I am back from a trip to Norway and Denmark. The impetus for the trip was an invitation to speak to a group of alumni of the Business Institute in Oslo. My topic was property bubbles.

The morning of my talk, I took a walk along the beautiful path next to the Akers River. My mind wandered, and at one point I tried to recall the steps to this dance, which I had learned recently and only done a few times. My mind also wandered to my talk, and so when I gave it I used the opening 25 seconds of the dance while singing (details below the fold).

Anyway, a lot of the questions were good ones. My favorite was when a guy asked if Norway would be less subject to a bubble because its mortgage loans come with recourse. In most states in the U.S., you can default on your mortgage and owe the bank nothing other than the keys to the house. With recourse loans, after the foreclosure sale, you still owe the bank any deficiency between the sale price of the home and the outstanding balance on the loan. I agreed with the thrust of the question, because recourse loans make people think twice about making speculative home purchases. I certainly think that recourse loans change the dynamics of the housing market. Canada has recourse loans, and that may be one reason that they did not suffer the bubble-and-crash that we did.

In my answer, I also pointed out that the underwriting criteria shift when you have recourse loans. You can be a bit less concerned about the property itself as security for the loan and a bit more concerned with the borrower’s capacity to repay the loan (income and assets) and with the borrower’s conscientiousness (as typically measured by a credit score).

For all the Dodd-Frank legislation and all the mumbo-jumbo about shadow banking, it really would have been simple to prevent the financial crisis of 2008. Recourse on mortgage loans would have done it. In effect, recourse loans give mortgage borrowers more “skin in the game.” Instead, Dodd-Frank tried to envision giving mortgage brokers more skin in the game.

And, of course, removing government support for investor loans probably would have done it as well.
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He writes,

The 30-year fixed rate mortgage should be retired — for good. Despite continued proof that it fails to build up wealth for the most disadvantaged Americans, and that mortgage debt should not be a burden as homeowners approach their 50s and 60s, misguided advocates maintain that the 30-year fixed rate mortgage should be at the core of the U.S. housing finance system.

I have been telling friends that the tragedy of this year’s election is that in my opinion this is a time when we need to change course in many ways, and the Trump phenomenon reduces the probability of that happening. One example is housing finance policy, where Democrats are always looking for an excuse for government to intervene, and I think any reasonable evaluation of history would say that it would be better to go in the opposite direction.

I am willing to claim that the whole financial crisis of 2008 could have been prevented with just one innocuous reform: take away any government subsidies for investor loans.

Subsequent research has confirmed that in the regions with the most pronounced price cycles, significant shares of home purchases were by non-owner-occupants. Their mortgages were eligible for purchase by Freddie and Fannie. They were eligible to receive favorable capital treatment when packaged into securities that were rated as safe by rating agencies.

Investor loans do nothing to promote the goal of home ownership. They are riskier than loans to owner-occupants. Why did regulators allow Freddie and Fannie to buy them, and why did they allow them to be eligible for favorable capital treatment? Probably because the powerful mortgage lobby was at work behind the scenes.

Speaking of the mortgage lobby, Pinto is probably correct that we do not need the 30-year fixed-rate mortgage. Canada does fine without it. But don’t hold your breath waiting for any reform that might be guided by his point of view. That is one example of what the Trumplosion of the Republican Party has made impossible.

Describing on a paper by Oscar Jorda and others, John Hamilton writes,

This “hockey stick” in mortgage lending was accompanied by a similar pattern in real house prices. These too had been largely stable for nearly a century. Since 1950, house prices have grown faster than inflation around the world.

My guess is that as of 1950, when the rise in mortgage credit began, there was too little mortgage borrowing. My guess is that since about 2000, there has been too much mortgage borrowing. In Minsky terms, we went from hedge finance in 1950 to speculative finance in the 1990s to Ponzi finance thereafter. Ponzi finance means that people get loans who cannot repay them except by getting new loans.

An idea that just will not die is that the government could have done a better job of bailing out mortgage borrowers. Larry Summers is one of the people who touts this idea without having any institutional facts at his disposal.

The key fact is that in the markets that experienced the strongest cycle, about 45 percent of homes were purchased by speculators. That means that the government faced the following choice:

1. Bail out these housing speculators. That would mean either that taxpayers or banks would reduce their mortgage amounts to the point where they could rent out their properties and cover their mortgages. Why this would be equitable or stimulative to the economy is not at all clear to me.

2. Have a bailout that was limited to owner-occupied homes. This would not have accomplished very much in the markets that had the strongest housing cycle. In addition, it was not easy to execute, for a variety of reasons. As I pointed out at the time, it involved creating new business processes that folded together loan servicing, loan origination, and security payments. Also, you face a trade-off. Give the borrowers too generous a bailout, and you generously reward the profligate. Give them too limited a bailout, and they re-default. Under the programs that were tried, re-default rates were very high.

I am reminded of this by a new paper by Patrick Bayer, Kyle Mangum, and James W. Roberts that documents the mindset of speculators during the housing boom. They found evidence that people who observed speculative behavior had a propensity themselves to speculate.

The presence of each neighbor that begins to invest in housing within 0.10 miles of a household increases that household’s probability of also investing in housing by 8 percent within the next year and up to 20 percent over three years. The presence of a flipped property that has just been re-sold, the other channel of contagion that we consider, raises the probability of that household investing by 9 percent and 19 percent over the same horizons, respectively. The magnitudes of both forms of investor contagion change over the course of the housing boom, especially the flipped property channel, the effect of which is greatest in the peak years, 2004-2006.