Category Archives: Housing and housing finance

The Future of Housing Finance

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1. It was the subject of this forum. My main meta take-away is that the future of housing policy is in the grasping hands of the housing lobby. There was a lot of talk about “the American dream,” the need to preserve the 30-year fixed-rate mortgage, etc. These are people who, when they talk about the need to bring private capital back into housing, actually think in terms of what sort of government guarantee is needed to accomplish this. When it comes to policy, the people who I think should be disqualified from participating are at the center of the discussion, and the people who I think ought to be at the center of the discussion are marginalized.

2. In my housing finance course, I have just started to get into one of my favorite topics, which is mortgage analytics. In a few weeks, I will get to the issue of the housing lobby, and if my mood is the same as it was after leaving the policy forum, my lecture on the housing lobby should be one heckuva rant.

Charles Calomiris on Politics and Banking

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From the WSJ:

That anti-populist political system — known in political science as liberal constitutionalism or liberal democracy — is a key ingredient in Canada’s stable banking track record, Mr. Calomiris contends in his paper, which is a summary of a much longer book he’s written with Stephen Haber due out in September. That’s because this kind of political system makes it difficult for political majorities to gain control of the banking system for their own purposes, the authors contend.

Having only experienced the American system, I think of politics and banking as hopelessly entangled. As I recently put it,

Politicians want to make credit allocation decisions. Whatever its nominal purpose, bank regulation is used to enable politicians to undertake credit allocation.

Calomiris seems to take the same point of view, but he argues that some political systems are less susceptible to interest groups gaining control of bank regulation. I am interested in reading more about the research. Meanwhile, you should at least read the whole WSJ piece.

Where Have We Seen This Movie Before?

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The Washington Post reports,

Housing officials are urging the Justice Department to provide assurances to banks, which have become increasingly cautious, that they will not face legal or financial recriminations if they make loans to riskier borrowers who meet government standards but later default.

The government should have tightened credit standards in 2005, when the housing market was taking off. It did the opposite. The government should have leaned against tightening in 2009, when the housing market was depressed. It did the opposite.

Maybe the government is getting it right this time. But (a) I don’t think they will get it right all the time and (b) when they get it wrong it’s you and I who pay the price.

Betting on the direction of the housing market is a job for private speculators, not government officials.

If government officials would take this lesson, they would at least have some basic understanding of mortgage lending decision analysis.

What I’m Reading

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Building Home, a biography of savings and loan mogul H.F. Ahmanson, who flourished from the 1930s until his death in 1968. I had low expectations for this book, but I’m actually getting much more out of it than I did the widely-praised Hirschman bio, even though the latter is the product of prodigious skill and effort. Eric John Abrahamson, the author of Building Home, does a really good job of capturing the post-WWII political economy zeitgeist. On p. 115,

Thus the relationship that developed between regulator and regulated by the early 1950s was often collaborative and mutually supportive. Regulators believed that a major part of their job was to protect the health of the industry as well as the consumer or depositor. When changes needed to be made to the law, industry officials often drafted the new legislation, and legislators in Sacramento and Washington often accepted their recommendations with little other public input. When influential regulators retired, they often became owners, managers, or consultants to savings and loans. Meanwhile, many legislators owned shares or served on the boards of local savings and loans.

The conventional wisdom after World War II was that industry and government had collaborated to win the war, and that similar partnerships could address social needs, such as housing. Public trust in government and industry was high. Supposedly, we now live in an era in which there is much more polarization concerning the free market vs. regulation, and there is much less public trust in government and in corporate behavior. But re-reading the excerpted paragraph, how much has really changed in the last 50 years about the way financial regulation operates?

The business-regulatory collaboration extended to mortgage redlining. On p. 107,

In the 1930s, the Home Owners Loan Corporation (HOLC) had institutionalized the practice of racial and economic segregation in housing development and residential lending…Social segregation continued to permeate public policy during and after the war, and the FHA explicitly perpetuated racial discrimination in mortgage lending. When the Community Homes cooperative in Reseda sought FHA approval to finance 280 single-family homes in 1947, for example, it was turned down by the government because the cooperative refused to adopt racial restrictions.

Knowledge vs. Incentives

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Ing-Haw Cheng, Sahil Raina, and Wei Xiong write,

Our analysis shows little evidence of securitization agents’ awareness of a housing bubble and impending crash in their own home transactions. Securitization agents neither managed to time the market nor exhibited cautiousness in their home transactions. They increased, rather than decreased, their housing exposure during the boom period through second home purchases and swaps into more expensive homes. This difference is not explained by differences in financing terms such as interest rates, or refinancing activity, and is more pronounced in the relatively bubblier Southern California region compared to the New York metro region. Our securitization agents’ overall home portfolio performance was significantly worse than that of control groups. Agents working on the sell-side and for firms which had poor stock price performance through the crisis did particularly poorly themselves.

Of course, the bad incentives in the securitization market could have selected for people who believed in the housing bubble. Still, I believe that the authors have dispelled a notion that the “insiders” knew more than the “outsiders” about the housing bubble.

UPDATE: James Hamilton comments

Suppose we gave an individual securitization agent perfect foresight of what was to come, that is, exact knowledge of the current and future path of their personal bonuses, stock options, and career path. If they had this information, would they have made the same decisions as they actually made in 2005-2006? If so, that would be confirmation that the basic problem was one of misaligned incentives.

Personal Accounts for Down Payments

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Alex Pollock proposes,

until the age of 35, an individual should be able to choose to have 12.4 percent of his salary paid not to Social Security taxes but instead into a restricted savings account covered by deposit insurance, from which savings can be used only to make a down payment on a house. The down payment (using this and possible other savings) must be a minimum of 20 percent, the house must be bought to live in, and the related loan must be a sound credit which is a “qualified mortgage,” as now defined by regulation. The point will be to create retirement savings in the form of equity in property, as a partial alternative to earning benefits from a troubled government pension program.

A major motivation behind the idea is a desire to steer government policy away from encouraging people to buy homes with little or not money down.

Can He Get Away with This?

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The Washington Post reports,

Fannie Mae and Freddie Mac will create a common platform for issuing mortgage-backed securities as they wind down operations and plan for a future in which the two companies no longer exist, their regulator said today.

I must have been absent the day they announced that Edward J. DeMarco was going to settle the fate of the housing finance system going forward. Not that I have a problem with it. I just thought that the Administration was more interested in kicking the can down the road.

By the way, my online course on the American housing finance system is proceeding. We will try a live video chat this Friday at 1 PM eastern time.

Meanwhile, Michael Barr reports on the recommendations of a group called The Bipartisan Policy Center’s Housing Commission. The recommendations include,

The 30-year fixed rate mortgage is an important option for American families. American homeowners are not the best bearers of interest-rate risk in our economy. To have a robust and liquid market for such mortgages for most households, there needs to be a government guarantee.

I disagree with this, and with nearly everything else in this group’s recommendations. So I Googled to see who they were. They represent all sides of the issue, if by all sides you mean left-wingers and housing industry lobbyists. My guess is that these folks representing all sides of the issue will not make life easy for Mr. DeMarco.

In other news, Peter J. Wallison and Edward J. Pinto write,

Despite the claim that it is “protecting consumers from irresponsible mortgage lenders,” the new Qualified Mortgage rule finalized in January by the Consumer Financial Protection Bureau turns out to be simply another and more direct way for the government to keep mortgage underwriting standards low.

Sounds like the Qualified Mortgage rule was shaped by the folks representing all sides of the issue.

The Controversy Over the 1920’s Housing Cycle

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Michael Brocker and Christopher Hanes write (NBER, $)

We find that cities which had experienced the biggest house construction booms in the mid-1920s, and the highest increases in house values and homeownership rates across the 1920s, saw the greatest declines in house values and homeownership rates after 1930. They also experienced the highest rates of mortgage foreclosure in the early 1930s. These patterns look very much like those around 2006, despite the gap between the house-market peak in 1925 and the businesscycle downturn in 1929. They are consistent with a bubble. They show that the effects of the mid-1920s boom on house markets were still present as of 1929. They suggest that in the downturn of the Great Depression house values fell further, and there were more foreclosures, because the 1920s boom had taken place.

This appears to be part of a conference volume. The introduction to the volume, ungated and recommended, is by Kenneth Snowden.

The conference volume also includes Gjerstad and Smith, who view the housing cycle as important in the Great Depression. But we saw that Alexander Field, another author in the conference volume, disputes the view that housing leverage was important in the 1920s and 1930s.

So confusing! I think that all of these economic historians agree that the 1920s boom peaked in 1925. All seem to agree that the economy survived the ending of the boom quite well until 1930. Apparently, the big decline in house prices took place in the 1930s, although the authors note that good data on house prices for this period is lacking. Note also that there was general deflation, so that the decline in real house prices was much less than in our recent financial crisis. Of course, that is of little comfort to someone who borrows at a positive nominal interest rate.

Based on this, I am reluctant to assign housing a major causal role in the Depression. If the big decline in house prices took place in the 1930s, then that could be an effect of, or a part of, the overall Depression. Note, however, that the authors write,

This [the cross-sectional correlation between severity of house price declines in the 1930s and the extent of the construction boom in the 1920s] remains true when we control for measures of the local severity of the depression – changes in family income, changes in retail sales – or for changes in average rents.

The Snowden piece is filled with interesting background information, such as

The home mortgage market of the 1920s grew even more rapidly than the nonfarm housing stock, with nonfarm residential debt tripling (from $9 to $30 billion) in less than a decade, while the ratio of debt to residential wealth doubled from 14 to nearly 30 percent

He summarizes other papers in the volume, including one by Eugene White.

He argues that the double liability rule faced by bank shareholders and the restrictions on mortgage lending meant that both national and state-chartered banks were well-capitalized relative to the modest risks that they carried on real estate loans.

White argues that although there were some common factors that affected the banks during the building booms of the 1920s and the 2000s…the important difference between the two episodes is that banks were induced in the modern period to participate in risky real estate finance by a set of policies that were missing in the 1920s—deposit insurance, the “Too Big to Fail” doctrine, and federal subsidization of risky mortgage lending and securitization.

My Housing Finance Course

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Has finally started.

My goal is to help mid-level staff at regulatory agencies on the Hill understand some important characteristics of mortgage risk and the mortgage business.

As Ed Pinto points out, there is still room for improvement in mortgage regulation.

Last month it was the Consumer Financial Protection Bureau (CFPB) promulgating its Dodd-Frank Act mandated Qualified Mortgage rule (QM). Dodd-Frank imposed QM to set minimum mortgage standards. Yet it is now being touted as making sure “prime” loans will be made responsibly. True to the government’s long history of promoting excessive leverage, QM sets no minimum down payment, no minimum standard for credit worthiness, and no maximum debt-to-income ratio. The rule provides an eight-year pass for loans approved by a government-sanctioned underwriting system.

The WSJ reports on a study by Brandeis University researchers:

Home ownership is the biggest contributor to net worth. But white families, the researchers say, buy homes and start acquiring equity on average eight years earlier than black families, largely because white families can lean on their own families for help with down payments. Because of less access to credit, lower incomes and government policies, they say, the homeownership rate for white families is 28.4% higher than for black families.

Brandeis is all about the oppressor-oppressed narrative. One of the complaints I have about housing policy is that the assumption is that home ownership drives wealth accumulation rather than the other way around. I will address the issue of housing and wealth creation in the course.

Philip Swagel writes,

The initial steps of reform will involve creating the government capability to sell secondary insurance on MBS, setting up the common securitization platform to allow new firms to compete with Fannie and Freddie, and gradually increasing the private capital required for MBS to qualify for the guarantee.

This is an example of the sort of uninformed policy wonk suggestion that my course is designed to warn against. It assumes (a) that securitization of mortgages is something that the government must support and (b) that there is zero institutional knowledge needed to run the business safely.

I do not intend in my course to get into the specifics of regulatory proposals. However, I will clearly lay out the factors that generate risk in mortgage lending. Policy makers can then pay attention to this information, or they can ignore it. I have little hope that a Philip Swagel, a Joseph Stiglitz, or a Martin Feldstein will take the course, or that they will stop pontificating about mortgage markets from a state of ignorance. Instead, my dream is that mid-level staffers will absorb some wisdom and use it to ward off some of the worst ideas coming from the academic types.