CoreLogic's 10 riskiest markets for mortgage delinquencies were in Michigan and Ohio, where the economy has suffered because of layoffs in the auto industry and related businesses. PMI, on the other hand, sees the risk of price declines in many markets in the Midwest as low, because they didn't see rapid price appreciation during the boom.

Of course, the industrial rust belt states largely bypassed by the housing boom -- Michigan, Ohio and Indiana -- and states with healthy economies that saw some of the most extreme runups in price -- Nevada, Florida, California and Arizona -- are all on RealtyTrac's list of 10 states now experiencing the highest rates of foreclosure (see story).

The bottom line may be that you can have foreclosures without price declines -- thanks, perhaps in part, to risky loans that make it difficult for homeowners to build up equity. But can you have price declines without delinquencies and foreclosures?

That seems unlikely, especially when many of the buyers in the states with strong economies but rapidly appreciating prices were second home owners, investors, or speculators.

According to the Mortgage Bankers Association, as of June 30, the non-owner occupied share of defaulted loans was 32 percent in Nevada, 25 percent in Florida, 26 percent in Arizona and 21 percent in California, compared with 13 percent in the rest of the nation.

Rather than concluding PMI is right and First American CoreLogic is wrong, perhaps it would be more fair to say that if you want to look ahead more than six to 12 months for clues about what might happen to prices in your market, focusing on historical price appreciation and volatility trends -- along with current affordability -- might be your best bet. And those are the factors PMI places the most emphasis on.

But nobody can predict the future. If the economy manages to emerge from the housing downturn without going into a recession -- and if investment capital starts flowing into mortgage lending again -- maybe it is a great time to buy (or at least lend money) in West Palm Beach, Orlando, Ft. Lauderdale and Phoenix.

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