An idea that just will not die is that the government could have done a better job of bailing out mortgage borrowers. Larry Summers is one of the people who touts this idea without having any institutional facts at his disposal.
The key fact is that in the markets that experienced the strongest cycle, about 45 percent of homes were purchased by speculators. That means that the government faced the following choice:
1. Bail out these housing speculators. That would mean either that taxpayers or banks would reduce their mortgage amounts to the point where they could rent out their properties and cover their mortgages. Why this would be equitable or stimulative to the economy is not at all clear to me.
2. Have a bailout that was limited to owner-occupied homes. This would not have accomplished very much in the markets that had the strongest housing cycle. In addition, it was not easy to execute, for a variety of reasons. As I pointed out at the time, it involved creating new business processes that folded together loan servicing, loan origination, and security payments. Also, you face a trade-off. Give the borrowers too generous a bailout, and you generously reward the profligate. Give them too limited a bailout, and they re-default. Under the programs that were tried, re-default rates were very high.
I am reminded of this by a new paper by Patrick Bayer, Kyle Mangum, and James W. Roberts that documents the mindset of speculators during the housing boom. They found evidence that people who observed speculative behavior had a propensity themselves to speculate.
The presence of each neighbor that begins to invest in housing within 0.10 miles of a household increases that household’s probability of also investing in housing by 8 percent within the next year and up to 20 percent over three years. The presence of a flipped property that has just been re-sold, the other channel of contagion that we consider, raises the probability of that household investing by 9 percent and 19 percent over the same horizons, respectively. The magnitudes of both forms of investor contagion change over the course of the housing boom, especially the flipped property channel, the effect of which is greatest in the peak years, 2004-2006.
The Government in fact did number 2. It just did it very badly, which is to be expected.
Good stuff to know.
You should start preparing your arguments against student loan forgiveness now…it’s only a matter of time…
Foreclosure is very expensive as well, but at least the lenders have to eat it; speculators on that end too.
I find it interesting to read discussions of speculation as a “contagious” phenomenon. A useful quote (from Charles P. Kindleberger, I had to look up the exact quote and the source) is appropriate:
“There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.”
Attestation:
Read more at: http://www.azquotes.com/quote/1414677
In addition it’s quoted at WSJ book review, paywalled from my current machine. Presumably from _Manias panics and crashes_.
In several key markets in the housing bust many mortgaged owner-occupiers were objectively speculators also. A reasonable definition of speculation is where the debt taken on to control a property only makes sense if large and rapid asset appreciation occurs. Very nice, normal people were speculating heavily on their owner-occupied properties. That is exactly what the no down and 2 or 3 years teaser-rate ARMs were all about. Negative amortization deals. Pretty much every loan type that wasn’t a 10% down, plain vanilla 15 or 30 year term was used in the speculative purchase of a property, owner-occupied or not.
I forgot to add that bailing out mortgage borrowers was a fairly ridiculous response to the fundamental “problem” in the market, which was falling prices. Underwater borrowers were often in better shape than their neighbors if they still retained no-recourse status on their loans. Their neighbors may have lost equity that they had fully paid for while such underwater borrowers had the option of defaulting. Yes, it was not an easy option, but to walk away from a $325,000 home on which you owed $500,000 probably beats owning a $325,000 home that you paid $500,000 of your own money for. So helping the borrower write down their loan by maybe $100,000 using the US Treasury was never going to be easy if the neighbor was expected to just shut up about where their $100,000 was.
As Eric says, the problem was falling prices. The only equitable solution was price stability. In cities that refuse to adequately expand their housing stock, simply living in the city, where rent inflation will be high, is an act of speculation. Buying very expensive homes in that context is as much a hedge as it is speculation.
http://idiosyncraticwhisk.blogspot.com/2016/03/housing-part-127-arguing-over-false.html