the commonly repeated anecdotes of janitors and checkout clerks being
handed $300,000 mortgages on a hope and a prayer do not appear to be representative. On net, all the new mortgages went to families with incomes around $45,000 and higher.
And elsewhere he writes,
growth in homeownership came from high income households and that households didn’t increase their debt payment/income ratios or their relative consumption of housing during the boom. The evidence against the standard narrative is even more stark when we look at dollar levels, because, despite frequent implications to the contrary, low income households don’t tend to take on nearly as much debt as high income households.
Consider two ratios:
1. Debt-to-income.
2. Debt-to-equity.
Many narratives of the financial crisis focus on debt-to-income ratios. The oppressor-oppressed narrative is that greedy lenders imposed inappropriately high debt-to-income ratios on innocent borrowers, who then could not meet their mortgage payments. The civilization-barbarism narratives stress the use of houses as ATMs and the forced expansion of lending toward irresponsible borrowers.
It seems to me that Erdmann is suggesting that debt-to-income ratios did not got out of line, or perhaps they only got out of line for high-income borrowers. He may be right, although I would suggest looking at the Home Mortgage Disclosure Act (HMDA) data and not just the survey of consumer finances.
Ever since Bob Van Order explained the mortgage default option to me almost 30 years ago, I have viewed debt-to-equity as more important than debt-to-income. If we define sup-prime lending in terms of debt-to-income, then I am inclined not to attach much significance to the proportion of sub-prime loans. To me, the dangerous loans are the ones with low down payments. There is some overlap between those and loans with high debt-to-income ratios, but not enough overlap to equate the two.
Let’s take Erdmann’s analysis of debt and income as accurate. I see no reason to change my preferred narrative of mortgage lending and the housing boom. That is, there was a surge in lending with low down payments. I am pretty confident that the HMDA data support this. In addition, there was a surge of lending for non-owner-occupied homes (speculators).
Think of owner-occupants with low down payments and non-owner-occupants as the speculative component in the housing market. My narrative is that the speculative component soared during the housing boom. These speculators did very well until house prices started to level off late in 2006. Then what had been a virtuous cycle on the way up turned into a vicious cycle on the way down, and the speculative buyers got hammered.
Getting from that to a recession is the more difficult part for me, because I do not allow myself to use the words “aggregate demand.” Instead, to explain the recession I have to make a case that many patterns of specialization and trade became unsustainable, or were finally perceived as unsustainable, while new sustainable patterns were difficult to discover. I might argue that the surge in government economic intervention exacerbated the difficulty of discovering new patterns of sustainable specialization and trade. TARP and the stimulus were largely efforts at redistribution, and that gave people a bigger incentive to focus on grabbing some of the loot than on developing a sustainable new business. Of course, Keynesians will tell you that the problem is that the surge in government intervention should have been bigger and lasted longer.
“Getting from that to a recession is the more difficult part for me, because I do not allow myself to use the words “aggregate demand.” Instead, to explain the recession I have to make a case that many patterns of specialization and trade became unsustainable, or were finally perceived as unsustainable, while new sustainable patterns were difficult to discover.”
What about “monetary disequillibrium” instead of “aggregate demand”? As in, “monetary disequillibrium can disrupt existing patterns of specialization and trade and inhibit the discovery of new such patterns”.
Thanks Arnold. And, you are correct. I don’t think there is any doubt that many new homes were purchased with low equity. Total leverage levels didn’t change much, so there was probably a bifurcation of previous owners with declining leverage and new owners with high leverage. I would say two things:
(1) With very low long term real interest rates and inflation, we should expect a natural trend to lower down payments.
(2) While I might agree that this could create systemic problems, it’s hard to tell if it did in this case. Delinquency rates rose from around 2% to more than 11%. They had only risen to 5.2% by 3Q 2008, and home prices had already dropped more than 20% (Case-Shiller 10 city index). Most delinquency growth happened after that. And even then, in 3Q 2008, the Fed decided to implement disastrously tight monetary policy.
Also, you are right. It does look like the low down payment loans were going to investors, not low income occupiers. I think these investors might have been looking for long term income as much as short term capital gains, though. But, even if they weren’t I think we need to be careful about assuming speculators are pushing prices away from equilibrium. More likely, they were pushing prices toward equilibrium. Public notions of the role of speculators are charged with prejudice.
Given what we’ve learned, or think we’ve learned, from the housing boom/bust, what do you prescribe, if anything, for the impending student loan boom/bust?
The feds are underwriting & guaranteeing loans for higher education that, to some ever-increasing extent, is either truncated before graduation, results in useless degrees, and/or does nothing for society but subsidize institutions of higher education, allowing them to raise tuition to unsustainable heights and without regard for limiting costs. The default rate for federal student loan debt repayment is increasing.
Refusal to pay is not an acceptable action. Student loan debt has no collateral — nonpayment results in total loss, charged against the federal taxpayer. Is this not a tsunami of a financial crisis advancing in plain sight?
http://finance.yahoo.com/news/heres-letter-15-students-refusing-154329062.html
“useless” degrees meaning that they do not qualify the holder for some remunerative job or career sufficient to repay the student loan in timely fashion.
The hazard here is relying on reported loan characteristics when these were largely forged to meet official standards. Neither of these measures is that good. Debt service to verified income is crucial because without that price is unconstrained. Debt to income is imperfect both because debt service will vary with interest rates and income will be forged if not verified. Debt to equity is a constraint on first time buyers and reduces speculation but escalating prices will fabricate equity just as well as forged income will fabricate prices. Increases in either of these will increase prices. Perpetually lowering standards through any means isn’t sustainable because at some point loans need to be paid and the income isn’t there to pay them or support prices, and when the tightening occurs, prices that have been rising in anticipation begin falling, equity and wealth declines, and spending contracts. In the absence of income gains to support prices and accommodate tightening standards, recession became inevitable, but what gains there were were largely from housing and lending in the first place. Earlier tightening may have slowed and reduced the size of the bubble, giving a chance for other growth to take its place before it became too large but wouldn’t spur it in itself, and falling rates and rising prices were in the right direction, just not as excessively as encountered.
There was no bubble.
I’m having a hard time distinguishing between the two “populations” — those who got sub-prime mortgages and those with no/low down payments. Wouldn’t these two groups be mostly overlap?
If you can’t afford a down-payment, my guess is that you are likely subprime material.
That’s one of the interesting things that I’m finding in the Survey of Consumer Finances data. I think there is a lot less overlap than you might think.
If policy-makers were honest about trying to reduce homeowner risk and discourage speculation, they would insist on buyers simultaneously taking a short futures position on their city index, to eliminate price variation not due to home improvement.