Category Archives: Housing and housing finance

Long-Term Trends in Rent

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Mark Gimien writes,

Crone, Nakamura and Voith estimate that this and other problems bring down the government’s measure of rent increases by about 1.4 percent a year for the whole period that runs from 1942 to 1985. Nakamura outlines these findings in a very readable paper published by the Philadelphia Fed. Over such a long period, 1.4 percent into a really big number. Add that in, and instead of falling 20 percent in real-dollar terms over six decades, rents rise 50 percent.

Pointer from Tyler Cowen.

The main problem mentioned in the article is that the government’s rent price measure ignored cases in which the rent changes when a new tenant occupies an apartment.

The article focuses a lot on New York City. I think most people believe intuitively that rents in New York have gone up a lot over the decades. By the same token, I think most people believe intuitively that rents in small and mid-sized cities, particularly in the Midwest, have gone down. So maybe we should not talk about “the” cost of rent as if the rental market were national.

Some Institutional Knowledge

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Tomasz Piskorski and Amit Seru write,

the organizational capability of servicers could have played a very important role in determining the rate of modifications and foreclosures during a financial crisis — and such capability takes a long time to build.

The policy wonks thought that they could implement a mortgage refinance program just by snapping their fingers. In real organizations, planning, testing, and training are necessary.

I could have warned policy makers about this (indeed, I did, at a Congressional hearing). In my forthcoming online housing course, I plan to discuss the business processes involved in mortgage lending. I think that this is important information for policy makers to have. However, you will not see academic economists interested in these sorts of details. Piskorski and Seru seem to have stumbled onto reality by way of the data ex post, rather than through industry experience. This puts them way ahead of folks like Joe Stiglitz and Martin Feldstein, who style themselves as experts on housing finance but who I regard as ignoramuses on the topic.

At best, I hope to interest some mid-level government staffers and research assistants in my course. If they can communicate up to the policy makers, maybe the ignoramuses will do less damage.

The New Fraud Paper

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It is by Tomasz Piskorski, Amit Seru, and James Witkin.

We find that mortgages with misrepresented owner occupancy status are charged interest rates that are higher when compared with loans with similar characteristics and where the property was truthfully reported as being the primary residence of the borrower. Similarly, interest rates on loans with misrepresented second liens are generally higher when compared with loans with similar characteristics and no second lien. Given the increased defaults of these misrepresented loans, this suggests that lenders were partly aware of the higher risk of these loans. Strikingly, however, we find that the interest rate markups on the misrepresented loans are much smaller relative to loans where the property was truthfully disclosed as not being primary residence of the borrower and as having a higher lien. This suggests that relative to prevailing interest pricing of that time, interest rates on misrepresented mortgages did not fully reflect their higher default risk.

Pointer from Mark Thoma.

My thinking goes like this. There are some loan brokers who have a reputation for participating in fraud, so they have a smaller choice of lenders that will do business with them. Customers of those brokers end up paying higher rates as a result. The lenders who do not blacklist those brokers wind up being adversely selected. They think they are getting a higher profit margin on these loans than other loans, but in fact the reason that they can get away with (slightly) higher interest rates is that other lenders (rightly) will not touch loans from the same source.

As I said when I first heard about this paper from Luigi Zingales but did not know where to find it,

Zingales says that the bankers should be prosecuted. He makes it sound as if the lenders would record a loan internally as backed by an investment property and report it to investors as an owner-occupied home. That would require a much more complex conspiratorial action on the part of the lender, and until I learn otherwise, I will doubt that it happened.

Indeed, the authors of the paper looked at one infamous now-bankrupt subprime lender, New Century.

Of all loans in this sample that we identified as having misreported nonowner-occupied status, none was reported as being for non-owner-occupied properties in the New Century database. This evidence suggests that the misrepresentation concerning owner-occupancy status was made early in the origination process, possibly by the borrower or broker originating the loan on behalf of New Century.

The authors go on to write,

In contrast, of all mortgages identified as having misreported second lien status to investors, 93.3% had a second lien reported in the New Century database. This confirms that the lenders were often aware of the presence of second liens, and hence their underreporting occurs later in the process of intermediation.

Consider these possibilities:

1. New Century sold loans in the “TBA market,” meaning that investors committed to buy the loans before they were closed. New Century sold these loans as not having seconds, because it had no idea about them. Lo and behold, when the borrowers went to closing, they needed a second loan in order to make the down payment. New Century then recorded in its database the existence of the seconds, but there was no further communication with the investors.

2. New Century new darn well all along about the seconds, but they have two records in their database–a record that they made for internal purposes and a record that they gave to investors.

#1 is still fraud, but it is not as blatantly intentional as #2. I suspect it was #1.

When my online housing course starts (by the end of this month, I am now told), I want to share my knowledge of these institutional issues.

A Housing Discrimination Rule

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From HUD.

the charging party or plaintiff first bears the burden of proving its prima facie case that a practice results in, or would predictably result in, a discriminatory effect on the basis of a protected characteristic. If the charging party or plaintiff proves a prima facie case, the burden of proof shifts to the respondent or defendant to prove that the challenged practice is necessary to achieve one or more of its substantial, legitimate, nondiscriminatory interests. If the respondent or defendant satisfies this burden, then the charging party or plaintiff may still establish liability by proving that the substantial, legitimate, nondiscriminatory interest could be served by a practice that has a less discriminatory effect.

So, suppose that a lender uses a credit-scoring algorithm produces scores below the approval cutoff for blacks more often than whites (step one). Then, the lender shows that the credit scoring algorithm predicts default probabilities accurately for both blacks and whites. Does that satisfy step two? And then what sort of can of worms is opened by step 3? Suppose a community-action group claims that “If you pay us to set up a lending diversity program, we can bring you minority loans with acceptably low default rates,” does it have to prove its claim? If so, then this is actually harder on community-action groups than the current situation, in which all they have to do is threaten to sue and a bank will pay them protection money to make them go away.

I am only sort-of kidding. I would put the burden of proof to HUD to show that in recent years there has not been a lot more suffering caused by anti-discrimination regulations than by actual discrimination. And I am talking about suffering by people with “a protected characteristic.”

Housing and Wealth Destruction

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Thomas J. Sugrue writes,

The bursting of the real estate bubble has been a catastrophe for the broad American middle class as a whole, but it has been particularly devastating to African Americans. According to the Center for Responsible Lending in Durham, North Carolina, nearly 25 percent of African Americans who bought or refinanced their homes between 2004 and 2008 (and an equivalent share among Latinos) have already lost or will end up losing their homes—compared to 11.9 percent of white families in the same situation. This disparate impact of the housing crash has made the racial gap in wealth even more extreme. As Reid Cramer, director of the Asset Building Program at the New America Foundation, puts it, “Basically, we have gone from an average minority family owning 10 cents to the dollar compared to the average white family to now owning less than a nickel.” The median black family today holds only $4,955 in assets.

Sugrue can only process this through the oppressor-oppressed model. He blames predatory lending. If he could open his eyes a little wider, he might be able to see the role played by government housing policy. Some notes:

1. From a wealth-destruction perspective, you cannot just look at the people who lost their homes. People who stayed current on their mortgages nonetheless experienced wealth destruction.

2. Probably more borrowers were “victimized” by Freddie Mac, Fannie Mae, and FHA than by Wall Street. That is, my guess is that a majority of the homeowners whose wealth has been crushed paid for their homes with loans backed by one of those agencies.

Speaking of housing, Luigi Zingales finds some numbers regarding occupancy fraud.

In fact, the authors find that more than 6% of mortgage loans misreport the borrower’s occupancy status, while 7% do not disclose second liens.

You get a lower rate by saying you plan to live in the home, so speculators will often lie about that. One of the reasons that programs to “help owners stay in their homes” are not doing very much is that a lot of those owners never occupied the homes in the first place.

Zingales references a working paper that I cannot find. Thus, I cannot tell whether the borrowers defrauded the lenders or the lenders defrauded the investors who bought the loans. I always presume that it is the borrower instigating the fraud. However, Zingales says that the bankers should be prosecuted. He makes it sound as if the lenders would record a loan internally as backed by an investment property and report it to investors as an owner-occupied home. That would require a much more complex conspiratorial action on the part of the lender, and until I learn otherwise, I will doubt that it happened.

Mortgage Narrative vs. Reality

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Two papers from the research department at the Boston Fed.

1. Christopher L. Foote, Kristopher S. Gerardi, and Paul S. Willen write,

Borrowers
Borrowers did get adjustable-rate mortgages but the resets of those mortgages did not cause the wave of defaults that started the crisis in 2007. Indeed, to a first approximation, “exploding” mortgages played no role in the crisis at all. Arguments that deceit by investment bankers sparked the crisis are also hard to support. Compared to most investments, mortgage-backed securities were highly transparent and their issuers willingly provided a great deal of information to potential purchasers. These purchasers could and did use this information to measure the amount of risk in mortgage investments and their analysis was accurate, even ex post. Mortgage intermediaries retained lots of skin in the game. In fact, it was the losses of these intermediaries—not mortgage outsiders—that nearly brought down the financial system in late 2008. The biggest winners of the crisis, including hedge fund managers John Paulson and Michael Burry, had little or no previous experience with mortgage investments until some strikingly good bets on the future of the U.S. housing market earned them billions of dollars.

Why then did borrowers and investors make so many bad decisions? We argue that any story consistent with the 12 facts must have overly optimistic beliefs about house prices at its center.

2. Kristopher Gerardi, Lauren Lambie‐Hanson, and Paul S. Willen write,

many borrowers
languish in persistent delinquency, in which they neither cure their defaults nor lose their homes to foreclosure. In short, judicial intervention succeeds in temporarily reducing foreclosure by increasing the incidence of persistent delinquency. We show that persistently delinquent borrowers are unlikely to cure and that most eventually experience foreclosure. Over time, the foreclosure gap between judicial and power-of-sale states shrinks whereas the cure gap, or lack thereof, stays exactly the same. In other words, in the long run, a given number of defaults is expected to yield the same number of foreclosures regardless of the laws. These borrower-protection laws do not prevent foreclosure, they merely delay it.

My take on this is that attempts to prevent foreclosure merely set borrowers up to fail again. This raises the cost to lenders.

The problem with both of these papers is that they contradict the oppressed-oppressor narrative. The first paper says that borrowers and investors did not have bad mortgages foisted upon them by evil banks. Instead, everyone involved made assumptions about home prices that proved to be erroneous. The second paper says that treating delinquent borrowers as oppressed and trying to relieve the oppression with leniency is counterproductive.

Mortgage Rules and Mortgage Risk

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To much fanfare (it was the lead story in last Thursday’s Washington Post), the Consumer Financial Protection Bureau promulgated rules intended to reduce risky mortgage lending. My thoughts:

1. Horse. Barn Door.

2. Ed Pinto offers valid criticism.

3. Nothing has changed in Washington. Pinto notes that Freddie and Fannie are effectively granted exemptions from following the rules. To me, this leaves no doubt that the housing lobby is still setting mortgage policy. The CFPB may be a brand new agency, but it is caving into the same old rent-seekers.

4. The rules do not strike me as evidence-based. As I point out in a new essay, mortgage defaults are driven largely by the borrower’s loss of equity. Thus, the most important risk factor at the time the loan is made is the size of the down payment. The rules ignore that. Instead, the focus in the borrower’s debt/income ratio, which is far and away the least predictive of the major factors used in predicting default (the down payment is most useful, followed by credit score and then by loan purpose, although the effects of these variables interact with one another so that it is not so easy to rank-order their importance).

5. Later this month, I am going to be launching a course on the American housing finance system at Marginal Revolution University. Details to follow. But the course will be aimed at the sort of agency staff who work on housing policy issues. My goal is to share what I know about mortgage analytics and business processes within the mortgage industry. I am confident that my target audience is capable of absorbing this information. I am less confident that they will be able to have as much influence with policy makers as the industry lobbyists. But one can only hope.

Rent Vs. Buy

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The New York Fed’s Jason Bram writes,

current rent levels, mortgage rates, and property tax rates make it difficult to account for the high prices of Manhattan co-ops and condominiums in 2011 without assuming an expected future price appreciation of at least 4 percent per year.

It is a nice article on the rent vs. buy calculation. Not surprisingly, much depends on expected appreciation rates.

Mortgage Brokers and the Three Axes

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Susan E. Woodward and Robert E. Hall write,

Untrained, inexperienced borrowers interact with specialist mortgage brokers in the mortgage origination market. Brokers earn two kinds of compensation, explicit charges the borrower pays in cash and a commission the lender pays based on the spread between the coupon rate the borrower agrees to and the par mortgage interest rate. Both types of broker compensation seem to confuse borrowers. The wholesale lender’s commission is determined by financial dynamics understood by a tiny group of professionals, and the rate sheet that summarizes the possible payments is never shown to borrowers.

…With respect to policy changes that might help achieve a more efficient equilibrium, we believe in evidence-based design. Disclosure law has historically been in the hands of lawyers, who designed dense forms that may help absolve their clients of blame for consumer error, but which did little to help consumers find better deals. A new movement to design disclosures that are proven to be helpful, through field experiments, may result in some progress. Whether these forms can overwhelm the persuasion of skilled expert salesmen remains to be seen. We are inclined to believe that simple admonitions, such as “mortgage brokers are salesmen and the only way to get a good deal is to shop and bargain” and “you are more likely to get a good deal if you shop for no-cost loans” are more likely to yield improvements than, for example, trying to teach borrowers enough financial economics to understand the tradeoff between cash and the interest rate.

(Note that the quote is from the published version, which is subscriber-only. The link goes to an earlier version.)

This can be viewed through the oppressor-oppressed narrative. Mortgage brokers can earn more money by luring borrowers into more expensive mortgages (usually, “more expensive” means a present-value cost to the borrower of $1000 or so, but it can be higher than that). Note, however, that as Woodward and Hall point out, this does not make mortgage brokers rich. The brokers operate in a highly competitive environment, and while they over-charge as many borrowers as they can, profits are competed away in marketing expenses used to try to lure those borrowers.

This also can be viewed through the civilization-barbarism narrative. This sort of business does not exactly attract and reward caring, conscientious sorts of people. I think of mortgage brokers as slick and deceptive salesmen, prone to sports cars, bling, and other signs of conspicuous consumption.

Of course, from the standpoint of the freedom-coercion narrative, nobody forces you to take a loan from a mortgage broker, and it is a highly competitive industry. However, I think you have to be at least in the 99th percentile for sophistication in legal and financial calculations in order to be able, as a consumer, to use the competition to your advantage and to get the best possible deal.

I am pessimistic that consumer education or rules-based regulation can prevent consumers from being exploited in these situations. I think that the best chance is with principles-based regulation. That is, rather than designing the disclosure form, introduce the principle that disclosure should enable the consumer to understand and compare fees from different lenders.

An Equal and Opposite Fact

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Sumit Agarwal, Efraim Benmelech, Nittai Bergman, and Amit Seru write,

We use exogenous variation in banks’ incentives to conform to the standards of the Community Reinvestment Act (CRA) around regulatory exam dates to trace out the effect of the CRA on lending activity. Our empirical strategy compares lending behavior of banks undergoing CRA exams within a given census tract in a given month to the behavior of banks operating in the same census tract month that do not face these exams. We find that adherence to the act led to riskier lending by banks: in the six quarters surrounding the CRA exams lending is elevated on average by about 5 percent every quarter and loans in these quarters default by about 15 percent more often. These patterns are accentuated in CRA-eligible census tracts and are concentrated among large banks. The effects are strongest during the time period when the market for private securitization was booming.

Robert B. Avery and Kenneth P. Brevoort wrote,

We rely on two empirical approaches. In the first approach, which focuses on the CRA, we conjecture that historical legacies create significant variations in the type of lenders that serve otherwise comparable neighborhoods. Because not all lenders are subject to the CRA, this creates a quasi-natural experiment of the CRA’s effect. We test this conjecture by examining whether neighborhoods that have historically been served by CRA-covered institutions experienced worse outcomes. The second approach takes advantage of the fact that both the CRA and GSE goals rely on clearly defined geographic areas to determine which loans are favored by the regulations. Using a regression discontinuity approach, our tests compare the marginal areas just above and below the thresholds that define eligibility, where any effect of the CRA or GSE goals should be clearest.

We find little evidence that either the CRA or the GSE goals played a significant role in the subprime crisis. Our lender tests indicate that areas disproportionately served by lenders covered by the CRA experienced lower delinquency rates and less risky lending. Similarly, the threshold tests show no evidence that either program had a significantly negative effect on outcomes.

It was from David Weinberger that I first heard the suggestion that facts do not settle disputes, because for every fact there is an equal and opposite fact.

Note that the Agarwal paper does not refer to the prior Avery paper, so that there is no discussion of the opposite conclusions arrived at by the two approaches.