Category Archives: Housing and housing finance

Mortgage Loan Limits, Housing Demand, and Supply

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Tobias Peter writes,

In the mortgage business, the drumbeat for the government to support more leverage is a constant, occurring in both a buyer’s and a seller’s markets. But it is the latter that has potential for dangerous buildup of risk. The latest fad is raising the conforming loan limit, which, since 2006 has been set at $417,000 in most areas, but allows for a higher limit in certain high-cost counties.

Of course, one reason that there are high-cost counties is because there are higher loan limits. Remember that the general pattern of government policy is to stimulate demand and restrict supply. Where this combination of policies is most blatant, in cities like New York and San Francisco, you see prices soar. More mortgage credit, which is supposed to make housing “affordable,” has the opposite effect.

For high-cost counties, one idea might be for the Federal government to try to encourage cities to break the logjam by offering a subsidy for every new housing unit that is fully approved in terms of permits within the next six months. I am not saying that I have that concept fully worked out, and of course it is not a first-best libertarian idea.

In any case Keeping the loan limits fixed, and getting rid of the alternative for “high-cost counties,” would be steps in the right direction.

The Affordable Housing Violins

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A commenter writes,

Somewhat apropos of this post, it would be interesting to read a response from Arnold, or a likeminded person, to the following: Kevin Erdmann

Erdmann in turn links to this commentary from Treasury.

Behind these statistics are creditworthy families who have not been able to access the wealth-building opportunity of homeownership or enjoy full mobility. This lack of access is particularly acute for minority and low-income families whose homeownership rates are considerably below the national average.

My comments:

1. Whenever people start playing the affordable housing violin, we should anticipate bad policy is to follow.

2. Kevin and Treasury are pointing to credit scores as an indicator that mortgage lenders, including Freddie and Fannie, have tightened credit. I don’t really focus so much on credit scores as an indicator of risk. I worry mostly about loan type (government-sponsored lenders should stay away from cash-out refinances and non-owner-occupied loans). Then I worry about down payments.

3. If you give a mortgage to someone with a low credit score who makes a low down payment, you are setting them up to fail (not most of the time, but enough to make it a questionable proposition). And of course, when the defaults come, you will be accused of predatory lending and have to pay a big fine.

4. I think government should get out of the mortgage subsidy business. Mortgage subsidies are mostly crony capitalism for Wall Street and mortgage bankers. If you want to support home ownership, help people save for down payments.

Timothy Taylor on Home Ownership Trends

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He writes,

Notice that homeownship rates tend to be much lower in large cities: indeed, if a homeownership rate below 50% seems implausible to you, you might reflect on the fact that this is already a reality in US cities. Notice also that homeownership rates in the Northeast and West regions are already below 60% (of course, this is in substantial part because there are more large cities in these regions). Thus, one’s belief about the future of homeownership is in some ways a statement about where people choose to live in the future.

In my view, the main drawback to renting (government distortions aside) is that you have to negotiate with the owner concerning maintenance and renovations. Perhaps somebody should work on contracts that address this.

As of now, one party (typically the landlord) must bear all of the costs, but maintenance and renovation is only done at the landlord’s discretion. One can imagine a different arrangement that allows the tenant to have discretion, but with incentive to protect the landlord’s interest.

For example, the cost of basic maintenance, such as fixing the HVAC system when there is a problem, could be split 80-20 between the landlord and the tenant. Because the tenant has skin in the game, the tenant gets to be in charge of getting the system fixed.

On the other hand, the cost of renovation, such as a kitchen remodeling, might be split closer to 50-50. Again, the tenant is in charge. The tenant pays a higher share than in the case of basic maintenance, because the renovation might prove less valuable to a subsequent tenant.

Another contractual possibility would be to address the state of the dwelling when the tenant leaves. In principle, the landlord could be compensated by the tenant for damage (that is what security deposits do, up to a point), and the tenant could be compensated by the landlord for increases in property value due to upgrades paid for by the tenant.

More Lifted from the Comments

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Kevin Erdmann writes,

The way costs serve as a filter is by constricting supply. Those cities are well past the cost level that would trigger supply. So, a unit that would cost $300,000 is already worth $1 million. To build it, you basically have to negotiate your way through a series of fees and kickbacks so that local governments and interest groups claim the $700,000 difference. It’s like third world governance with a functional bureaucracy. You don’t necessarily bribe anyone, but the parks department gets $100,000 per unit because your building throws a shadow somewhere for 30 minutes, and that money funds a healthy pension.

“third world governance with a functional bureaucracy” describes a very effective kleptrocratic system.

Set Up for Failure

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W. Scott Frame, Kristoper Gerardi, and Joseph Tracy write,

The extinction of the private subprime market and the rapid rise of the government insurance programs may strike many as a largely positive development. After all, it was the subprime segment of the mortgage market that triggered the global financial crisis and subsequent Great Recession as subprime loans defaulted at an astronomical rate during the housing bust. However, while government-insured mortgages are typically underwritten with more rigor and discipline than private subprime loans, they are not low-risk loans. The combination of high leverage and low credit scores documented above translates into extremely high default rates. The table above shows that five-year cumulative default rates (CDRs) by year of origination varied between 5 and 25 percent over our sample period. To put these numbers into perspective, the five-year CDRs associated with loans insured by Fannie Mae and Freddie Mac (the housing government-sponsored enterprises, or GSEs) are typically an order of magnitude lower. According to our calculations, the 2002 and 2009 vintages of GSE loans had five-year CDRs of approximately 2 percent, while Ginnie Mae’s same vintages had five-year CDRs of almost 10 percent and 13 percent, respectively.

Pointer from Mark Thoma.

The Federal Housing Administration, FHA, sets up many borrowers to fail. One could argue that these borrowers put up so little of their own money that this is a worthwhile risk from their point of view. It is the taxpayers that are being set up to fail.

Reverse Mortgages

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An NYT story says,

it may surprise you to learn that some community bankers are quietly offering the loans, too, bringing a kind of Main Street respectability to a product that has long lacked it.

Pointer from Tyler Cowen.

Here is how I think of a reverse mortgage.

Step 1. Sell your house to the bank.

Step 2. The bank rents your house back to you.

Step 3. The bank forgives the rent, but instead charges you interest that accumulates until you die or move out.

Step 4. When you die or move out, the bank adds up the accumulated unpaid rent and interest. If you want to pay it up, you can get your house back. Otherwise, if the debt is higher than the value of the house, then it makes more sense to let the bank keep the house.

In principle, whether this works out financially depends on how long you live in the house relative to expectations at the time you take out the reverse mortgage. You want to live so long that the value of living rent-free in step 3 is so high that at step 4 you or your heirs gladly hand the bank the house rather than pay all that rent and interest. But if you move out or die relatively soon, the bank will have priced the mortgage in such a way that if you or your heirs pay off the debt the bank will come out ahead–and it will come out ahead even more if you give up the house.

Thus, as in any sort of life insurance or annuity situation, you are making a bet against the financial institution. My guess is that this is unwise.

1. In general, the individual loses bets against financial institutions. I tell my daughters, “remember that insurance companies always price to make a profit.” My point is not that you should never buy insurance of any kind. But you should always at least consider self-insuring (rather than paying for extended warranties, for example) or alternative ways of insuring.

2. I think that old people are inclined to over-estimate how long they will live in their houses. They do not like to think about how they might lose the ability to climb steps, to tolerate bad weather, or to live independently.

3. I do not think that many old people need to live rent-free in the short run. In the short run, you can just take out a regular mortgage and use some of the proceeds from the mortgage to meet the payments. Ten years from now, after you have used up most of the proceeds on making the payments and financing consumption, you can think in terms of selling the house. By that time you will probably want to. See (2).

Upward-Sloping Demand Curves

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Why are big cities becoming expensive places to live? One answer is that they have good jobs and restrictions on housing construction. That may be right.

But one possibility I want to throw out there is that people want affluent neighbors. If I want an affluent neighbor, and an affluent neighbor is going to live in a neighborhood with high prices, then in some sense I want to live in a neighborhood with high prices. In the extreme, this makes my demand for neighborhoods upward-sloping. Higher prices make me want to live there.

I first considered this possibility many years ago when thinking about school vouchers. I thought that if what people really want for their children is to have them go to school with affluent children, then vouchers would not work as well. Instead of allowing non-affluent parents to send their children to good private schools, the result would just be that good private schools would raise prices so that only affluent children can attend.

I also think that some colleges that are not in the top tier may face upward-sloping demand. George Washington University, which is hardly an academic icon, may benefit from charging very high tuition. Affluent parents come and see a student population that is predominantly affluent, and this gives them comfort that sending their children to GW is a high-status thing to do.

Back to cities. Suppose that an important “urban amenity” is having a lot of affluent people around. Young singles may wish to meet potential marriage partners who are affluent. People who have acquired affluent tastes (sushi, yoga, wine) may want to be around people with similar tastes.

If that is the case, then there is not much that a mid-sized midwestern city can do to lure affluent people. The cost of living there is not high enough to create a barrier to non-affluent people living there. And that means that affluent people will not want to live there.

The Construction-worker Bottleneck

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Conor Sen writes,

From a labor slack standpoint, the pool of potential construction workers is probably well-represented by unemployed men under the age of 55. To get back to late ‘90s levels of male unemployment (from a level standpoint, not an unemployment % standpoint), we would need essentially every single male unemployed worker who finds a job in the coming years to go into construction.

Generic pointer from Tyler Cowen. Like Kevin Erdmann, Sen sees us having to build a lot of housing to make up for under-production from 2008-present.

I am not sure there is a housing shortage. A lot of people my age have too much house. That is why they do not mind having their kids move back in with them. It could be that what we need is not so much a surge in construction as a redistribution of housing.

Indeed, Mark J. Perry writes,

In 2015, the average size of new houses built in the US increased to an all-time high of 2,687 square feet (see dark blue line in top chart above), and the median size new house set a new record of 2,467 square feet (see light blue line in top chart). Over the last 42 years, the average new US house has increased in size by more than 1,000 square feet, from an average size of 1,660 square feet in 1973 (earliest year available from the Census Bureau) to 2,687 square feet last year. Likewise, the median-size house has increased in size by almost 1,000 square feet, from 1,525 square feet in 1973 to 2,467 last year. In percentage terms, both the average and median size of new US houses have increased by 62% since 1973.

Combined with a decline in household size, this means according to Perry that living space per person has nearly doubled.

Because we need more space to store our cookbooks, vinyl records, maps, encylopedias, radios, and photo albums.

Indulging in Confirmation Bias

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For my view of the housing bubble. John Geanokoplos and others wrote,

Notice that if we freeze leverage (LTV) at constant levels, the boom gets dramatically attenuated, and the bust disappears.

This statement is based on a simulation of an “agent-based” model for house prices. Pointer from Eric Beinhocker from Mark Thoma.

Beinhocker writes,

rather than predict we should experiment. Policymaking often starts with an engineering perspective – there is a problem and government should fix it. For example, we need to get student mathematics test scores up, we need to reduce traffic congestion, or we need to prevent financial fraud. Policy wonks design some rational solution, it goes through the political meat grinder, whatever emerges is implemented (often poorly), unintended consequences occur, and then – whether it works or not – it gets locked in for a long time. An alternative approach is to create a portfolio of small-scale experiments trying a variety of solutions, see which ones work, scale-up the ones that are working, and eliminate the ones that are not.

American pragmatist John Dewey also thought that technocrats should take an experimental approach. That is not a new idea. (I learned this from Jeffrey Friedman, who sent me a draft from his forthcoming book.) Of course, my view is that I would rather see experiments come from the market than from technocrats.

Later, Beinhocker writes,

A major challenge for these more adaptive approaches to policy is the political difficulty of failure. Learning from a portfolio of experiments necessitates that some experiments will fail. Evolution is a highly innovative, but inherently wasteful process – many options are often tried before the right one is discovered. Yet politicians are held to an impossibly high standard, where any failure, large or small, can be used to call into question their entire record.

I would argue that avoidance of failure is natural in any large organization, not just government. That is why I think that markets are better able to conduct experiments to solve problems.

I found Beinhocker’s essay interesting. However, if we are going to try to improve economics, it is important to include behavioral policy-making and politics into the analysis. Do not simply assume a benevolent, rational technocrat as decision-maker.

Speaking of confirmation bias, a recent Instapundit post linked to an old essay of mine, one which speaks to this comparison between expertise mediated by markets and expertise mediated by government.

Housing Finance Policy to Maximize Harm

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A reader pointed me to this Urban Institute forum on housing finance policy. It is a topic that leads me to be bitter and uncharitable. I take the view that America’s housing policy in practice is to subsidize demand and restrict supply. There is no economic model that would argue for this, but it makes perfect sense from the standpoint of public choice theory (i.e., policy driven by interest groups)

Since, as usual, nobody asked me for my opinion, I will give it on this blog. My contribution will be to list what I think are the most harmful ideas and hope that they are not implemented. These are:

1. Restrict supply as much as possible by encouraging rent controls, the strongest tenant rights possible, Nimbyism, making environmental regulations difficult to comply with, encouraging additional environmental challenges by private groups, loading builders with expensive requirements (such as setting aside a percentage of their developments for “affordable” housing), etc.

2. Encourage as much housing speculation as possible by subsidizing mortgages with low down payments and by giving the same subsidies to investors as to owner-occupants.

3. Instead of going back to the “originate to hold” model or the Freddie-Fannie model, invent a whole new complicated approach to mortgage finance that mixes government support and private sector activity. This will ensure privatized profits and socialized risks. Above all, creating a new system will ensure that no one has enough experience to be able to manage risk or even to observe where it is being concentrated.