Category Archives: Housing and housing finance

Bipartisan cronyism on housing finance

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Norbert Michel writes,

The witnesses supporting the bipartisan approach represent the following groups: the Housing Policy Council, the National Low Income Housing Coalition, the National Association of Realtors, the Mortgage Bankers Association, the National Association of Home Builders, the Community Home Lender Association, the National Association of Federally-Insured Credit Unions, and the U.S. Mortgage Insurers.

He refers to a bipartisan housing finance “reform” bill. With that list of rent-seekers in support, you know that one should pray that the bill never passes.

Kevin Erdmann on housing

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He writes,

Four main urban centers—New York, Los Angeles, Boston and San Francisco—share two important characteristics: They’re centers of new economic opportunity, and they permit new housing at rates much lower than their successful peers. Call them closed-access cities.

. . .The prudent path toward a stable housing market is more construction, more lending and more homeownership. Housing restrictions make economic growth painful by overinflating the price it takes to access the gains. Until they are reformed, many Americans will be stuck in the hopeless circumstance of running from booming regions rather than toward them.

You know Erdmann’s views from reading his comments on this blog and from reading Idiosyncratic Whisk. But the essay excerpted above appeared in the Wall Street Journal.

Kevin’s book, Shut Out, is available. Ironically, the Mercatus Center’s publisher is charging $34 for you to read the book on Kindle, and more for the print version. Talk about shut out!

Selection effects

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A few weeks ago, Handle wrote,

The major problem with any mechanism that lets good people evade government control for good reasons, is that it lets bad people evade government control for bad reasons.

I have been thinking recently about which economic concepts are over-rated and which are under-rated. In general, I think that over-rated concepts fit with our intuition of small-scale society, and under-rated concepts deal with large-scale society. Thus, one under-rated concept is “selection effect.”

In a small scale society, you don’t have to worry about selection effects. You know everybody and you have repeated interactions with everybody.

In a large scale society, you don’t know the people with whom you transact. You apply rules, and those rules will, for better or worse, be attractive to people who like those rules when compared with other rules.

So, going back to the context of the comment, if you offer people the ability to make large financial transfers without being monitored by any government agency, you will attract people who don’t want that monitoring. Some of those people will be good people who are just annoyed by monitoring, but you are going to draw all the people whose motives for avoiding monitoring are not so good. You are going to select for criminals.

As another example, take mortgage origination rules that require the applicant to document income, employment, and assets. The rules are in some respects pretty inefficient. For any given set of mortgage applicants, the documents themselves add essentially no information for predicting default risk.

But when you change the rules to allow “no-doc” loans, you draw in a different pool of potential borrowers. You get the applicants who are not so conscientious and reliable. You get loans from mortgage brokers who do not have a problem coaching applicants to over-state what they earn or what they have in the bank. So even though their credit scores look ok, you are going to select for borrowers who are less conscientious from a pipeline of mortgage brokers who are less honest.

To take a more provocative example, consider the “____ studies” fields in academia. Even if they don’t explicitly require professors to have left-wing ideas, they select for such professors by making uncomfortable anyone with a different point of view. In other fields, this is less the case. But I fear that in those other fields, any lack of diversity along gender or racial lines will be used as a wedge to make them to come up with selection criteria that have the effect of pulling in people with a left-wing viewpoint. In economics, I call this the “road to sociology watch.”

More AI skepticism

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From a commenter.

If we start from new loans to train the computer, we have no real test until lots of defaults happen. If, as mentioned above, only 2.5% of mortgages default in normal situations, it will take a long time to accumulate more observations than there are variables to look at. The machine can’t test itself until there are hundreds or thousands of defaults to compare, even assuming there was not a special case like a financial crisis that skews the numbers. Our only real hope is that the defaults that do happen occur very quickly in the life of the mortgage, first 3-5 years or so, in which case in a decade we will probably have good amounts of data. I don’t know how long it takes the average mortgage default to happen, so it might work, or it might not.

Defaults do tend to occur early in the life of a mortgage., Over time, there is usually equity buildup due to paydown of principal and rising home values, so that seasoned loans tend to perform well. This was true in 2007 and 2008–loans originated in 2003 or earlier were not prone to default. But the commenter’s points (read the whole thing) are still well taken.

With chess, a database of games is probably very representative of all of the circumstances that the computer is going to encounter. That is not true with mortgage lending.

I read recently that average credit scores are currently the highest they have ever been. Does that mean that making a loan right now is safer than it’s ever been? I doubt it. If conditions are unprecedented, then obviously they cannot be represented in the database.

Russ Roberts’ podcast with Rodney Brooks also elaborates on AI skepticism.

Don’t try to fix our housing finance system

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Congressman Jeb Hensarling writes,

The compromise plan would permanently repeal the Fannie and Freddie charters, ending the monopoly model. In its place it proposes using Ginnie Mae, the government corporation that explicitly backs the payment of principal and interest to investors in Federal Housing Administration and other government-insured loans. The proposal would direct the corporation to guarantee qualified privately insured mortgage-backed securities.

Loan originators would have to acquire coverage from an approved “credit enhancer,” or private mortgage credit guarantor, to use the Ginnie Mae system. That would function as a private capital buffer on the loan, which could then be securitized by any of Ginnie Mae’s more than 400 approved issuers with an explicit, full government guarantee of mortgage-backed securities.

To protect taxpayers from new risks, the credit enhancer’s guarantee would be market-priced and backed by the strength of its balance sheet, which requires bank-like capital. Credit enhancers also would have to use risk transfers to disperse credit risk horizontally and participate in a rainy-day fund to protect against unexpected financial downturns.

The thing that most people don’t realize is that the way that Freddie and Fannie operate right now achieves most of the objectives of this restructuring proposal. That is, the agencies transfer a lot of the credit risk on their securities to private entities.

There are ways I would like to see the current system tweaked: consolidate the loan purchasing functions of Freddie, Fannie, and FHA into a single unit, so they do not create opportunities to take advantage of whichever one offers the most generous terms; eliminate all government support for loans with a purpose other than owner-occupied house purchase or rate-and-term refinances–get rid of support for second mortgages, investor loans, loans for second homes, and cash-out refinances; keep loan limits low, and perhaps lower them from where they are now.

If you wanted to try to steer Americans away from the 30-year fixed-rate mortgage, then you could be more aggressive with reforms. But that is not a fight I can imagine politicians wanting to start.

My guess is that anything Congress initiates to try to improve our current housing finance system will in fact make it more fragile.
It may be brave of me to say this, but I would describe the current state of housing finance in America as, “It ain’t broke, don’t fix it.”

Mike Munger on non-ownership

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You can watch the podcast at Cato (I watched it live yesterday, so the link may be different). The book is Tomorrow 3.0: Transaction costs and the sharing economy. It can be summarized by a remark from one of my commenters.

The commenter writes,

Ownership is a form of market failure:

– Your car being parked 23hrs a day just to ensure that it’s there when you need it.
– Transaction costs of selling/buying your house tying you down and decreasing efficiency of your human capital.

This reminds me of my line to my high school students that “Do It Yourself is market failure.” I had an economist friend who built a deck for his house to “save money.” I pointed out that if he could get paid his economist’s wage rate while working more hours and then paid someone to build the deck, then that would have saved a lot more money. His inability to get paid for marginally more hours worked as an economist was the market failure.

Transaction costs and agency costs related to land are fundamentally important. In theory, the best way for me to own land is to include a well-diversified mutual fund that invests in real estate as part of my portfolio. In practice, transaction costs make me want to stay in a particular dwelling much longer than might otherwise be optimal, and agency costs make it more likely that a property will be well cared for by an owner than by a renter. Overcome those sources of market failure and you make it feasible to own a diversified real estate portfolio instead of being stuck with one home.

Handle is skeptical of Yimbyism

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He writes,

Right now Libertarians and some Progressives are on a pro-density “just build more housing” kick, and tend to dismiss and disparage the motives of local residents who try hard to stop it. What I’ve tried to point out is that a legitimate reason for protest is the fact that our system government – especially in big winner city centers – is simply no longer capable of “preserving infrastructural adequacy” let alone at anything approaching reasonable costs and timescales.

Read the whole comment.

The thing is, Boston is capable of undertaking infrastructure projects. It now has bike lanes galore.

Boston’s strange housing market

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From Mark Pothier in the Boston Globe.

In Plymouth, the median sale price of a single-family home at the end of 2017 was about 4 percent below its pre-recession peak in 2005. Towns such as Hyannis and Southbridge sat deeper in the hole  —  still more than 15 percent down. Compare that with Cambridge, where the median sale price rose by 96 percent between 2005 and 2017. In parts of Boston, prices have outright doubled since 2005. Never has home-value disparity in Eastern Massachusetts been so extreme.

I have a hypothesis about the cause of house price divergence in the area. Boston has peculiarly bad transportation woes. The “subway” runs above ground on some routes, which makes it quite slow. Parking regulations and parking shortages in Cambridge and Brookline make car transportation difficult, especially for commuters. The road system is terrible. Construction on major streets creates major bottlenecks. A major economic activity is remodeling old houses, and the streets are choked with contractors’ trucks.

These transportation problems make commuting a nightmare in Boston. That in turn puts a premium on close-in housing and lowers the value of housing in suburbs that are nearby in terms of mileage but remote for commuting purposes. I think once the Baby Boomers hit their 80s and no longer have the ability/desire to take advantage of urban amenities, there may be enough of an exodus from the expensive suburbs to stop the price spiral there.

City income differentials widen

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Thomas B. Edsall writes,

According to Romem, between 2005 and 2016, those moving into the San Francisco area had median household incomes averaging $12,639 a year more than the households of the families moving out, $70,015 to $57,376.

Conversely, in the struggling Syracuse metropolitan area (Clinton 53.9 percent, Trump 40.1 percent), families moving in between 2005 and 2016 had median household incomes of $35,219 — $7,229 less than the median income of the families moving out of the region, $42,448.

It’s a long essay, worth reading in its entirety. Edsall’s focus is on the evolution of the political coalition that makes up the Democratic Party. But I find the economic phenomenon interesting. The data support the Handle Hypothesis that urbanization has become a winners-take-most game. The article by Issi Romem that Edsall refers to is also worth reading. Romem writes,

Why do the expensive coastal metros exhibit positive income sorting? These metros are expensive because they have restricted their supply of new housing even as they continue to generate strong demand for it.

Kevin Erdmann and many others have been saying this for quite some time.

Related: Pew reports,

In 2001, 13 percentage points separated the shares of white and African-American renter households that were burdened: 26 and 39 percent, respectively. . .By 2015, the share of African-American-led renter households that were burdened had risen to 46 percent

Rent-burdened is defined as spending more than 30 percent of a household’s income on rent. Pointer from Tyler Cowen.

I think that the political threat to the Democratic Party is minimal. Group identity seems to overcome anything. The Democrats can be anti-Israel and still get most of the Jewish vote. Their policies make housing less affordable and drive African-Americans out of Washington, D.C. or San Francisco, but they still get most of the black vote.

Were mortgage securities badly mis-rated?

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Juan Ospina and Harald Uhlig write,

AAA securities did ok: on average, their total cumulated losses up to 2013 are 2.3 percent. . .Losses for other rating segments were substantially higher, e.g. reaching above 50 percent for non-investment grade bonds. . .

Cumulative losses of 2.2% of principal on AAA-rated securities surely is a large amount, given that rating. Such losses after six years may be expected for, say, BBB securities, and not for AAA securities. AAA securities are meant to be safe securities, and losses should be extremely unlikely. From that vantage point, an average 2.2% loss rate is certainly anything but “ok”. We have chosen this label not so much in comparison to what one ought to expect from a AAA-rated security, but rather in comparison to the conventional narrative regarding the financial crisis, which would lead one to believe that these losses had been far larger. Ultimately, of course, different judgements can be rendered from different vantage points: our main goal here is to simply summarize the facts.

Authors’ emphasis. They also say,

these facts provide challenge the conventional narrative, that improper ratings of RMBS were a major factor in the financial crisis of 2008.

I object to this conclusion. The capital requirements for the securities depended on the ratings. Because of the AAA ratings, the capital requirement was less than what the loss percentage turned out to be.

As I see it, the facts in the paper support the conventional narrative. If the securities had been correctly rated, then there would have been no financial crisis. If the securities had been properly assigned BBB ratings, or any ratings below AA, banks could not have bought the securities without having at least five times the amount of capital that was required for AAA.

The charitable interpretation is that the authors do not appreciate the significance of capital regulations. The uncharitable interpretation is that they are trolls.