Imperfect competition has been an important branch of economic theory, at least since Cournot's (1838) model of duopoly. A more recent development is spatial competition, which serves as a foundation for models of imperfect competition. The concept of space as the groundwork for imperfect competition provides many useful insights into price determination and resource allocation. Our goal is to illustrate these insights. In pursuing this track, we ignore many traditional issues in location theory including issues revolving around the shape of market ares. We also bypass questions about the existence of equilibrium in spatial models, which are discussed along with many of the locational issues in a recent lengthy survey by Gabszewicz and Thisse (1984).

Technical progress in originating and pricing mortgages has enabled a trend since 1979 toward more relaxed credit standards on mortgage lending, which is reflected in rising foreclosure rates. We develop a methodology for decomposing the trend in mortgage performance in the national serviced portfolio into a part due to economic conditions and a part due to underwriting changes. The decomposition provides natural metrics or indices of underwriting quality and economic conditions. The results suggest that the recent mortgage debacle can be attributed about equally to each factor. The relaxation in observable credit standards is not monotonic. While the easing of important risk characteristics, like loan to value ratios, in the early 1990s was arguably deliberate, the negative effects of lower standards was masked by strong local and national economic conditions. After 2000, there was little change in observable loan characteristics; nevertheless, loan performance continued to erode even after controlling for the economic environment. We present evidence that the erosion in the latter period must have arisen from underwriting covariates that are typically unobservable to investors in securitizations. This evidence is consistent with the hypothesis that moral hazard in "non-agency" securitizations of mortgages, particularly subprime and Alt-A loans, caused underwriting risks to be mispriced.

In this research we exploit the power of a large and rich sample of individual loans originated from 2000 to 2007 to study the relative roles of underwriting, moral hazard and local economic conditions in the Great Surge in mortgage defaults. With these data we can observe the information available to investors and control for observable underwriting as well as economic conditions. We can also use the data to infer the share due to moral hazard. Estimates from these data suggest that much of the variation was due to economic conditions.

In this paper we use two models to decompose the causes of the recent surge in defaults. Our first model uses aggregate data (foreclosure rates by state) to decompose defaults into shares caused by economic conditions and a time trend, which we interpret as changes in underwriting. We find approximately a 50-50 split between the two. We then turn to a large sample of individual loans. We use the data to model default, and we try to tease out estimates of moral hazard by looking at discontinuities or ―notches‖ in behavior that are consistent with a ̳cheapest to deliver‖ model. The strongest evidence of moral hazard arises in discontinuities in the relation between loan-to-value ratios and defaults for low documentation loans. We find about a 50-50 split between underwriting variation and changes in economic conditions as causes of default variation across borrowers, with only a small part being explained by our moral hazard variables. We then isolate changes over time, and we find no role for changes in observed underwriting. Almost all of the difference between the actual experience of loans originated from 2005-2006 and previous history is explained by economic conditions, mainly declines in property values with a smaller (about 20% of the difference) residual part that might be due to unobserved changes in underwriting. Surprisingly, we find no separate role for low documentation. * Dale Dykema Professor of Business Administration, Ross School of Business, University of Michigan ** Oliver T. Carr Professor of Finance and Real Estate, George Washington University

This research hypothesizes that in markets where information costs, transactions costs and the economic impact of information can vary widely, we should expect both significant predictability and systematic variation in the predictability. Controlling for other factors, we find that on average, 15-30% of the difference between the stock price and the estimated intrinsic value is removed in a year. We document that levels of predictability vary with firm characteristics like leverage, size and number of analysts. Momentum is stronger for larger firms with more analysts. Reversion to the intrinsic value is greater for smaller firms with more analysts.

We document that technical progress in originating and pricing mortgages has enabled a trend since 1979 toward more relaxed credit standards on mortgage lending, which is reflected in rising foreclosure rates. We then decompose annual variation in mortgage performance measured by share of loans entering foreclosure into a part due to economic conditions and a part due to underwriting changes. The decomposition provides natural metrics or indices of national underwriting quality and economic conditions. The results suggest that the recent subprime debacle can be attributed about equally to each factor. The deterioration since 1990 was marked by two periods. In the first, during the 1990s, there was a lowering of observable credit standards, like loan to value ratios. It was deliberate and related to the use of credit scores and the development of more sophisticated underwriting systems. The negative effects of eroding loan quality on foreclosures were to some extent masked by strong local and national economic conditions during this period. In the second period, after 2002, there was little change in observable loan characteristics like loan to value or credit history. This second period is associated with the rise of subprime and Alt-A markets but also with subprime and other "non-agency" securitization. Securitization induced moral hazard and a deterioration in underwriting standards that was not easily observed by investors in the securities.

This research hypothesizes that, in markets where information costs, transaction costs and the economic impact of information can vary widely, we should expect predictability to vary systematically. We test this hypothesis with data on equity real estate investment trusts (REITs) from 1985 to 1992. We document that levels of predictability vary with firm characteristics like leverage, size and focus. Momentum is stronger for larger, more levered REITs. Reversion is faster for focused, levered REITs. The results are consistent with the hypothesis that, in equilibrium, securities, where information is either less costly to acquire or has less impact on fundamental value, should exhibit less predictability.

When a mortgage borrower becomes seriously delinquent (i.e., defaults), the lender initiates a time consuming and complex recovery process that may or may not result in foreclosure and eventual disposition of the real estate collateral (REO). This research studies this transition process for a unique sample of subprime mortgages that were seriously delinquent on September 30, 2001. Eight months later, possible states for the delinquent loans, in order, are 1)to remain delinquent without deteriorating further, 2) foreclosure, 3) worsen, i.e., become more months delinquent, 4) bankruptcy and 5) cure. The data indicate that, relative to prime loans, when subprime loans become seriously delinquent (90 days or longer) they are about twice as likely to become REO but take about four times longer to get there. It is unusual for a subprime default to be cured suggesting considerable forbearance by subprime lenders. We explore determinants of the transition probabilities and find that the most economically important predictors of transition from default to any other state are the number of payments the borrower has made and the loan to value ratio.

The appraisal of the "market value" of homes serving as the collateral for mortgages is a fundamental part of the underwriting process. If a loan should default, however, it is not the retail market value that the lender obtains, but rather the.. recovery value." In this research, we show how recovery values differ from market values at origination and explore the reasons for the differences. Using a large sample of chattel mortgages on manufactured homes, we explore the relationship among the selling prices, the book values, and the fitted values from simple hedonic models with spatial autocorrelation. We then address the differences between selling prices at origination and recoveries from repossessed homes. We find that the spread between them varies systematically with home characteristics and especially with "atypicality," that is, with measures of how unusual a home is. Selling prices both at origination and recovery affect borrower defaults.

Lender losses on mortgage loans arise from a two-stage process. In the first stage, the borrower stops making payments if and when default is optimal. The second stage is a lengthy and costly period during which the lender employs legal remedies to obtain possession and execute a sale of the collateral. This research uses data on subprime mortgage losses to explore the role of borrower and collateral characteristics, and local legal requirements, as well as traditional option variables in the decisions of borrowers and lenders. Although subprime borrowers default earlier, which should reduce lender losses, these borrowers, nevertheless, impose greater realized losses on mortgage lenders.

This research analyzes the dynamic properties of the difference equation that arises when markets exhibit serial correlation and mean reversion. We identify the correlation and reversion parameters for which prices will overshoot equilibrium (“cycles”) and/or diverge permanently from equilibrium. We then estimate the serial correlation and mean reversion coefficients from a large panel data set of 62 metro areas from 1979 to 1995 conditional on a set of economic variables that proxy for information costs, supply costs and expectations. Serial correlation is higher in metro areas with higher real incomes, population growth and real construction costs. Mean reversion is greater in large metro areas and faster growing cities with lower construction costs. The average fitted values for mean reversion and serial correlation lie in the convergent oscillatory region, but specific observations fall in both the damped and oscillatory regions and in both the convergent and divergent regions. Thus, the dynamic properties of housing markets are specific to the given time and location being considered.

This is the first of two special issues of Real Estate Economics dedicated to the study of Real Estate Investment Trusts or REITs. The goal of these special issues is modest. Rather than attempting to provide a comprehensive survey of current research on REITs,1 our objective is instead to provide readers with a sampling of the various general directions of inquiry either about REITs or employing REITs. The volume of research on REITs has exploded in recent years. The objective of this introduction is to provide three non-mutually exclusive catalysts for this explosion, and to provide brief summaries of the studies contained herein.

We investigate relations among inside ownership, managerial expenses, risk sharing and equity valuations. Our engine of analysis—Real Estate Investment Trusts (REITs)—provides a unique and rich framework for analysis since we can calculate extremely accurate measures of asset replacement costs, and hence relative valuation (Tobin's q). Further, the nature of the financial statements allows us to examine the impact of insider ownership on agency costs since we can accurately measure the costs of the entire management team. Our results show that firms with greater insider holdings tend to invest in assets with lower systematic risk and use less debt in their capital structure. At the same time, managerial expenses are lower as inside ownership increases. Finally, higher levels of insider ownership are associated with higher relative valuation as measured by both higher premiums to net asset value and higher multiples of cash flows. The results have implications for the design of optimal management contracts for both REITs and firms in general.

This is the first of two special issues of Real Estate Economics dedicated to the study of Real Estate Investment Trusts or REITs. The goal of these special issues is modest. Rather than attempting to provide a comprehensive survey of current research on REITs,1 our objective is instead to provide readers with a sampling of the various general directions of inquiry either about REITs or employing REITs. The volume of research on REITs has exploded in recent years. The objective of this introduction is to provide three non-mutually exclusive catalysts for this explosion, and to provide brief summaries of the studies contained herein.