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.

see:
http://www.fooledbyrandomness.com/FatTails.html

5 thoughts on “Two Lifted from the Comments

  1. Those are good points. I have responded via a post at my blog:
    http://idiosyncraticwhisk.blogspot.com/2013/10/real-interest-rates-housing-boom.html

    The summary version is that I also think the causation of the banking bubble and the housing boom is reversed from the conventional point of view. The housing boom was justified, and that would include some expansion of mortgage lending to populations that would have previously been priced out of mortgages in higher rate environments.
    That was not a bubble. But, in combination with public policy, it did lead to a banking bubble. There may have been some feedback from the banking bubble back into the housing market, mostly in the form of an excessive expansion into subprime mortgages that were used to create AAA paper, but most of the price movements in housing in the 2000’s can be explained without it.
    One piece of evidence for this is that home prices are on the rise again, with no help from the banking sector.

  2. I wonder to what extent a cultural shift in the attitude toward saving can also play a role.

    Assuming boom years like 2003-2006, many buyers have relatively high incomes but low assets. But they point is that don’t just have low assets, there seemed to be a general posture that requiring a high down payment was /unfair/.

    That is, it does not seem to matter how much money one makes, the expectation is that it will all be spent rather than saved*, so anything that requires large savings is fundamentally unjust since it is practically impossible to achieve.

    * Retirement savings, like 401K, being an entirely separate category. In fact, I wonder how much dedicated retirement saving schemes have eroded the more general concept of savings. That is, the new acme of responsible saving takes the form of maxing out your 401K/IRA contributions and spending the rest.

    • FWIW, if I am right about that last part, retirement income schemes like Social Security and 401Ks have had a hand in raising debt levels by at the societal level redefining the concept of “savings” into the much more narrow “retirement savings.”

      This is kind of understandable to me. If you’ve already paid X to Social Security this month and Y to your 401K, how much are you expected to have left? More importantly, precisely how much consumption must I defer? I am already deferring both ‘X’ and ‘Y’, come on, do I have to defer ‘Z’ too? What am I working for?

  3. It is an error to believe that monthly payments are “high” when interest rates are high, and vice versa. Home buying using mortgages, in an environment of regulated lending standards, is *entirely* driven by the amount of income buyers are willing/able to dedicate to the *total* monthly payment. How much of that payment is interest and how much is principal is immaterial to the buyer. Therefore home prices and interest rates move in opposite directions. If interest rates were to rise substantially, home prices would drop to compensate. In the end you would be able to buy the same house for the same money, because otherwise the house will sit unsold.

    If the above is false, and a low (high) interest rate equilibrium exists, we should observe the housing market completely failing to clear in the presence of high (low) interest rates. AFAIK this is not the case.

    • Noah,
      Purchasing a home is a pre-payment of imputed rent, so the home acts as an inflation hedge. Therefore, the value of the home, as a product of future cash flows, is similar to that of an inflation protected bond, with a convex, inverted relationship between long term real interest rates and the home price.

      But, the amount of income that must be dedicated to the nominal monthly payment is a product of the nominal interest rate, not the real interest rate. In a low inflation period, like the 2000’s, this is inconsequential, and so home prices acted like bond prices, moving up substantially as real long term interest rates hit new lows. But, in a high inflation period, like the 1970’s, even though real rates were low, the high nominal rates acted as a drag on demand, making the price/yield curve less convex, and pulling the market clearing price down.
      My point is that there is nothing aberrant about home prices in the 2000’s. It’s just that in the previous low-real-rate environment that we are comparing it to, the nominal rate’s effect on home prices made the prices at that time aberrant, in that they were lower than they would have been without the high inflation premium. In fact, the power of low real rates on home values is so strong that in the late 1970’s, with mortgage rates rising above 10% due to the inflation premium, home prices were increasing sharply going into the 1980 recession because of low real rates. If inflation had not been creating such high nominal monthly payments, home prices would surely have been much higher.

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