By James Kwak
The Dodd-Frank Act was supposed to require securitizers to retain 5 percent of the credit risk of the mortgage-backed securities that they issued, in order to reduce the risk of a repeat of the last housing bubble. Today, the federal financial regulators said, “Whatever,” and ignored that requirement. In particular, they created an exemption that would have covered at least 98 percent of all mortgages issued last year.
“adding additional layers of regulation would have contracted credit for first time home buyers and borrowers without large down payments, and prevented private capital from entering the market.”
That’s according to the head of the Mortgage Bankers Association.
This is the exact same argument that was made in favor of deregulation during the two decades prior to the last financial crisis, without the slightest hint of irony. It’s further proof that everyone has either forgotten that the financial crisis happened or is pretending that it didn’t happen because, well, maybe it won’t happen again?
Even leaving aside the specific merits of this decision, the worrying thing is that the intellectual, regulatory, and political climate seems to be basically the same as it was in 2004: no one wants to to anything that might be construed as hurting the economy, and no one wants to offend the housing industry.
By James Kwak
Loyal readers already know what I think of housing as an investment. The main issue, in my mind, is that it’s extremely risky as an investment: not only are most middle-class families putting more than their total net worth in a single asset class (and one with low average real returns compared to the stock market), but they are putting it into a single asset, which violates the most fundamental principle of investing.
That said, on a pure expectation basis (not considering risk), buying is probably better than renting. It’s not as simple as saying that “renting is throwing money away while paying a mortgage is building equity” because (a) homeowners usually pay more cash than renters on an ongoing basis (mortgage, homeowner’s insurance, maintenance, etc.) and (b) you have to consider the returns you could get by investing your capital (down payment and principal payments) in another asset class. But the tax deduction for mortgage interest probably tilts the scale toward buying.
So if you’re thinking about buying or renting, I recommend that you read “The Effectiveness of Homeownership in Building Household Wealth” by Jordan Rappaport, an economist at the Kansas City Fed (hat tip David Leonhardt). The most valuable part of the paper is that it clearly outlines the financial tradeoffs between owning and renting. Rappaport creates a model that estimates the cash flows from buying a house and selling it ten years later and renting for ten years, assuming that you invest all the money you save by renting. He then looks at historical ten-year periods beginning from the 1970s through the 1990s to see which strategy would have been preferable.
Continue reading “Renting and Buying Compared”
By James Kwak
Many commentators who want to blame Fannie and Freddie for the financial crisis base their arguments on analysis done by Edward Pinto. (Peter Wallison bases some of his dissent from the FCIC report on Pinto; even Raghuram Rajan cites Pinto on this point.) According to Pinto’s numbers, about half of all mortgages in the U.S. were “subprime” or “high risk,” and about two-thirds of those were owned by Fannie or Freddie. Last year I pointed out that Pinto’s definition of “subprime” was one he made up himself and that most of the “subprime” loans held by Fannie/Freddie were really prime loans to borrowers with low FICO scores. Unfortunately, I made that point in an update to a post on the somewhat obscure 13 Bankers blog that was mainly explaining what went wrong with a footnote in that book.
Fortunately, there’s a much more comprehensive treatment of the issue by David Min. One issue I was agnostic about was whether prime loans to people with low (<660) FICO scores should have been called “subprime,” following Pinto, or not, following the common definition. Min shows (p. 8) that prime loans to <660 borrowers had a delinquency rate of 10 percent, compared to 7 percent for conforming loans and 28 percent for subprime loans, implying that calling them the moral equivalent of subprime is a bit of a stretch. Min also shows that most of the Fannie/Freddie loans that Pinto classifies as subprime or high-risk didn’t meet the Fannie/Freddie affordable housing goals anyway — so to the extent that Fannie/Freddie were investing in riskier mortgages, it was because of the profit motive, not because of the affordable housing mandate imposed by the government.
Min also analyzes Pinto’s claim that the Community Reinvestment Act led to 2.2 million risky mortgages and points out that, as with “subprime” loans, this number includes loans made by institutions that were not subject to the CRA in the first place. Of course, the CRA claim is ridiculous on its face (compared to the Fannie/Freddie claim, which I would say is not ridiculous on its face) for a number of reasons, including the facts that only banks are subject to the CRA (not nonbank mortgages originators) and most risky loans were made in middle-income areas where the CRA is essentially irrelevant.
Mainly, though, I’m just glad that someone has dug into this in more detail than I did.
By James Kwak
(Yes, I know that isn’t saying much.)
Most people think that Fannie Mae and Freddie Mac had something to do with the financial crisis. Some people think that they were the major reason the crisis happened, which (to them) proves that activist government policy was the cause of the crisis. Other people, including me, think they were a modest contributing factor because they did buy a lot of securities that were backed by subprime loans, but they were well behind the curve when it came to mortgage “innovation” and the creation of toxic assets. But that’s not the question here.
The question now is what to do about them. Although they had been private, profit-seeking companies for forty years, they were taken over by government regulators in September 2008 when they had become clearly insolvent, and are still being operated in conservatorship. Because Fannie and Freddie were very, very long housing, they have suffered massive losses since the financial crisis began. But because the private mortgage securitization market has collapsed, they are the bulk of the secondary mortgage market at the moment, which means the housing market could collapse without them.
Continue reading “My Most Libertarian Post Ever”
By James Kwak
Adam Levitin and Susan Wachter have written an excellent paper on the housing bubble with the somewhat immodest title, “Explaining the Housing Bubble” (which has been sitting in my inbox for a month). My main complaint with it is that it’s eighty-one pages long (single-spaced), which is most likely a function of law review traditions; had it been written for economics journals, it could have been one-third the length. I also have some quibbles with the seemingly obligatory paean to the importance of homeownership, which I think is an assumption that deserves to be contested. But overall it presents both a readable overview of the history and the issues, and a core argument I have a lot of sympathy for.
The argument is that the motive force behind the credit bubble was an oversupply of housing finance—in other words, the big, bad, banking industry. Levitin and Wachter’s key evidence is that the price of residential mortgage debt was falling in 2004-06 even as the volume of such debt was rising. As Brad DeLong’s parrot would say, that can only happen if the supply curve is shifting outward, not if the demand curve is shifting outward (which is what would happen if it were all the fault of greedy borrowers who wanted to flip houses).
Continue reading “Finance and the Housing Bubble”
By James Kwak
Since most of you probably read Calculated Risk, you’ve probably seen the Sun Sentinel story of the man in Florida who paid cash for a house–and still lost it in a foreclosure. Not only that, but he bought the house in a short sale in December 2009, the foreclosure sale happened in July 2010, and only then did he learn about the foreclosure proceeding.
Even after that,
“Grodensky said he spent months trying to figure out what happened, but said his questions to Bank of America and to the law firm Florida Default Law Group that handled the foreclosure have not been answered. Florida Default Law Group could not be reached for comment, despite several attempts by phone and e-mail. . . .
“It wasn’t until last week, when Grodensky brought his problem to the attention of the Sun Sentinel, that it began to be resolved.”
Bank of America now says it will correct the error “at its own expense.” How gracious of them.
If the legal system simply allows Bank of America to correct errors, at cost and with ordinary damages, after they happen, this type of abuse will only get worse. There’s obviously no incentive for banks not to make mistakes, and as a result they will behave as aggressively as possible at every opportunity possible. Yes, this was probably incompetence, not malice, on the part of the bank. But if you don’t force companies to pay for the consequences of their incompetence, they will remain willfully incompetent, and the end result will be the same.
By James Kwak
“Housing Fades as a Means to Build Wealth, Analysts Say.” That’s the title of a New York Times article by David Streitfeld. Here’s most of the lead:
“Many real estate experts now believe that home ownership will never again yield rewards like those enjoyed in the second half of the 20th century, when houses not only provided shelter but also a plump nest egg.
“The wealth generated by housing in those decades, particularly on the coasts, did more than assure the owners a comfortable retirement. It powered the economy, paying for the education of children and grandchildren, keeping the cruise ships and golf courses full and the restaurants humming.
“More than likely, that era is gone for good.”
I’ve been telling my friends for a decade that housing is a bad investment. These are real housing prices over the past century, based on data collected by Robert Shiller:
Housing is generally a worse investment than either stocks or simple U.S. Treasury bonds. Then why do so many people think it’s such a great investment?
- Continue reading “Housing in Ten Words”
By James Kwak
Mike Konczal did some more great work earlier this week in two posts on the not-so-exciting topic of second liens. I don’t have much in the way of new insight or analysis to provide, so let me just summarize.
A second lien is a second mortgage on a house. The second lien is junior to the first mortgage, meaning that if the borrower defaults and the first lender forecloses, the proceeds from the sale go to pay off the first mortgage; the second lien only gets paid back if the sale proceeds exceed the amount due on the first mortgage. You can see where this is heading.
Konczal’s first point was that in the stress tests almost a year ago, the big four banks held $477 billion of second liens and estimated that these assets were worth 81-87 cents on the dollar, so they would take $68 billion in losses (under the “more adverse” scenario). Konczal estimated that they were instead worth 40-60 cents on the dollar, implying $191-286 billion in losses.
Continue reading “Underwater Second Liens”
Since the peak of the financial crisis, both the Bush and Obama administrations have been trying to rescue both large banks and homeowners, often announcing programs for both in the same press conference. The programs for large banks have gone well, from the beneficiaries’ perspective (but not for small banks); programs for homeowners, not so much. As more people walk away from underwater mortgages, Assistant Treasury Secretary Herb Allison recently said, “We haven’t yet found a way of dealing with this that would, we think, be practical on a large scale.”
The failure of the Obama administration so far to come up with a working solution to the problem of mass defaults and foreclosures may be due to practical barriers, such as lack of capacity among mortgage servicers or legal uncertainties regarding securitization trusts. Alternatively, however, it may simply be that the administration doesn’t care that much. Perhaps the primary goal of homeowner assistance all along was to detoxify the toxic assets on large banks’ balance sheets; now that those banks are off of life support, maybe the mortgages themselves don’t matter that much.
Congressman Brad Miller’s proposal in The New Republic should put that question to the test.*
Continue reading “Brad Miller’s Challenge”
For months now, Calculated Risk has been criticizing the policy of “extend and pretend”–the practice of pretending that real estate loans are still worth their full value, making modifications so that borrowers can avoid going into default, so that banks don’t have to recognize losses on their assets. Here’s one story about “zombie buildings”–office buildings, in this case.
Alyssa Katz has a great article in The American Prospect about extend and pretend when it comes to multi-unit residential buildings, focusing on New York City. Expensive condo towers are now “see-through” buildings (so named because you see through the glass walls right through the empty floors–a phenomenon I first saw in 2001, after the Internet bust, along Highway 101 on the San Francisco Peninsula). Another problem is apartment complexes that were bought by private equity firms and flipped to developers during the boom with plans to evict the low-rent tenants and replace them with high-rent tenants; the high-rent tenants never arrived, the developers can’t make their loan payments, and no one is maintaining the buildings for the remaining tenants. (And no one is saying that property developers have a moral obligation to pay their debts rather than turn their properties over the bank.)
One of the underlying problems is that developers (or the banks that inherited their properties) have an incentive to hang on and hope for a return to prosperity that will deliver the promised condo buyers or high-rent tenants–in other words, betting on another boom. The alternative is selling the properties to someone who will convert or restore them to the type of housing that there is actually demand for–affordable rental units–but that means that someone has to take a loss, because an affordable building is simply worth less than one stuffed with investment bankers. Unfortunately, as Katz says, “With so many lenders at the brink of insolvency, the Treasury Department and the Federal Deposit Insurance Corporation (FDIC) appear to be in no rush to cause them further pain.” The lack of urgency was unwittingly confirmed by a Treasury spokesperson, who said, “The commercial real-estate market is something we’re watching closely, but it’s premature to discuss solutions.”
By James Kwak
The Community Reinvestment Act is a law originally passed in 1977 that directed federal regulatory agencies to ensure that the banks they supervised were not discriminating against particular communities in making credit available.The onset of the subprime mortgage crisis triggered a flood of sloppy, lazy attacks on the CRA claiming that since the crisis was created by excess lending to the poor, and the CRA was intended to increase lending to the poor, the CRA must have caused the crisis. These arguments suffered from a mistaken premise (subprime lending had a modest negative correlation with income, but many subprime loans were used by the middle class to buy expensive houses in the suburbs and exurbs of California and Nevada) and a failure to check their facts (“Only six percent of all the higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas, the local geographies that are the primary focus for CRA evaluation purposes.” — Randall Kroszner, former Fed governor appointed by President George W. Bush, in a Federal Reserve study that also found that subprime loan performance was no worse in CRA-covered zip codes than in slightly more affluent zip codes not covered by the CRA.)
Yesterday at a Cato Institute conference, Edward Pinto, chief credit officer at Fannie from 1987 to 1989 and currently a real estate financial services industry consultant (according to recent Congressional testimony), rolled out the new line. The new argument is a curious mirror image of the old argument (which Pinto himself may not have made): now the subprime explosion did not cause the housing bubble, but was caused by the housing bubble and … wait for it … the CRA caused the housing bubble, along with the affordable housing goals of Fannie and Freddie.
Continue reading “CRA Bashing, Nth Generation”
Calculated Risk says there is a deal (bullet points are from his post):
- Income eligibility for first-time home buyers stays at $75,000 for individuals, and $150,000 for couples.
- For move-up buyers, income eligibility is $125,000 for individuals and $250,000 for couples.
- There is a minimum 5 year residency requirement – in their current home – for move-up home buyers.
- The tax credit is the lesser of $7,290 or 10% of the purchase price.
- The credit runs from Dec. 1, 2009 to April 30, 2010, with an additional 60 day period to close escrow. (So end of April to sign contract, end of June to close escrow)
- Expect bill to be signed by Friday, packaged with the unemployment benefit extension.
So my wife and I fit under the $250,000 couples limit. We’ve lived in our house for eight years. So now the government is willing to give me $7,000 to buy a new house? That would be a sale that wouldn’t have happened otherwise — but what good would it do the economy?
As I tried to explain previously, an $8,000 credit for first-time homebuyers will raise prices by less than $8,000 (leaving aside the effect of leverage for simplicity), because demand at any price point only goes up for first-time homebuyers, not all homebuyers. That means that the buyer gets a fair chunk of the subsidy. But vastly expanding eligibility like this (about 67% of households own houses, and probably about half of them have been in the same house for five years) increases the amount by which prices will go up, which lowers the buyer’s share of the subsidy and increases the seller’s share.
By James Kwak
Our Washington Post online column today is another cry in the wilderness against the homebuyer tax credit.
There are many arguments against the tax credit. One argument we make is that the tax credit is a benefit for sellers of houses more than for buyers of houses. This is simplest to see if you imagine a permanent credit available for all buyers: “Imagine the credit were expanded to all home buyers and made permanent. This would simply boost housing prices at the low end of the market by close to $8,000, since all buyers would be willing to pay $8,000 more. (Prices would rise by a little less than $8,000 because at higher prices, more people would be willing to sell.)”
It turns out Nemo had made a similar argument already.
Continue reading “Tax Credits, Screwdrivers, and Supply and Demand Curves”
With everyone hoping for positive GDP growth in Q3 and Goldman Sachs analyst Jan Hatzius now predicting growth at an annual rate of three percent in the second half of the year, the banks, investors, and politicians are all hoping that that nasty problem of foreclosures would just go away already. Unfortunately for everyone – especially the people losing their houses – there’s no reason for it to go away.
Unemployment is always a lagging indicator, and given the record low number of average hours worked, it will turn around especially slowly this time. Until then, people will continue to lose their jobs and wages will remain flat, and any small rebound in housing prices is unlikely to help more than a few people refinance their way out of unaffordable mortgages. So unless the other part of the equation – monthly payments – changes, the number of foreclosures should just continue to rise.
Calculated Risk provides this great chart from Matt Padilla (see the CR post for definitions of the categories):
Continue reading “The Problem That Won’t Go Away”