Saturday, April 14, 2018

Housing: Part 292 - Dodd-Frank was an unprecedented assault on working class homeowners.

I have looked at this from a few different angles already.

I have put together a new measure that helps to focus on the effects of credit collapse on home prices.  I have graphed the relative prices of the median homes in each zip code in the top 20 metro areas.  I split each MSA into 5 quintiles, by median home price.  Then, over time, I compare the relative change in those prices, indexed to the year 2000 (Quintile 5 divided by Quintile 1).

Here, I have taken the average measure for MSAs, which I have divided into three categories:

1) Closed Access cities (NYC, LA, Boston, San Francisco, San Diego).
2) Contagion cities (Miami, Phoenix, Riverside, Tampa).
3) Other cities in the top 20.

As I have discussed earlier, the peculiar rise in low-tier home prices which has been attributed to credit supply is (1) generally limited to the Closed Access cities and (2) happened because high tier prices systematically rise at a slower pace than low tier homes.  It is unlikely, then, that this effect was due to credit access to financially marginal borrowers.  Furthermore, there are an insignificant number of middle class home buyers in the Closed Access cities.  And, there was no relative rise nationally in borrowing among households with less income, education, etc.

We can see that in the graph, here.  I have inverted the y-axis, so that where low tier prices rose relative to high tier prices, the measure rises, and where low tier prices declined relative to high tier prices, the measure declines.  (This is all from the awesome data available at

Here, we can see how the rise in low tier prices was mostly in Closed Access cities during the boom.  Most of the effect in the Contagion cities was in Miami and Riverside, because prices there reached levels where high tier prices begin to level off.  In other cities, on average, low tier prices never rose at a faster pace than high tier prices.

The housing market was then faced with a succession of three credit shocks.

1) The CDO collapse.  The first shock hit private mortgage securitizations.  By scale, these loans were mainly facilitating home purchases by buyers with high incomes buying into Closed Access cities.  So, there was little effect in the other cities.  Even in the Contagion cities, relative prices of low tier homes only really began to decline in 2008.  The private securitization panic mostly hit the Closed Access cities.  (And, in hindsight, prices in these cities are justified by rising rents, and have continued to show strength in the long run, even in tight credit conditions.  Prices across the board have been stronger there.  And, notice that, while low tier prices in the Closed Access cities have retreated from their highs, they remain stronger than low tier prices in other cities.  Low tier home prices in every city have been hammered by credit contraction, but in total, credit contraction didn't hit the Closed Access cities any harder than it hit anywhere else.  That is because the relative rise of low tier prices in the Closed Access cities wasn't the result of credit supply.)

2) GSE Conservatorship.  Credit access was tightened to an extreme at the GSEs (Fannie Mae and Freddie Mac) after they were taken over.  Looking at FICO scores, the GSEs practically closed down lending to the bottom half of the existing market.  The book of business with FICO scores below 740 declined sharply, even in absolute terms.  The drop in Closed Access prices continued, and then leveled off.  The price drop in the low tier markets of Contagion cities accelerated.  And, the relative price drop in low tier markets in other cities started to moderately grow.

3) Dodd-Frank.  In the summer of 2010, with the passage of Dodd-Frank, a clear downshift happens in all of these markets.  In the Closed Access cities, the last bit of a downshift in low tier prices happens.  In the Contagion cities, where low tier prices were beginning to level off after the GSE shock, now reaccelerated downward.  And, now, low tier markets in other cities, which had never risen to high levels, and which had held up relatively well all the way until mid-2010, suddenly down-shifted.

It has taken me a while to fully appreciate the damage that Dodd-Frank did to the net worth of working class families in this country.  Maybe this graph is the best picture I have developed so far of the damage.  It would be difficult to overstate the gratuitous scale of the damage here.  This was the summer of 2010.  The entire country had just crawled through a generation defining financial crisis.  Unemployment was at multi-decade highs, and was beginning to finally decline.  Borrowers were losing their homes by the millions.  And most of the damage of Dodd-Frank was imposed on homes outside the Closed Access and Contagion markets that had made it through the crisis relatively unscathed!

This was after the crisis.  This was very late in the process.  Consider what we have done.  First, consider the Contagion cities.  This was a double-whammy to the Contagion cities, which had first been overwhelmed by a migration event as households flooded into their cities to escape the high costs of the housing-deprived Closed Access cities.  Then, when that migration event suddenly stopped in 2007 and 2008, their local economies and housing markets were devastated.  This was worsened first by the contraction in GSE lending, and then, after all of that, when homeowners across those cities were sitting on high double digit losses, another shock was leveled on them that pushed low tier prices another 15% lower compared to high tier prices.  So, by 2014, after this series of shocks, low tier home prices had been pushed down by more than 30% compared to high tier prices.  The misinterpretation of these events is so ubiquitous in the American conversation, that I can hear many readers, still, saying to themselves as they read this that this was simply a reversal of the excesses of the boom.  So, I will reiterate: This was a reversal of nothing.  These zip codes had never appreciated significantly more than the higher tier zip codes in their cities.  This was a wealth shock amounting to more than 30% of property values.

As devastating as this was to the Contagion cities, the story in the other cities is even worse.  In many other cities, prices in general had never risen to "bubble" prices.  And, in other cities, low tier home prices had managed to hang on relatively well, even through the first two credit shocks and the financial crisis.  These are markets with stable, low prices, which households with less savings and lower incomes can afford to purchase.  After the passage of Dodd-Frank, low tier housing markets dropped by 13%, relative to high tier markets.  From July 2010 to 2013.

The damage here has been drowned out by the scale of events of the other shocks.  But, imagine that it is 2007 again, and none of these shocks had happened.  Even the naysayers and housing bears would have considered a 13% drop, by itself, to be a cataclysmic event.  And of all of the zip codes in the country, these zip codes would have been at the bottom of the list of places where even the housing bears would have said that this sort of price drop might have happened.

Since public consensus has coalesced so strongly around the issue of banking risk and financial regulation, the conversation about Dodd-Frank has mostly been about its effects on banking stability.  But, in terms of its affects on working class housing markets, its effects have been disastrous.  We may just have well salted the fields or contaminated the drinking water.  Those policies would have been just as justified and just as useful.

It would be hard to conceive of a law whose timing and policy targets were more perverse.


  1. Kevin, sorry to be so clueless, but I'm still missing the mechanism. How does Dodd Frank lead to steep declines in home prices? Was it higher capital requirements for commercial banks?

  2. Great post. Like Duda, I am not picking up on the connection between Dodd-Frank and constrained mortgage lending. Sure, Dodd-Frank raise capital requirements though rather modestly.

    Interestingly enough, the American Bankers Association website for years has been nearly mute on Dodd-Frank.

  3. Kevin, I haven't read this paper but the summary looked like it might be interesting to you.

    1. Thanks.

      Just another brick that is getting knocked out of the wall from the conventional explanation. The ratings on basic MBS AAA securities were actually ok. A lot of indignation has been spewed over that idea for the last decade.

      I suppose you could say that the AA-BBB securities were horribly rated even though the AAA securities were rated ok. But, that doesn't fit the narrative of overleveraged bankers, etc.

  4. The correlation is noticeable, now that I have your post to focus my attention on it. But what's the theory that explains why Dodd Frank connects with open access housing prices? Absent a theory, a correlation isn't usually enough to persuade me of anything.

    1. ha, missed the Duda and Cole comments--count me as a +1 to their question about the mechanism at work here, and also a +1 that this is an interesting post.

    2. Thanks for the feedback, heckle.

      I have this post:

      I will be adding more posts around this topic when I have the time.

    3. This comment has been removed by the author.

    4. Yeah, just found that too--these two posts work much better read together. There is a lot to chew on here... count me among the people who (remain) pretty sure bank misbehavior fueled in part by looking for somewhere to park lots of money was a key factor in housing market weirdness in the years leading up to the financial crisis, and who will probably re-read and reflect more before I say how much this persuades me. But it's a great pair of posts, thank you.

      I mean, at a basic level, the book "The Inside Job"--all of that really happened, it isn't made up. This isn't aimed at changing the picture (I say to myself), so much as adding more canvass--a lot more--outside the old frame. I really thought financial crisis/employment crunch was what hit working class folks so hard, so I wasn't looking for more things to explain. Maybe that's true for most everyone else, which is why nobody noticed a connection between Dodd Frank and housing... nobody looked.

    5. For background: Here is a brief policy paper making the supply shortage case.

      Here is a timeline of events:

      On the credit side, there is a lot of stuff that just didn't happen. No surge of mortgages to borrowers with low incomes or FICO scores, no surge of early defaults among borrowers with low incomes, etc.

  5. Great work. Finally someone has quantified what we should have known was happening (some of us did know). Have you computed an estimate of the total household wealth (consisting of home equity) lost/transferred from low and middle income households during the financial crisis of 2008-2015?

  6. - I have a different view on this topic. I don't look at the situation after 2008 only. I think that the situation after say 2008 was simply a return to a (more) normal situation.

    - I clearly remember someone saying that around the year 2000 every creditworthy US citizen, who wanted to have a morgage and a house already had a house. And that only the less creditworthy borrowers were left/remained. In order to continue the lending the bankers/mortgage "industry" had to resort to "subprime lending" in order to keep the flow of revenues going. This was helped by the fact that from 2000 up to 2004 short term rates fell from about 6% down to 1% (No involvement from the FED, the FED FOLLOWS the 3 month T-bill rate). Long term rates were between say 2000 and 2008 Always higher (although gradually falling) than (say) 4.5%.
    - When those rates rose between 2004 up to 2007 A LOT OF those owners of a subprime mortgage also were confronted with higher (mortgage) rates.
    - In that regard Dodd-Frank was - IMO - just an attempt to reign in these irresponsible lending pratices. It would have happend anyway. Banks simply became more cautious when it came to lending.
    - After say 2011 A LOT OF those subprime mortgages were "rescued" by the fact that the reset rates was VERY low. Short term rates remained very low for a very long time.
    - One also has to look at the dynamics between the US Budget Deficit and the US Current Account Deficit. The relationship between these 2 was between say 1995 and say 2008 (very) in favour of the US. After say 2008/2009 the relationship returned to an "unfavourable state" for the US. (Like it was before 1995) This unfavourable situation is that the US Budget Deficit was larger than the US Current Account Deficit after 2008/2009. That also has a MAJOR impact on the US housing market(s).


    1. Thanks for engaging with the post.

      I don't want to be combative, but I have to tell you that the 291 posts leading up to this one have been a slow, meandering discovery that just about everything you have written here is factually wrong in some way.

      I'm not sure how to reply. I have two books coming out where the story will be laid out more clearly. The first should be out this fall.

  7. - I also had a "meandering discovery process" in the last say 10 years.
    - I re-read the entire post to see where I could have missed something. But I simply continue to don't see why Dodd-Frank (D-F) should have been so devastating (for the working class). The 3 lines already started to go south before D-F. The downturn for all 3 lines starts even before the takeover of the GSEs.
    - And IF D-F had such a devastating impact then it should have been implemented say 20 years earlier. This would have reduced the size of the financial crisis.
    - Although there's NOT a one-on-one relationship, there's certainly a relationship between the US budget Deficit, the US Current Account Deficit on the one hand and foreign demand for GSE paper on the other hand.


    1. Sorry, I wasn't clear. My point was that I have found detailed empirical evidence against the points you are referencing, but there are so many issues there, I would have to point you to dozens of posts to address them. I can understand if you don't want to go combing through 300 posts looking for them.

      Regarding this comment, it is the premise that is wrong. The graph here shows the difference between high tier prices and low tier prices. The relative rise in low tier prices only happened in a few cities - mostly the Closed Access cities. It wasn't caused by lending to low income households. This is a complicated issue, but here I will simply point out that working age households in the bottom 60% of the income distribution just don't own many homes in those cities. They were an insignificant part of the market during the boom. It doesn't make any sense that if credit was the cause of those rising prices, it would only happen in cities where low-income buyers are negligible and low income households were migrating away from town, net, at a rate of 2% per year or more. Those prices didn't rise in the cities that mid and low income households were moving to.

      That brings us to the "Other" cities in the graph. This is what you should focus on. In those cities there was never a spike in low tier home prices. So, the effects of tight lending at the GSEs and of Dodd-Frank weren't undoing anything. They imposed a new credit shock on markets that hadn't had a credit boom. There had been no relative growth in homeownership, borrowing, or home prices among households with low incomes, FICO scores, education, etc. But, in those cities, since the crisis, there has been a sharp decline in ownership, borrowing, and home price levels for households in low tier markets, with low FICO scores, less education, and lower incomes.

      And that's the problem. That graph shows a huge dislocation imposed on low tier housing, and everyone thinks its some sort of righteous return to normalcy. It's not a return to anything.

      You are technically correct that if we never had anything to lose then we could have avoided the pain of losing it. On the other hand, since Dodd-Frank and the housing bust were meant to solve problems that never existed, it seems possible that even if we didn't have the non-existent housing bubble problem to solve we could have found other non-existent problems to solve.