Elastic Housing Supply?

Megan McArdle writes,

Over the past few years, developers have rectified the situation; a great deal of new housing is coming on the market. Which means the end of double-digit rent increases and housing appreciation in those cities. But we seem to have reached the end of “making up for lost time” and headed toward “glut.”

She speaks of the NY city and DC markets in particular. I admit I have wondered about the wisdom of developers treating Bethesda like beachfront property, with all the high-rise condos they are building.

But I am skeptical of her view that the shortage of housing in these urban markets is about to abate. Nationally, the rate of housing construction remains well below the normal rate of family formation. When I talk to people involved in real estate, they say that it’s not local demand that is driving prices anyway–all the talk is of “foreign money.”

But the main thing is that I do not believe that the supply of housing is really elastic in NY, DC, LA, or SF. The restrictions on development are still formidable.

Housing Re-Bubble?

Nick Timiraos reports,

the [Federal Housing Agency home price] index shows U.S. prices now standing just 6.4% below their previous peak in April 2007.

…The Case-Shiller national index, which is set to report its own measure of July home prices next Tuesday, showed that home prices in June were 9.9% below their 2006 peak.

Some comments:

1. Overall, consumer prices have risen about 15 percent since 2007, so you might say that on an inflation-adjusted basis home prices are more like 20 or 25 percent below their 2007 peak.

2. However, even on an inflation-adjusted basis, house prices are higher than they were in late 2003, by whichi point cries of “bubble” already were being heard.

3. If I were Scott Sumner, perhaps I would say that this suggests that the 2007 prices were not really a bubble. Indeed, the real anomaly was the crash in house prices in 2008-2009, due to tight money. But I am not Scott Sumner.

4. The case that we are in another bubble strikes me as weak. It is certainly is not a sub-prime lending phenomenon. Two phrases that I hear a lot in casual conversation with real estate folks are “all-cash deal” and “foreign buyer.”

5. Even if house prices were to fall sharply again, my guess is that there would be many fewer loan foreclosures. Lenders are taking on much less risk, and instead home buyers are taking on more of it.

6. It seems to me that we are much closer to full recovery in the housing market than we are to full recovery in the labor market. Does that not pose a problem for the theory that the recession was mostly an aggregate-demand phenomenon caused by the loss of housing wealth?

7. Again, today’s economy feels so much like 2003 and 2004. Very low r, seemingly below g. Last decade, Bernanke labeled this a “global savings glut.” This decade, Larry Summers calls it “secular stagnation.”

8. In June of 2004, I wrote Bubble, Bubble, is there Trouble? arguing that low r was the central economic puzzle, and that given low r, housing prices were not out of line. I have been excoriated since then for failing to call the housing bubble. In 2009, that excoriation seemed warranted. Today, it seems like you could change the date to June of 2014 and re-print it.

There is No Free-Lunch Mortgage

Ed Pinto is pushing something he calls a “wealth builder home loan.” Here is his thought process:

1. With a 15-year mortgage, the borrower accumulates equity faster than with a 30-year mortgage. However, by the same token, the monthly payment is higher, which creates a hurdle for low-income home buyers.

2. With an up-front payment, you can buy down the interest rate on a 15-year mortgage, making the monthly payments more affordable.

3. Therefore, a 15-year mortgage with an interest-rate buydown is a way to help low-income borrowers afford mortgage payments and build up equity rapidly.

(1) and (2) are true. However (3) is false. The problem is that the interest-rate buydown undermines the borrower’s equity. Consider two cases.

Case 1: the borrower pays for the buydown. As this article describes it,

let customers of modest means use a down payment of up to 5 percent to “buy” a lower interest rate

So, if you buy a $200,000 house and you have $10,000, you use that $10,000 to buy down the rate. But you could have used that $10,000 as a down payment on the house! That would have given you 5 percent equity to start with, instead of starting with zero.

Case 2: the seller pays for the buydown. If the seller pays $10,000, then the transaction price will be $10,000 above what the house would sell for without a seller concession. So if the borrower makes no down payment, the borrower starts out with $10,000 in negative equity.

There is no free lunch in mortgage lending. People with low incomes and little money to put down on a home are home speculators. There is no reason to encourage them to become home speculators.

Help people save for the down payment. That is the only “affordable housing” approach that does not foster speculation.

Mortgage Equity Withdrawal

Bill McBride tracks data on mortgage equity withdrawal as a percentage of disposable income. You withdraw mortgage equity when you take out a second mortgage or refinance your existing mortgage with a larger loan (“cash-out refi,” as we call it). The graph at the link shows how from 2002-2007, the withdrawal rate was between 4 and 9 percent each quarter. Ordinarily, the number should be slightly negative, as people pay down the principal in their mortgages. We had big negative numbers in 2009-2011, “mostly because of debt cancellation per foreclosures and short sales, and some from modifications.”

Thanks to a commenter for the pointer. Some further comments:

1. From an AS-AD perspective, you can say that mortgage equity withdrawal boosted AD from 2002-2007, and then it went into reverse when the subprime crisis hit. This might be the best story for the drop in AD.

2. From a PSST perspective, you can say that a lot of consumption patterns were unsustainable, based on people spending capital gains on housing. When the capital gains leveled off and then turned into capital losses, the economy needed to find new patterns of trade, and it still has not done so.

3. Apropos of nothing, I once cursed out the guy who developed the measure of mortgage equity withdrawal. In about 1982 or so, Jim Kennedy was the forecaster for Industrial Production, and I was the forecast co-ordinator (we were both economists at the Fed). The forecast process, which was pretty much all clerical, was time-consuming and grueling. I had finally put a forecast to bed when Jim came in and said that the forecast for Industrial Production was out of synch and needed an update. He was very concerned about who might be blamed for the glitch. I shouted, “I don’t care whose bleeping fault it is!” I really lost my temper. It was just a case of my being tired, still at work long after I usually went home, and caught off balance by having my relief at being finished turned to anguish at finding that there was more work I had to do.

On Housing Finance Reform

I write,

The dysfunctional and regressive nature of policy in housing reflects the political configuration in Washington. For several decades, policies combined the efforts of social engineers clumsily seeking to expand home ownership with well-heeled interest groups skillfully lobbying for profits. The social engineers put taxpayer subsidies up for grabs, and the interest groups do the grabbing.

Paul Willen on Risk Retention

He notes that the new risk-retention rules in mortgage securities mandate a lower rate of losses than the securitizers actually took in the subprime crisis. In other words, Congress claims to have improved the safety of securitization by mandating “skin in the game” that amounts to less than what the securitizers actually had.

Tim Geithner on Freddie and Fannie

Nick Timiraos extracts from the new Geithner book.

But the erosion in underwriting standards, the rush to provide credit to Americans who couldn’t have gotten it in the past, was led by consumer finance companies and other nonbank lenders that did not have to comply with the Community Reinvestment Act—which, after all, discouraged redlining for nearly three decades before the crisis. These firms took credit risks because they wanted to, not because they had to; they believed rising home prices would protect them from losses, and their investors were eager to finance their risk-taking. Fannie and Freddie lost a lot of market share to these exuberant private lenders, and while they did belatedly join the party, the overall quality of mortgages they bought and guaranteed was significantly stronger than the industry average.

That strikes me as beside the point. The comparison to make is not between risk of the mortgages Freddie and Fannie bought with some industry average. The comparison that matters is between the mortgages that they bought and their capital and loss reserves. With enough capital, they could have taken on the worst of the subprime mortgages and survived. Conversely, even relatively safe mortgages can take you under if you do not maintain the loss reserves and capital that are needed in an adverse house price scenario.

This defense of Freddie and Fannie comes across to me as purely rhetorical. I hope he is too smart to really believe it. Otherwise, I would say that if this is the way that high government officials think about finance, then anyone who thinks that such people can prevent crises is making a really unsound wager.

Having said that, much of the rest of the article makes Geithner sound a lot more sensible than the typical progressive housing policy type. He recognizes that the key to housing finance reform is bringing back a reasonable down payment. He also seems to be one of the few people who gets it that the attempts to bail out homebuyers were based on unrealistic expectations of the mortgage servicing industry.

Which Errors Would You Prefer?

Nick Timiraos reports,

some economists, together with policymakers at the White House and Federal Reserve, are warning that mortgage-lending standards have become too restrictive, years after carelessness by lenders inflating the housing bubble.

… the Urban Institute, a think tank in Washington, estimated that around 200,000 fewer mortgages were made in 2012 due to credit standards that were more stringent than they were before the housing bubble.

Don’t say that like it’s a bad thing!

In mortgage lending, a type I error is making a loan that defaults. A type II error is turning down a loan that would have been repaid. Some remarks.

1. When home prices rise, it very hard to make a type I error and very easy to make a type II error. If the house price has gone up, the borrower’s equity is presumably positive, and borrowers who get in trouble will sell their homes and pay off their loans.

2. During the bubble, Congress and HUD officials were convinced that lenders were making type II errors due to racial bias and anachronistic conservative lending standards.

3. After the crash, Congress and government officials were convinced that lenders had been making type I errors due to greed, predatory lending, and lack of regulatory oversight.

My own view is that lenders make type I errors and type II errors all the time. Still, I would rather have errors made by people for whom credit risk assessment is a profession, without the amateur meddling that comes from the political sector.

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.