I’d Connect These Data Points

1. From Atif Mian and Amir Sufi.

We are now five full years from the end of the recession (if you buy NBER dating). And housing starts are still below any level we’ve seen since the early 1990s!

Pointer from Mark Thoma.

2. Shaila Dawan writes,

Nationally, half of all renters are now spending more than 30 percent of their income on housing, according to a comprehensive Harvard study, up from 38 percent of renters in 2000. In December, Housing Secretary Shaun Donovan declared “the worst rental affordability crisis that this country has ever known.”

Pointer from Tyler Cowen.

By the way, I saw this coming, and so I made a big investment last year in several companies that own and manage apartments. The performance of these investments was terrible, particularly when compared with the overall market. Go figure.


Nick Timiraos writes,

Mortgage rates could rise by as much as 1.5 percentage points for homeowners with weaker credit or smaller down payments under various legislative proposals to overhaul Fannie and Freddie Mac, according to a study prepared for an industry group.

The study purports to estimate what is seen. How about what is unseen? That is, suppose we reduce the distortions in capital markets that funnel money into high-risk mortgages. That means that the interest rate on high-risk mortgages goes up. And…? Some other interest rate goes down. It might even be the interest rate paid by firms undertaking productive investment.

Shame on the Consensus

Nick Timiraos reports,

A consensus has emerged over the last few years among economists, academics, and industry officials that says any new system should do the following:

  • Make the “implied” guarantee explicit and require any successors to Fannie and Freddie to pay a fee for that guarantee, as the chart up top illustrates. Successors would compete for business, selling securities and taking initial losses before any guarantee would be triggered.
  • Get rid of those investment portfolios, or shrink them to the point where they don’t create systemic risks. This way, the firms wouldn’t be guaranteed by the government—only their securities.
  • Require more capital and tighter regulation, since too little of both is what got Fannie and Freddie into trouble. Just how much capital will be required will be a major point of contention, because having more will protect taxpayers but would also raise borrowing costs.

As I have said before, what this “consensus” would accomplish is to complete the Wall Street takeover of the mortgage industry. The history is roughly as follows:

1. In the 1970s, Wall Street saw an opportunity to “disintermediate” the savings and loan industry, which formerly supplied mortgage loans. In a high-inflation economy, money market funds had a regulatory advantage for attracting funds (banks and S&Ls were constrained by regulatory limits on the interest that they were allowed to pay on deposits ceilings).

2. In the 1990s, with the savings and loan industry dead, Wall Street along with Freddie and Fannie took over the mortgage finance system. But Wall Street always resented having to work with Freddie and Fannie. See All the Devils are Here, by McLean and Nocera.

3. In the 2000s, Wall Street thought it had figured out a way to get around having to work with Freddie and Fannie. Investment bankers would issue “private label” mortgage securities, use the CDO structure to get most of these securities a AAA rating, and use those high ratings to substitute for the Freddie-Fannie guarantee. Wall Street firms managed to pull off this trick with a lot of subprime mortgages.

4. Then came the bust, which discredited the Wall Street model of securitization.

5. Now, what Wall Street wants is to re-start securitization. They realize that nobody will fall for the AAA-rating scam any more. They need a government guarantee. But they don’t want the government-guaranteed enterprise to take profits away from them the way that Freddie and Fannie did. Hence, the three items listed by Timiraos, particularly “get rid of the investment portfolios.”

Assuming that the “consensus” eventually becomes policy, the decks will have been completely cleared for mortgage finance in the United States to be a 100 percent shadow-banking enterprise, exactly what Wall Street wanted.

For me, this is painful to watch, even though for a long time I have realized that is the most likely scenario. It is like watching a young brat who wrecked the five-year old family sedan have his parents console him by buying him a brand-new sports car.

My suggested alternative to housing finance reform can be found here.


The Washington Post reports,

Five years after the federal government bailed out more than 1 million struggling homeowners, many who got the relief may end up losing their homes after all.

…The initiative was based on the flawed assumption that the economy would bounce back more quickly, undoing the damage wrought by plunging home prices and high unemployment.

No, the initiative was based on the flawed assumption that keeping people in homes that they should never have purchased in the first place was a good idea. At the time, I kept saying over and over that we should pay people’s moving expenses to get into rental units that they could afford.

These results are exactly what I predicted would happen. I remember complaining about setting people up to fail again when I testified at a Congressional hearing almost five years ago.

Dean Baker on Housing Finance Policy

He writes,

Way back in the last decade we had a huge housing bubble which was propelled in large part by junk loans that were packaged into mortgage backed securities (MBS) by Wall Street investment banks and sold all around the world. Unfortunately few people in policy positions are old enough to remember back to the this era, which is why they are now in the process of altering rules so that investment banks will be able to put almost any loan into a MBS without retaining a stake.

Pointer from Mark Thoma.

I have argued that the general trend of housing policy is to give Wall Street and the housing lobby, particularly the Mortgage Bankers Association, exactly what they want. Baker is one of the few economists on the left who is willing to speak up on this. When I suggested to an audience of conservatives that we needed to engage Brookings and the Urban Institute to study the effects of housing finance subsidies, people came up to me afterwards to say that they thought that those think tanks would not want to offend important donors.

Will They FUBAR Mortgage Finance, Too?

James Stock said,

It is hard to see how a private guarantor could credibly provide full insurance because of its inability to diversify against severe common, or macro, risk. The presence of a government guarantee, as opposed to a private guarantee, resolves the credit risk asymmetric information problem associated with MBSs that do not yet have their constituent mortgages fully specified. With this asymmetric information problem resolved, the TBA market provides liquidity, hedging, and price discovery to the mortgage market.

Thanks to Nick Timiraos for the pointer.

What Stock is advocating, and what seems to have the support of the Obama Administration and many in Congress, is a completely new business process in the mortgage industry, with a government guarantee of mortgage securities as the critical element. As you read this, I am appearing on a panel of experts who take a different point of view.

In my contribution two years ago to a Mercatus center collection of alternative proposals, I stressed the danger of trying to stand up a completely new set of institutional arrangements in the mortgage industry. I was worried that implementation could prove troublesome. That argument might not have seemed so powerful then, but maybe in light of healthcare.gov it might get more attention now.

In my presentation to the panel, I will say that a government mortgage guarantee is like the ethanol mandate. Whatever the alleged public policy justification, it is really a special-interest handout. See Your Mortgage, Their Rent. Of course, just as with the ethanol mandate, it will be very hard to stop and, once in place, impossible to kill.

I am so pessimistic about the politics of housing finance reform that I think that the best hope would be to try to create a restrictive charter for the new government guarantee agency. Make it illegal for the agency to guarantee cash-out refinances, second mortgages, investor loans, home-equity loans, negative-amortization loans, and ARMs. Limit the agency to owner-occupied mortgages, for purchase or rate-lowering refis, with fixed rates for 15 or 30 years. Getting that would be a huge victory, and it would not detract from any legitimate public policy goals, but I doubt that it is achievable. Wall Street and the housing lobby are going to have their way with the public, and we’re going to end up having to bend over and submit.

Two Lifted from the Comments

1. On this post. Kebko writes,

Arnold, you have the causality backwards. The reason the standards for down payments were not reduced in the 1970′s is because the high monthly payments were the bottleneck for qualification. Reducing the down payment increases the monthly payment. But, in the 2000′s, the down payment was the bottleneck, so reducing the down payment at the expense of higher monthly payments was useful.

Comparing the two contexts, we should, in hindsight, expect that this would be an obvious paradigm shift between a high nominal rate environment and a low rate environment. The low down payments in the 2000′s are an effect, not the cause.

Certainly, reducing the down payment requirement does not cause market interest rates to be lower. So between those two variables, causality can run at most in one direction.

You are saying that the real estate industry is not going to push for lowering the down payment requirement in a high interest-rate environment. I can see that if the marginal homebuyer is low on income and low on assets. If nominal interest rates are high, the monthly payment will be daunting, and lowering the down payment requirement cannot help this person.

On the other hand, suppose that the marginal homebuyer has decent income and low assets. Even in a high interest-rate environment, lowering the down payment requirement might help that person. And if interest rates are high because of general inflation, including house price inflation, then from the bank’s point of view it is safer to lower the down payment requirement in this environment than in an environment of low inflation.

I think that the main reason that down payment requirements went down was because the people lending the money at least implicitly assumed rising house prices. In addition, government officials were beating up on lenders for rejecting applicants from what was called the “under-served” segment of the market. (Of course, by 2010, government officials described this segment as “borrowers who were not qualified” and were shocked, shocked that the evil, predatory lenders had forced these people to take loans that they could not repay.)

2. From a comment on my post on Shiller and Taleb,

Hi I am Taleb, honored to come here. The problem is more complicated. The class of proba distributions needed is restricted, so only thin-tailed ones are allowed. In other words, the law of large numbers operates too slowly to make a certain class of claims.


Market Monetarists Jump the Shark

Scott Sumner writes,

In America mortgage debt is commonly structured so that monthly payments stay constant over 30 years. This means that during periods of high NGDP growth, when nominal interest rates are also high, monthly payments will start very high in real terms, and then fall rapidly in real terms. But your ability to qualify for a house depends on how large the initial nominal monthly payment is, relative to your current income.

Read the whole thing. The logic is this:

1. In the 1970s, house prices started rising, but they did not rise as much as during the recent bubble.

2. In the 1970s, because mortgage rates were high, even though real interest rates were low it was hard to get mortgage credit. That is what choked off the bubble. The same thing did not happen in the recent bubble.

3. High mortgage rates reflect loose monetary policy. Hence, the difference between the 1970s and the recent bubble is that this time monetary policy was tighter.

I agree that there is a “money illusion channel” between nominal interest rates and housing. Back in the 1970s, economists proposed price-level-adjusted mortgages (PLAMs) to get around this problem. If you want more background, go to MRUniversity and watch the first half-hour or so of videos from my housing course.

But….come on. The extension of the recent bubble compared to the 1970s came from the abandonment of standards for down payments. If you think that looser monetary policy would have choked off the recent housing bubble, you’ve jumped the shark.