Here is a story on how local regulations impede homebuilding in California.

More than two-thirds of California’s coastal communities have adopted measures — such as caps on population or housing growth, or building height limits — aimed at limiting residential development, according to the Legislative Analyst’s Office. A UC Berkeley study of California’s local land-use regulations found that every growth-control policy a city puts in place raises housing costs by as much as 5% there.

What makes this exciting is that the piece appears in the LA Times, hardly a libertarian bastion.

Ike Brannon writes,

The private market for mortgage-backed securities all but dried up in the aftermath of the Great Recession, so Fannie and Freddie are the only games in town. If they won’t buy a mortgage–or if there is any possibility that it could declare ex post that mortgage it purchased did not, in fact, meet its exceedingly strict standards and could be returned–a home loan will simply not be made in most instances.

Prior to 2008, politicians saw lenders as making type II errors, meaning that they did not lend to borrowers who probably would repay their loans. So they imposed “affordable housing goals” on lenders.

After 2008, politicians saw lenders as making type I errors, meaning that they made loans that borrowers did not repay. So they extracted “settlements” from big banks that were involved in lending prior to the crisis. And they made it known that Freddie and Fannie could force lenders to repurchase any loans that go bad, unless the underwriting file is pristine.

So now, the situation is what it is. It’s dangerous to make a loan with any chance of default. Brannon thinks that GSE reform will solve the problem. My guess is that what we have now, while not optimal, is better than what we would actually end up with if there were “reform.”

I also think that the reluctance to make loans that might default is due to more than just the possibility that Freddie and Fannie will make you buy back the loans. You have to somehow convince banks that they won’t be shaken down by attorneys general any time there is an opportunity.

Fundamentally, I would like to see a mortgage market free from political interference. I just don’t think we will ever see that.

Some good comments on the earlier post, better than it deserved.

I regret writing that mortgage lenders and owners are on the opposite end of a transaction. It is more apt to say, as Kevin Erdmann pointed out, that the house is financed with debt and equity. Both can earn a return.

Another commenter offered a numerical example. Let me riff off some of the numbers.

Suppose the house costs $200,000, it is 100 percent financed, and the mortgage rate is 4.0 percent. Then you can think of the interest expense as $8000. Pretend that it is the same for the owner-occupant as it would be for a landlord. Both the owner-occupant and the landlord can deduct the interest expense for tax purposes. They also can both deduct property taxes. I think that 3 percent is high, so I would go with something like 1.5 percent, or $3000.

If depreciation is 2 percent per year, it amounts to $4000, which is what the commenter suggested for repairs. Depreciation is tax deductible for the landlord but not for the owner-occupant. The commenter suggests that insurance is $1200, which again the landlord could deduct as an expense. If the landlord pays for utilities, then the landlord can deduct those as an expense. That might be another $2400 in deductions. Condo fees or Homeowners’ Association fees, if any, would work similarly.

If the price/rent ratio is 10, then annual rent is $20,000. If the price/rent ratio is 20 (high by historical standards), then the annual rent is $10,000. In any case, that is income to the landlord, who has to pay taxes on it. So overall, the owner comes out ahead.

Erdmann offers an interesting take on cities where supply is clearly constrained by regulation.

political obstacles to the allocation of capital into new residential housing has caused market prices to be wholly unmoored from replacement cost in those cities. In those cities, buying a house is like buying a taxi medallion. It is not so much a claim on shelter as it is a claim on political exclusion.

His point is the return on investing in housing would be more predictable, and much of the speculative aspect of home purchase would go away, if house prices were more closely tied to construction costs. And they would be more closely tied to construction costs if development were less constrained by regulatory restrictions.

A commenter asks,

aren’t Real Estate lobbies most powerful with local governments?

The local and national lobbies work very differently.

Locally, the commercial real estate developers are the most active. And often it’s case by case, as opposed to policy lobbying. It’s one developer buying off local officials to get a particular project approved. It’s not like there is a powerful coalition trying to fight against building restrictions generically.

Nationally, you have a broader coalition fighting for tax and mortgage subsidies. You have the home builders as a trade group, plus real estate agents, plus mortgage bankers, plus Wall Street.

So the folks fighting to subsidize demand are powerful at the national level. At the local level, where the decisions are made to restrict supply, the activist groups that fight development are opposed only by home builders, and the home builders are usually just trying to get individual projects approved.

Alex Tabarrok writes,

owner’s equity in real estate is about to exceed it’s 2006 peak

I get the sense that in the cities most constrained by housing supply, markets are very hot at a price just below, say, $1 million, but somewhat tepid once the price gets above, sa,y $1.3 million. If this is an accurate guess of the shape of demand, it could be explained by income constraints. That is, would-be buyers are willing to bid as much as their income will allow, based on mortgage qualification rules. As prices rise, there is a drop-off in the number of potential buyers who can qualify for a loan.

One sign that this is taking place would be that one can find much better value (say, lower cost per square foot) in houses that are priced too high for most buyers to qualify. The most over-priced homes (with the highest cost per square foot) might be the ones that sell in the range where there are many qualified buyers.

If this story is correct, then the current home price boom will run into income constraints. If the typical young professional household can afford a $1.0 million home but nothing more expensive, then prices are going to stop rising once those households have satisfied their demands.

I think we might see that happen this year. This summer could see the last of the bidding wars.

Greg Buchak and others write,

the market share of shadow banks in the mortgage market has nearly tripled from 14% to 38% from 2007-2015. In the Federal Housing Administration (FHA) mortgage market, which serves less creditworthy borrowers, the market share of shadow banks increased by a staggering seven fold during the same period, from 20% to 75% of the market. In the mortgage market, “fintech,” lenders, have increased their market share from about 5% to 15% in conforming mortgages and to 20% in FHA mortgages during the same period.

Pointer from John Cochrane, who writes,

Maybe we want the crisis-prone traditional banking model to die out where it is not needed!

My thoughts:

1. Traditional banks do not have to hold loans. They can sell the loans they originate to FHA, Freddie, and Fannie just as easily as a “shadow bank” can. The ability to sell loans to the agencies cannot be the source of the advantage of the non-bank originators.

2. Using a web site to source loans is not a brilliant new innovation. Using a computer algorithm to approve loans is not a brilliant new innovation. An originator does not need to develop such an algorithm–Freddie and Fannie have been letting originators use their algorithms since the early 1990s. I doubt very much that technology is the source of advantage of the non-bank originators.

3. Ed Pinto, who follows the mortgage data closely, says that credit quality standards have been loosening dramatically, particularly in the “back-end ratio.” It used to be that you would not want to have a borrower whose total monthly debt obligations (mortgage payments, car payments, interest on credit cards, etc.) exceeded 30 percent of income. According to Ed, we are now seeing at the agencies, particularly at FHA, borrowers with back ratios of 50 percent or more.

4. If I were a traditional bank, and credit standards were loosening, I would let that business go to the non-bank originators. When the market tanked in 2007-2008, subsequently banks were shaken down by government officials for their “predatory lending” and hit with large “settlements.” Who needs to go through that again?

5. Non-banks need not fear a shakedown so much. They do not have nearly as much in assets for regulators to go after.

So my hypothesis is that the big advantage non-bank originators have in today’s market is that they have less to lose in a shakedown if another bust takes place.