Tuesday, June 7, 2016

Housing: Part 158 - Low Down Payments and Stability

Subprime loans and highly leveraged homes have taken such a central position in the narratives about the housing boom and bust.  Yet, my review of the data suggests:

  • Local supply and rent were the overwhelming factor behind home prices.  Credit appears to play a very minor role.
  • There was no increase in low income owners during the boom.
  • There may have been no increase in the total number of highly leveraged homes.  There certainly was a decrease in market share of Ginnie Mae + Subprime.
  • Subprime loans don't appear to be related to marginal new homeownership, in the aggregate.
  • Nonetheless, neighborhoods with high numbers of highly leveraged homes were more vulnerable to large price declines.
In sum, the importance of all of this is probably much lower than the amount of attention it has received.  The price declines should never have happened, so the existence of highly leveraged homes should not have been a systemic problem.  But, highly leveraged mortgage options don't appear to facilitate much homeownership.

Further, if one does conclude that credit availability does cause home ownership and home prices to rise, then a regime where credit availability is limited is a regime that creates a deeper divide between owners and non-owners, and increases the relative incomes of those with access to credit.  This is a mathematical inevitability.

In the end, I'm not sure that it matters much at all what policy we have.  Whatever balance we strike in marginal credit markets, the marginal difference is overwhelmed by the effects of our moral panic about private lenders and borrowers.  Marginal borrowers, on the whole, are probably capable of engaging in credit markets like the rest of us do.  They will have higher levels of risk, but I don't think the risk levels in any regime we are considering are outrageous or unmanageable.

Their main risk, though, is that every once in a while the rest of us dirty our pants while we tell each other ghost stories about predators and speculators, and then we go and implement highly disruptive policy shifts.  As unpleasant as some marginal activity in credit markets is, the unpleasantness we impose, through our concern, is an order of magnitude worse.  So, maybe we need to limit access to credit on the margin in order to protect them from us.  At this point, credit constraints are creating large influences on home ownership because we have gone far beyond just cutting down on high LTV loans.

One result of that is that low-end landlords will be making high returns by renting to low income households who are locked out of those credit markets.  That isn't happening because landlords suddenly became more greedy.  It is the inevitable result of closed access policies.  Or, using North, Wallis, and Weingast's language from "Violence and Social Orders", it is a limited access order.  That is what we are imposing, in order to protect marginal households.  Limited access orders, by the way, are not associated with stability.  But, when low income households who didn't have a chance to be owners are evicted, we direct our ire at the landlord, not at the Consumer Financial Protection Bureau.

One last point I would like to consider is the idea of the homeowner-in-name-only where households with no equity had all the upside of ownership, but left the homes with the banks when prices dropped.  The idea is that they were speculating recklessly by trying to take the gains of ownership without actually investing capital.

But, I think that position is more benign than that description implies.  Especially for marginal households in low priced neighborhoods, there is a large premium to control and certainty.  For landlords in those neighborhoods, the risk of bad renters is large, and the premium they earn on the properties reflects that risk.  The main return the homeowner earns in that context isn't the speculative gain from unsustainable expectations of home price appreciation.  The main return is the capture of the premium that comes from being responsible tenants in the home they own.  In effect, this can be the source of their accumulation of equity.

So, even though, in the aggregate, I'm not certain that these loans make much difference, the potential cost of shutting them down, in qualitative and quantitative terms, is high.  The main reason we have to impose those costs is because the rest of us have a tendency toward moral panic.

Maybe one solution is to get rid of the pressures on the GSEs to pursue affordable housing and go back to a concentration on FHA/Ginnie Mae loans.  I don't think there is much difference between using private conduits, the GSEs, or Ginnie Mae as the source of high LTV ownership in practice.  The main difference is that our tendency toward moral panic declines respectively among those sources.  We are much more comfortable with mortgage insurance firms earning profit on Ginnie Mae loans than we are with the mezzanine tranche of subprime originations that provides the same service.  In some ways, the question of why that is isn't that important.  It just is the way it is.  The best outcome would probably be to remove the federal government from the market so that innovations that were less dependent on highly leveraged debt could develop.  But, private ownership programs not based on highly leveraged debt would probably involve some sort of shared equity or some sort of call option arrangement.  Most of those innovations would probably be vulnerable to populist panics and the same national bouts of Munchausen Syndrome that we currently are engaged in.


  1. I still can't find the specific market failures that are keeping home prices "too low." For example, if landlords are making excess returns why aren't they simply buying more properties thus pushing property prices to equilibrium? Even private equity appears to be moving away from the business.

    As you know, I think current prices are cheap for a reason...the earnings outlook for the bottom half of the population is truly terrible.

    1. Well, landlords do have some costs that owners don't, so a landlord-dominated market may have price levels below the owner-occupier market. Measuring that difference was actually my focus 158 posts ago, but I got distracted by other issues.
      I'm skeptical of demand-side explanations. They tend to be plausible but not falsifiable. I don't see evidence of lower rent inflation in low priced neighborhoods. And rent inflation in general is high.
      It seems clear to me that there are willing buyers who are locked out of mortgage access. The lack of new home sales also suggests prices are too low. And, any model with even a moderate sensitivity to long term real interest rates puts prices out of whack.
      But, at some point this is a subjective point of view, I guess.

    2. By the way, some of this is subtle, and may be a good example of priors determining conclusions, as is a common occurrence on this topic. For instance, I believe that there is a control premium that makes homeownership valuable for some households. Being locked out of ownership reduces the value of shelter for them. Since they can't capture that premium, their actual demand for housing declines. So, the lack of credit can end up looking like low demand for housing. The broken mortgage market is basically imposing a deadweight loss on the low end of the market.
      Someone else might interpret what I'm saying as simply encouraging a housing bubble - pushing credit on unworthy borrowers to push prices up too high.
      The difference in interpretation is subjective. From my point of view, the other interpretation has become so overdone that I am confident enough to make this a personal focus. But, the reason I think so many people have it so wrong is also the reason I don't expect most people to accept my argument. The evidence seems extreme, to me, though. The typical mortgage denial today is far outside any previous norm.

  2. More great blogging.

    I suspect that many public-policy issues are like this: The narratives of the left- and right-wing are convenient, and way off from the facts on the ground.

    If one makes the slightest assent to one side of the other, you are accused of "being a lib" or being a "reactionary."

    No one is discussing property zoning, let alone push-cart vending (which would also lower property prices).

    If you say the F-35 fighter jet program has been underway for 22 years, and still cannot test-fly a plane, you are a "liberal."

    If you say financiers only give home loans to people who ask, and ask how is that predatory, you are a "conservative." (Set aside oblique teaser rates. Home mortgages should be very easy to read.)

    Egads. Somewhere along the line, it became a point of honor in the American Right that monetary policy had to be tight. After a while it did not matter if tighter was in fact better, one still had to talk about the need to be tighter.

    It is wonder anything ever gets built.

    1. Yeah. The whole right wing Austrian thing is almost like a personality tick. They only ever think there is malinvestment from overpriced assets. It's like a grumpy old man syndrome. So they are cynical whenever there is growth and say "I told you so" when there is a contraction - even if it's helped by their tight monetary demands. The problem is worsened on both right and left by the closed access problem, I think, because that's what causes the income inequality, the overpriced homes, and the high debt levels. Since they don't see that, they are left to presume it is their preferred bugaboos that are to blame.

  3. Chang-Tai Hsieh and Enrico Moretti have a very nice new working paper "Why do Cities Matter?"

    John Cochrane cites the paper. It is "new" but I think we read this before.