Useful Housing Market Charts

From the San Francisco Fed. Pointer from Mark Thoma.

II mostly wanted to keep this link for future reference. It charts some key housing market indicators before and after 2008. One bit of text:

The price-to-rent ratio (red line) reached an all-time high in early 2006, marking the apex of the housing bubble. Currently, the price-to-rent ratio is about 25% below the bubble peak.

My reading of the charts is that after the bubble burst, housing construction really fell off. The result has been an increase in rents, which in turn justifies an increase in house prices. You can argue about how much overbuilding there was prior to 2007 and how much underbuilding there has been since. I doubt that one can give a definitive answer. The problem is that I do not think that anyone can say what the “right” amount of average housing space per person is. And we are in the midst of trend increases in urban and outer suburban population, and I do not know how that affects things.

Houses and Land

Kevin Erdmann writes,

The real long term natural rate right now is about 2.5%. If you have tons of cash or you can run the gauntlet and get a mortgage, or if you are an institituional investor going through the difficult organizational process of buying up billions of dollars of rental homes, you get the preferred rate of 4% real returns.

Pointer from Tyler Cowen. Erdmann thinks that we have not built enough houses, so rents will be rising, so owning rental property is a great investment. My comments:

1. I would have thought so, too. I put a lot of money in REITs. It has not done well. I also invested a lot of money in firms that own/manage a lot of apartments. It did not do well. Maybe all that says is that I played in a segment of the market that is efficient, when the point is to try to exploit the inefficient segment.

2. If I understand his thinking, there are not enough buyers to bid house prices to their fair market value. So you can own an apartment building at a high rent/price ratio. But it seems to me that, at least in some markets, the price/rent ratio has gone up rather than down in the past few years.

3. I am not sure that I trust my intuition about housing markets. My friends and relatives tend to be located in Blue cities where regulation restricts supply. I do not have a good feel for less-regulated markets.

Idiosyncratic Charts

Kevin Erdmann writes,

there was little change in the share of securitized mortgages during any of the boom years from the mid-1990s to the height of the boom. The share of these pools was 57% in 1995 when rent inflation began to rise, it peaked at 62% by 2002 before the steepest moves in home prices, and then declined back to 59% at the end of 2005 when housing starts and home prices peaked.

Within this group, there was a shift to private pools, much of which were subprime. But, as we can see in the graph, there was a gradual shift from Ginnie Mae to private pools from about 1990 to 2003.

…After 2003, the GSE’s began to decline as a portion of the market also. It was during this period that private pools shot from about 10% to about 20% of the market, until the private pool market collapsed in 2007. This period was not associated with a rise in homeownership, and included the last period of sharply rising prices followed by two years of flat prices.

What I find idiosyncratic about the chart is that it is based (I think) on total mortgage debt outstanding. Also, he charts the share of mortgages, rather than total amounts. Both of those factors tend to make the chart tamp down changes in dollar mortgage flows.

One point is that the issuance of mortgages by agencies was affected by loan limits interacting with higher house prices. My guess is that the substitution of private mortgages for agency mortgages took place in locations where house prices were rising faster than the loan limits adjusted.

Yet another point is that a lot of lending was in the form of cash-out refinances (people using their homes as ATMs). I may be wrong, but I don’t think that FHA was in that business.

Another chart shows the increase in mortgage debt by income class. Kevin writes,

The proportion of mortgage debt held by the bottom 80% of households declined during this period [2004 to 2007].

What I would want to see is the behavior of the ratio of debt to equity by income class. Suppose that everybody is using their homes as ATMs. If a rich guy with a million dollar home raises refinances his $400,000 mortgage for $500,000 and a poor guy with a $100,000 home refinances his $90,000 mortgage for $100,000, then most of the new mortgage debt goes to the rich guy. But it’s the poor guy whose equity is disappearing.

Bethany McLean responds

In an email (which she gave me permission to post), she writes,

So first of all, thank you for your kind words about All the Devils. I’ve always been a fan of your work, and I wholeheartedly second the title of your blog! Secondly, I’m always fine with criticism of my work and disagreement with any interpretation I’ve made. In particular, the GSEs are a nuanced, difficult subject, and frankly, I learn new things all the time. I am always willing to change my mind if someone shows me that I’m wrong.

What I’m not ok with is mischaracterizations of my work, whether deliberate or because you didn’t actually read most of the book [her newest book, Shaky Ground]. My main reason for writing is that you say I dismiss Ed DeMarco as a free market ideologue. That is exactly the opposite of what I actually wrote, which is that you cannot dismiss him as just that! I think Ed is a good man who did the best job he could and held true to his beliefs – saving taxpayers money – under very difficult circumstances. I don’t want people reading your review to think I impugned someone’s character when in fact, I did the opposite. It’s really unfair of you.

You are intellectually dishonest about some other points as well, but frankly, everyone is intellectually dishonest about the GSEs, so I won’t bother with most of it. But since I’m writing, I’m going to point another one out.

You also say that the shareholders made a political bet, which they lost, fair and square. There are many different types of shareholders, but as I detail (gory detail – it’s hard to miss!) a number of them made a purely financial bet, and totally missed the poisonous politics. They did loan level analysis and saw that the GSEs were going to become profitable again. Their bet was not that they could buy special favors, but precisely the opposite: that the government would treat Fannie and Freddie as normal companies – ie, like AIG, like Chrysler, like the big banks. Which, not incidentally, is what Jim Lockhart said would happen at the time of conservatorship. And the government set up this situation by leaving the common and preferred shares outstanding. You can blame the investors for being politically naive, but I don’t see how you can fail to acknowledge that there’s a lot of blame to go around here. (It might be a fair point to say that the GSEs are only profitable again because of government support. But then, you’d have to say the same thing about the big banks. In fact, you’d have to say the same thing about our whole stock market, which is supported by the Fed! Etc, etc. )

I agree with your point about there being a powerful case to be made against the government caving into the housing lobby. Perhaps I do give in too easily to what I view as the political reality. That said, the history of the private market financing residential real estate is not a pretty one either! Look back to the booms and busts in the 1800s and the spectacular default rates in the Great Depression. I also would contest the idea that there is such a thing today as a private sector, as pertains to the mortgage market. If the big banks finance the mortgage market, they too will be GSEs, if they aren’t already. But on this, there is much grist for debate, and criticism is fair.

Anyway, the tag line on your blog, “taking the most charitable view of those who disagree,” is so important. Live up to it! Don’t set up straw men so that you can knock me down.

My remarks:

1. I am glad that she respects Ed DeMarco, and I am sorry that I interpreted her as siding with his opponents.

2. She and I will have to agree to disagree about the hedge fund investors in Freddie and Fannie stock. I see no role for financial calculation, or “loan-level analysis.” Instead, it would have been obvious that the GSEs could be restored to profitability if you kept them going long enough using Treasury funds to borrow while having the entire mortgage market to themselves. The wild, speculative bet was that in the meantime there would be no reform of the housing finance system and that politicians would then decide to return Freddie and Fannie to the status quo prior to 2008. However, neither the Bush Administration nor the Obama Administration indicated any intent to do that. If you bought GSE stock for pennies in 2009 or 2010, you were making a bet that could pay off spectacularly, but only if Congress and the Administration were to do something very different from what they were saying.

In dealing with the crisis, the only purist, follow-the-law approach would have been to put the firms (including big banks) through bankruptcy. I would have preferred that, although I understand the fears that policy makers had about such a process. In my view, the next best alternative would have been to nationalize the GSEs and the failed banks, on the grounds that taxpayers were on the hook for the losses of those firms. Then the government would gradually wind these firms down. Instead, the policy makers chose bailouts, which necessarily involved arbitrary treatment of stakeholders. I do not think that any of those stakeholders has a compelling legal complaint at this point, because the rule of law went out the window with TARP and the bailouts.

Just the other day, some bloggers at the New York Fed wrote,

our view is that an optimal intervention into Fannie Mae and Freddie Mac would have involved the following elements:

The firms would be able to continue their core securitization function as going concerns, supporting the supply of mortgage credit.

The firms would continue to honor their debt and mortgage-backed securities obligations.

The value of the common and preferred equity in the two firms would be extinguished, reflecting their insolvent financial position.

Note that last sentence.

3. For writing my earlier post, I have been subjected to vicious, ad hominem attacks from former members of the Fannie Mae lobbying arm. If nothing else were to convince me that restoring the status quo for the GSE’s is a bad idea, then these crude, juvenile social media posts would suffice. Perhaps government backing for housing finance is inevitable in America. But at least let us hope that the institutions that receive such support do not replicate Fannie Mae’s aggressive and unprincipled lobbying machine.

In an opinion piece in today’s WaPo, McLean dismisses this lobbying with an “everybody does it” line.

One legitimate complaint about the old Fannie and Freddie was the way they garnered political clout through their promotion of homeownership. In their heyday, it was immense and ugly. (“Fannie has this grandmotherly image, but they will castrate you, decapitate you, tie you up, and throw you in the Potomac,” a congressional source told the International Economy in the late 1990s. “They are absolutely ruthless.” That would pale next to the political clout of a big bank that also controlled the mortgage market, and whatever evils grew out of the GSEs’ need to please politicians, there could be worse. Imagine the conversation in a back room between the politicians and the bank executives, where they agree that if the bank will loosen up credit in their states, the politicians will go easy on, say, derivatives regulation. It almost makes the old Fannie and Freddie look pure.

No it doesn’t. And the rest of her piece consists of cheerleading for housing finance subsidies, which is exactly what makes her new book such a disappointment.

Housing Finance Policy and African-Americans

From The Atlantic:

“Becoming a homeowner was not a fruitful asset accumulation strategy for low- and moderate-income black families in the 2000 decade, in either the short- or medium-term,” write Sandra J. Newman and C. Scott Holupka, authors of a new study from Johns Hopkins University.

…Black families who bought in 2005 lost almost $20,000 of net worth by 2007, according to the paper. By 2011 those losses were more like $30,000. White homeowners didn’t have quite the same problem. Those who purchased in 2007 saw their net worth grow by $18,000 in two years, and then those gains eroded, leaving them with an increase of $13,000 by 2011. All told, the black families lost, on average, 43 percent of their wealth.

…in general black families would have been better off if they hadn’t bought homes at all.

And yet, the advocates of mortgage subsidies and other misguided government housing policies are as active as ever lobbying for more.

Why did the sample of comparable white home owners not do as poorly?

Presumably, the value of their homes declined less. One possibility is that “affordable housing goals” for lenders temporarily increased the prices of homes in black neighborhoods and also created pockets of foreclosures concentrated in those neighborhoods. There are other possibilities, of course.

Two Stars for Shaky Ground

For the first time in many years, I wrote a review for Amazon. About Bethany McLean’s book on Freddie and Fannie, I say,

I was disappointed with this book, because I think that her earlier work, All the Devils are Here, co-authored by Joe Nocera, is probably the best journalistic account of the run-up to the financial crisis.

On “Shaky Ground,” here are my thoughts:

1. This book might have been titled “Sympathy for the Devils.” There is way too much sympathy expressed for the hedge funds that bought preferred stock in Freddie and Fannie. They were making a bet that the political process would come out a certain way, and they lost that bet, fair and square. End of story, as far as I am concerned. I should note that on several occasions representatives of the hedge funds have felt me out about doing some “research” or writing an article to support their position. I would not have done it for any amount of money. I am not accusing McLean of having succumbed to this, but I would not completely rule it out.

2. The other devil who gets a ton of sympathy is former Fannie Mae executive Tim Howard. McLean endorses all of his self-serving views, which include a claim that he did nothing wrong in Fannie’s giant accounting scandal. Also, his view is that had the Fannie management not been replaced, his team would have averted the crisis. Both claims may be true. In my opinion, Freddie and Fannie were better managed before both of their management teams fell in accounting scandals. But I think that more journalistic skepticism is in order. Regardless of who was in charge, there was pressure on Freddie and Fannie management to dive into high-risk lending, with shareholders seeing profits and regulators seeing a mission to expand home ownership opportunity.

3. She is no fan of Ed DeMarco, who was the only person in Washington working to gradually wind down the GSE’s, which is supposedly what everyone wanted. I think it is fair to say his approach was too unpopular with key players to be sustained. But he does not deserve to be dismissed by McLean with boo-words, like “free-market ideologue.”

4. She says that if you take it as given that the government is going to promote what the housing lobby wants, namely “home ownership” with little actual equity and a mortgage market dominated by the 30-year fixed-rate loan, then keeping Freddie and Fannie is better than the alternatives. If you accept the premise, then I agree. But there is a powerful case to be made against government caving into the housing lobby. The costs of this, including serial financial crises (the S&L crisis, the crisis of 2008) and misallocation of capital, are huge, and the social benefits are miniscule. (The private benefits can be enormous–just ask Tim Howard.) McLean does mention some of the evils of this housing-industrial complex, but her bottom line is, in effect “you can’t beat ‘em, so don’t try.”

Overall, this is not a terrible book. But if you read it, you should keep in mind that she gives the most favorable treatment possible to Freddie, Fannie, the hedge fund investors, and to policy makers who attempt social engineering using housing finance. Although the book is not completely one-sided, she does not give alternative points of view as much respect as I think they deserve.

Bethany McLean Slips

In her new book, Shaky Ground: The Strange Saga of the U.S. Mortgage Giants, she writes,

Originally, Fannie and Freddie owned the mortgages they purchased. but over time, as the capital markets in this country evolved, Fannie and Freddie began to package up the mortgages they purchased, stamp them with a guarantee. . .and sell them as securities to investors.

This is true of Fannie. But for Freddie the history is the opposite. They were in the securitization business from the beginning in 1970, and only around 1990 did they start to hold a substantial share of mortgages and mortgage securities as assets. There were several reasons that Freddie shifted to holding a large portfolio, funded by debt.

1. By 1990 Freddie was a shareholder-owned company (before that, they were basically a government agency), and shareholders were interested in profits. Having a large portfolio was profitable.

2. Prior to that, Freddie was concerned about the risk of holding mortgage portfolio. If you fund with short-term debt and interest rates rise, you end up paying more in interest expense than you earn on mortgages. If you fund with long-term debt and interest rates fall, borrowers refinance at lower rates and you are stuck with the high long-term debt costs. But Fannie Mae found a solution, which consisted of issuing callable debt. For example, they might issue a 10-year bond that can be called in 5 years. The market charged a surprisingly low interest rate on such securities, so Freddie started issuing them. Combining callable debt with some interest-rate derivatives gave Freddie and Fannie something close to an arbitrage profit in portfolio lending. They were helped, of course, by their “too big to fail” status, which made investors treat their debt as risk free–until the summer of 2008.

Anyway, I am sorry McLean slipped up on this. I really liked her book with Joe Nocera, All the Devils are Here, and I still have high hopes for her new one, which I have just started. I expect to post more on it.

I found this interesting:

When they were taken over, Fannie and Freddie had a combined $5.3 trillion in outstanding debt,, which, had it been put on the government’s balance sheet, would have increased the public national debt by about 50 percent. Partly to avoid that, the government left 20.1 percent of Fannie’s common stock, as well as other securities known as preferred shares, in the hands of investors.

Fannie and Freddie were originally government agencies. Fannie was privatized not for ideological reasons, but because Lyndon Johnson wanted Fannie’s debt off the government balance sheet. He was trying to fund the Vietnam War, plus the war on poverty, and he did not want Congress bothering him with debt-ceiling issues.

So here we were in 2008, and Fannie and Freddie should have been re-nationalized, but once again, the cosmetics of the government balance sheet took precedence.

The Causes of Mortgage Defaults

The latest paper is by Fernando Ferriera and Joseph Gyourko. This article about the paper says,

Ferreira’s data show that even with strict limits on borrowing—say, requiring every borrower to put 20% down in all circumstances—wouldn’t have prevented the worst of the foreclosure crisis. “It’s really hard for certain regulations to stop the process [of a bubble forming],” Ferreira says. “I really wish my research had showed that it’s all about putting down 20% and all problems are solved, but the reality is more complicated than that.”

This analysis has both good points and bad points. The good point is that it goes against the “predatory lending” narrative. As a home buyer, you were better off with a predatory loan in 2002 (when prices were still headed higher) than with a prime loan in 2006 (when prices were near the peak). The bad point is the implication that there was nothing wrong with loans with low down payments. In fact, it was those loans that allowed speculation to get out of control.

Scott Sumner thinks that the finding that many of the mortgage defaulters were “prime” borrowers is enough to confirm that mortgage defaults were caused by a slowdown in nominal GDP growth. But mortgage defaults do not come from a lack of nominal GDP growth. They come from negative equity among mortgage borrowers.* And that comes from house prices falling, for which the main cause was the rapid rise in the first place. And both the rise in prices and the subsequent wave of defaults were much exacerbated by the fact that so many borrowers, “prime” or otherwise, had so little equity to begin with.

From part of the NBER coverage of the paper that Sumner does not quote:

The authors’ key empirical finding is that negative equity conditions can explain virtually all of the difference in foreclosure and short sale outcomes of prime borrowers compared to all cash owners. Negative equity also accounts for approximately two-thirds of the variation in subprime borrower distress. Both are true on average, over time, and across metropolitan areas.

Let’s assume that we can agree that the big drop in house prices caused the wave of mortgage defaults. Three possibilities:

1. The drop in house prices was a purely exogenous shock.

2. The drop in house prices was due to the slowdown in nominal GDP growth.

3. The drop in house prices was due to the internal dynamics of a housing market that had become saturated with speculative buying with little or no money down.

The stories about the study make it sound like it was (1). Sumner believes (2). I vote for (3).


UPDATE: See Megan McArdle for a similar point of view.

Financial Advice for Bryan Caplan

He says that he maintains as much housing debt as possible, in order to take advantage of the mortgage interest deduction.

My advice to him is to sell his stock portfolio, pay off his housing debt, and take long positions in stock index futures.*

*In practice, the prospect of incurring capital gains taxes might make this a bad move.

Here is my thinking.

1. If you maintain housing debt that you could pay off, you have to put the money to work somehow. The question is whether you can earn more on your money than the after-tax interest rate. If you invest in risk-free securities, the answer is obviously “no.” Borrowing at 3 percent to invest in a money-market fund is a losing proposition, tax deduction or no tax deduction.

2. There might be some bond that you can buy that earns more than the after-tax mortgage interest rate, but that bond is going to have some risk attached to it. And you will have to pay taxes on the interest from that bond.

3. That leaves stocks. If you maintain housing debt in order to own stocks, then you are saying that you are happy to have a leveraged position in stocks, because you think that the expected return on stocks is higher than your borrowing rate. In Pikettyian terms, you believe that g is greater than r.

Fine. But if that is true, then I am pretty sure that the most efficient way to take your position would be by holding a position in stock index futures, rather than by taking out a mortgage loan to invest in stocks.

If you don’t like paying taxes, I understand that. As much as I disparage non-profits, I give large amounts to non-profits because I prefer that to paying taxes. But from a purely financial perspective, I think that maintaining mortgage debt that you could afford to pay off strikes me as a losing proposition. You unnecessarily enrich the mortgage lender at your expense.