Raising the demand for housing makes sense now. While fundamental factors clearly played a role in driving down house prices that were at excessive levels two years ago, we have argued in a paper (to be published in the Berkeley Electronic Journal of Economic Analysis and Policy) that in most markets house values are today lower than what is consistent with the average level of affordability in the past 20 years.
Nonetheless, without policy action house prices are likely to continue falling, thanks largely to the meltdown in mortgage markets and the weakening employment outlook. Conversely, we see little risk that increasing the demand for housing will touch off another housing bubble. And indexing the mortgage rate to the Treasury yield could avoid this outcome in the future. While the economy is contracting, low interest rates would spur housing activity. When economic activity improves, the U.S. Treasury yield and mortgage rates would rise.
A 4.5% mortgage rate is not too low. The 10-year U.S. Treasury yield closed at 2.3% on Dec. 12, 2008. Hence a 4.5% mortgage rate is 2.2% above the Treasury yield, above the 1.6% spread that would prevail in a normally functioning mortgage market.
Some have argued that lenders should earn more than the average 1.6% spread, to compensate for the fact that housing is a much riskier investment today. We don't think so. Recall that a mortgage can be thought of as a risk-free bond plus two possibilities that increase risk to lenders: default and/or prepayment. Historically, the risk of default adds about 0.25% to the interest rate. The remaining spread of the mortgage rate over the Treasury yield represents the risk of prepayment and underwriting costs. With falling house prices, the risk of default could indeed add 0.75% or more for a newly underwritten and fully documented loan. But 4.5% would be the lowest mortgage rate in more than 30 years -- so the additional risk to lenders of prepayment would be almost nil. And low mortgage rates would substantially reduce the risk of further house price declines...
Brad DeLong seconds the motion. Arnold Kling vehemently dissents.
I've been thinking a lot about this because I've been following rather closely Elizabeth Warren's attempt to broaden TARP's mandate from protecting the financial system to making sure that people don't suffer from falling house prices. (See Economics of Contempt for an acerbic critique of that attempt from the center-left). My recent foray into the housing market has exposed me to the tragedy of overextended landlords, and it is indeed tragic. We've seen a lot of landlords who are clearly at the end of their financial rope. Can we help them?
I'm pretty sure we can't, for several reasons. The first is that a lot of economists (and me) think that the housing market has quite a bit further to fall--but perhaps Glenn Hubbard is right and they are wrong. But the second problem is that I don't think what we're seeing is simply a matter of excessively high interest rates. ARM rates (that being what the problem mortgages mostly had) are not high right now.
I think we're seeing a lot of problems that low mortgage rates won't fix: a supply overhang, as Arnold points out, and people who need to sell in order to move or downsize after a job loss. But mostly I think the problem is that the housing market, and homeowners, had not merely become dependant on easy credit, but on expanding credit. House prices two years ago were founded on the implicit assumption that the homeownership percentage would keep rising, not merely stay steady. And it can't rise any more, or even stay where it is, without putting a lot of people into risky loans.
Risky not because they necessarily have a high interest rate, but because when you own a house, you're very illiquid. If you need to sell quickly, to move or downsize, you can end up in big trouble. The way we used to protect against that illiquidity was to require big downpayments--traditionally, 20% of the house. That way you could be virtually assured that you could, if you really had to, get out without involving the bank.
Some of the problems in mortgage markets are because of resetting interest rates. But a lot of the problems are because people are hitting financial hardship, or they need to move for some other reason. In the olden days, people in trouble could take out home equity loans to tide them over, or sell the house. But with negative equity, they can do neither. If someone has lost their job, lowering their mortgage payment from $1,000 to $850 is not going to help for long--and indeed, getting into that sort of program will probably take longer than they have.
The only way to really stabilize markets is to somehow build up home equity. But such a program is both incredibly expensive, and politically ludicrous--are you really going to give people tens of thousands of dollars outright because they took out a mortgage they couldn't afford?
Beyond that is the problem of how the government manages all these loans. They will, definitionally, be the ones to the borrowers most likely to default on even the newer, cheaper mortgage. Foreclosure is said to cost banks 25-50% of the price of the house; it will not be cheaper for the government.
Whether or not it should, there are certainly situations where the government can prop up prices artificially. But the housing market is too big, and too dislocated, for that to work at this point. The supply curve and the demand curve will find each other--and given the overhang of new construction, I'd guess that in the near future, they'll meet at a point even lower than we're seeing now.
Hear, hear! (Or, is that, "Here, here!", or, "Hear, here"?)
I don't think the government should try to prop up home values even if it could. My concern is the massive incentive this would create for risky behavior. Many homeowners did not max out their borrowing during the decade of easy credit and rising home values. At the time, family, friends, and neighbors chided us for being too conservative (or lazy) in managing our personal finances. Why not borrow out the equity in our home and buy a rental property or invest in stocks? Why not trade up from our 2,000 sqft home to the McMansion 4,000 sqft home in the gated community?
The answer, in my case, was always the same: doing those things wouldn't be prudent. Yes, if everything went as hoped, borrowing out cash and investing and/or buying a larger home, would have been wonderful. But, if things didn't go as we hoped -- if I lost my job, if interest rates went up, if my stock portfolio fell, or if housing prices collapsed -- I'd have put my family's financial security in jeopardy. So, I and millions of other homeowners did not take huge risks with our financial futures.
Now, if the government steps in and rescues all those who did (willingly!) take on too much risk, I'm worried about the implications of such a precedent. Next time, why should I avoid risk if the government is going to absorb all or most of the downside? Four years ago my wife and I choose not to invest in a rental property along with her brother. My brother-in-law invested with another couple and sold the property a couple of years later for a $50,000 profit. Why should I forgo a chance for such profits -- no matter how remote -- if I can rely on the government to bail me out? Might as well build my dream house in the middle a flood plain, on top of a fault, backed up next to the wild-fire-prone nature preserve.
"Since Labor Day, the Fed's assets have zoomed to $2.31 trillion from $905.7 billion. And what is the significance of this stunning rate of asset growth? Simply this: The Fed pays for its assets with freshly made dollars. It conjures them into existence on a computer; "printing" is a figure of speech." From a link 'too little trust' at Instapundit recently. Obviously, the kind of plan you criticize, as David says, would lead to further cynicism. Ultimately in that scenario 'the change people believe in' can become pretty volatile.
I don't even see Obama's plan. What, are we going to have finance guys building bridges? The Hatch Act will make sure we go back to that FDR system where we overpay those working, and are we going to start with jobs for illegal immigrants? They are a significant part of the construction work force in Texas.
Which "system" is that? The only people on this planet who are "overpaid" are the parasites who sit in their corner offices all day, trying to increase their wealth by sucking up to stock analysts, while telling their admin. ass't. to get them more coffee, "& get the creamer right this time!!"
Your final paragraph only confirms your willfully blind ignorance.
There's one missing point to your fine analysis -- the price of homes long ago outstripped the real price most families could afford to pay. So a "market correction," which brings the standard cost of a home in line with what the standard family can pay, would seem inevitable at some point.
Another solution to the problem might be the kind of advice we give to investors in the stock market; view the home as a long term investment, and borrow against the end of the mortgage. While this won't work for people who have to sell now, for people who want to stay in their homes, re-write the mortgage to a more affordable amount, and put the pay-off for the equity difference on some future sale (or at the end of the mortgage payment cycle.) That would give the homeowner the ability to build equity at a slower rate, with a lump sum payment going to the lender at the time the home is sold.
And on that construction work force losing jobs; beware. Skilled tradeworkers -- plumbers, electricians, welders, etc. -- were already in short supply; average age was about 47 a few years ago. Joe the Plumber, who worked for a plumbing company but wasn't a real plumber and didn't really want to be one, is the rule, not the exception. Expect to see these folks become harder and harder to find as they retire over the next many years; particularly without a boom to bring new trade workers on line.
"are you really going to give people tens of thousands of dollars outright because they took out a mortgage they couldn't afford?"
Are you REALLY asking that question in light of what we have already seen? People are already getting that much in regards to the various handouts from the government.
Alexander Tyler was right.
"Democracy cannot last as a permanent
form of government. As soon as the citizen know that they can vote money out of the public coffers the majority will always vote for the candidate that will give them the most money. And the civilization will fall from fiscal irresponsibility."
And to add in some of my own observations from experience in and watching committees or executive positions in the workplace.
me quoting myself: "Democracy and Tyranny are only different in the short term. But in the long run, Democracy will end up with the same conclusion as Tyranny, it just takes longer to get there."
I'm growing more jaded with every passing day...
OK,
Here is what I don't understand. I know a bunch of 20 somethings who are in the process of buying homes now. These are people who for career reasons may need to move in the next three to five years. I told them that home prices could still go down another 30% from here.... Their response - we need a place to live. I said - rent. Their response - renting is throwing your money away.
I told them if you buy a 250k house now and we go down 30% you've lost 75k. If you need to move in three years you could lose 75k in equity and since 80% of those first couple years mortgage payments are interst - if you are forced to sell, you've basically flushed those payments down the toilet.
The final response - we want a house.
I just don't understand it. Everyone seems to have based their thinking on ever rising home prices - so many can't even grasp what it would mean to them financially if they were forced to sell.
Sam,
That quote from Alexander Tytler isn't from Tyler (Tytler).
http://www.lorencollins.net/tytler.html
Which means that someone made a compelling (not necessarily true, just compelling) insight and tried to hock it onto someone who is dead.
JMO,
You aren't supposed to understand irrationality. That's why it's irrational.
JMO,
I've wondered at the same thing as you, and I've decided it's a class thing - owning your own home signals to yourself and others that you've got it together financially. Middle class people seem to have trouble respecting themselves if they're still renters in their thirties.
Also probably everyone they know other than you has telling been them for the last five years they're a financial idiot if they don't buy, and it's hard to buck all that disdain on top of the class issues.
people on this planet who are "overpaid"
It's conventional wisdom that you can build a bridge without the Hatch Act cheaper because union scale wages are required under the act.
During the Depression, if you had a job it was typically at above market clearing rates, union determined. Unemployment at the same time was high. That didn't change until the War Board in WWII abrogated union contracts.
JMO,
Surely they can rent a house? Most suburbs of big cities are teeming with rental house opportunities. And you can be that plenty of owners of these rentals are more than happy to rent them out considering the alternative is to leave it empty or sell at a loss.
Sam,
They can rent a house - they just don't belive in renting.
Anne is totaly righ. I also think most middle class people wouldn't feel comfortable bringing a baby home to an apartment.
JMO,
You can rent a house. That is what I do. Apartments and condos suck. Living asshole to elbow with your neighbors gets really old after you are about 30. With all of the forecosures, now is a great time to rent a home. Here in Washington, the price of renting is considerably less than the cost of buying, even when you consider the tax advantages of the home mortgage deduction.
The 20 somethings you speak of need their heads examined. Not only do they risk losing money when they move in five years, even if they break even, they still will have to pay the outragous realtor fees to sell their house. Absent an unreasonable rise in the value of your home, something that in this market is not going to happen for a long while, the transaction costs of realtors mean you lose money on a house if you stay in it less than five or six years. Further, Forbes is projected that ten of the bigggest markets in the country will lose 20% or more of their value in 09. Which part of buy low sell high do these people not understand?
Look! People are doing something financially and socially unsustainable and the consequences are catching up to them...
... Quick, let's subsidize it so they can do it even more!
But we gave the greedy bankers $700 billion, and badly managed polluting auto makers $17 billion. How can we now fail to help the homeowners?
And for that matter, now that we went to war with Iraq, how can we not go to war with Iran?
If people find it declasse to rent, just wait until they have to start taking the bus.
I think it was Nouriel Roubini who had a somewhat different idea. His proposal was for the government to temporarily seize by eminent domain mortgage notes for properties in zip codes/locations where prices had dropped by a certain percentage -- and then write down the principal (and lower the interest, too, IIRC) of any homeowner wishing to participate. Wouldn't help everybody -- but borderline cases who wish to save their homes would be helped. Basically, it amounts to forced haircuts for lenders, which costs the taxpayers nothing compared to direct government bailouts. Lenders themselves would be compensated by sharing in any equity at time of resale. Don't know if this idea is still being discussed, but I thought it was clever.
Subsidizing 4.5% mortgages isn't a bad idea, as long as it's limited to those with significant equity in their houses, e.g., limited to mortgages with a loan-to-value ratio of 80% or less (with value based on current appraisals, of course). The chances of the government losing money on a deal like that would be slim. This wouldn't directly help borrowers who are currently underwater on their houses, but it would help stabilize real estate prices and act as a fire wall preventing a wider swath of borrowers from going underwater on their mortgages. It would also provide an economic stimulus by increasing many households' cash flows by a few hundred dollars per month each, as the result of lower mortgage payments.
Making these loans available to new buyers (again, with the 80% L-T-V requirement, e.g., those who put 20% down) would make the deal fair to those prudent renters who saved their money for years, waiting to buy.
Jasper,
There are five problems that come to mind with forcing lenders to take haircuts on mortgages via the scenario you mention.
The first is that there's no need to resort to eminent domain to buy non-performing mortgages: most lenders (or other owners of the loans) will be willing to sell them, at a significant discount to their face value.
The second is that most lenders and other loan holders are also already willing to modify their non-performing loans, and are already doing this.
The third problem is that most modified loans still default.
The fourth problem is that without the threat of foreclosure (a threat most loan owners would prefer not to act on, because it's a money-loser for them), more borrowers would be tempted to stop paying in order to qualify for this government program (moral hazard).
The fifth problem is that (assuming there is still a private sector mortgage industry then) future mortgage interest rates will rise to compensate lenders for the risk of this sort of government cram down.
Dave,
Points 1-4 are spot on. But, as to point 5:
Maybe for 5 year -10 years at most... But as soon as prices start rising again, the real estate bust and gov't cramdown with be quickly forgoten.
DaveinHackensack: The first is that there's no need to resort to eminent domain to buy non-performing mortgages: most lenders (or other owners of the loans) will be willing to sell them, at a significant discount to their face value.
Yes, but, the fact that somebody new owns the paper doesn't mean that that the new owner will modify the terms. The purpose of the plan I regurgitated (admittedly quickly, without much detail) is to get mortgage principal and hopefully interest rate reduced on folks who are upside down -- in other words to reduce their payments so they can stay in their homes.
The second is that most lenders and other loan holders are also already willing to modify their non-performing loans, and are already doing this.
Maybe so. I read this proposal on the 'sphere a couple of months ago, when apparently foot-dragging by lenders was allegedly a problem.
The third problem is that most modified loans still default.
Sounds likely, although I'm not sure the proposal required re-writing of terms to eschew analyzing creditworthiness. Perhaps the proposal is primarily geared toward reasonably solvent folks in an effort to get them to decide NOT to join the ranks of people mailing their keys; in other words, for plenty of people -- many of them with decent incomes and solid credit -- walking away is the rational thing to do. This plan addresses that.
The fourth problem is that without the threat of foreclosure (a threat most loan owners would prefer not to act on, because it's a money-loser for them), more borrowers would be tempted to stop paying in order to qualify for this government program (moral hazard).
There is no such requirement -- that's one of the idea's most elegant parts. It attempts to get around the moral hazard problem found in most of these ideas by allowing everybody to get their loan re-written if the property in question A) is worth less than the debt; and B) the property in question is situated in a zip code whose average decline meets the decided upon requirement (say, 15% or more average decline since the peak). Borrowers, of course, would have a powerful incentive NOT to take advantage of the plan unless they really needed to because they'd have to share any equity with the lender.
The fifth problem is that (assuming there is still a private sector mortgage industry then) future mortgage interest rates will rise to compensate lenders for the risk of this sort of government cram down.
Maybe. But on the other hand the taxpayers save billions. Or, lenders could (heaven forbid!) develop stricter standards, so they never/rarely find themselves with collateral worth less than a note, in which case they'll face no risk of cramdown.
Again, this plan was discussed several months ago so I could have a few of the details wrong -- although I am certain it's associated with Roubini -- but I just thought it was worth discussing and wondered why it died.
Also probably everyone they know other than you has telling been them for the last five years they're a financial idiot if they don't buy, and it's hard to buck all that disdain on top of the class issues.
That's exactly right. "Renting is just throwing money away" is one of the most ridiculous financial memes out there. What do its proponents say about mortgage interest, property taxes, homeowner's insurance, maintenance, HOA fees, etc, etc?
Middle class people seem to have trouble respecting themselves if they're still renters in their thirties.
Yeah, it's another example of cargo cult economics, where we get the idea that emulating the incidental results of success will lead to actual success. In a strong economy consumer spending is high, therefore we should hand out stimulus checks and encourage everyone to spend rather than save or pay off debts. Financially secure people can afford nice houses, therefore everyone should buy one.
I wrote a blistering letter to the Wall Street Journal, taking issue with Hubbard and Mayer. I still cherish the hope that they may print it. Basically, they're taking the fall in home prices as a problem, but to plenty of people (those who want to buy at affordable prices, it's a solution. Why should renters saving to make downpayments see their taxes used to make it harder for them to afford homes?
Also, Hubbard doesn't mention it, but a big part of teh bubble is in land, not buildings, so the ordinary balance of supply and deamnd doesn't work. They aren't making any more land, so higher prices don't raise the supply.
Given low taxes on land, lad speculation looks profitable, and often is, so we get these bubbles. But the bubble prices have expected future appreciation, so once prices stop rising so fast (and they have to, sooner or later), they don't reach a point of stability, they crash. And then speculators and their hacks call for a government bailout.
If we taxed land at a high rate, and cut other taxes, this kind of bubble wouldn't happen in the first plce, because it wouldn't make sense to hold valuable land on speculation. Read Henry George, o ye little chickadees of Megan's, read Henry George.
Jasper:
"Yes, but, the fact that somebody new owns the paper doesn't mean that that the new owner will modify the terms."
The investor who buys the non-performing mortgage has every incentive to modify it: it's easier to make a profit by buying non-performing mortgages at a steep discount to face and getting the borrowers to start making (lower) payments again than it is to foreclose on the property and try to sell it in this market (and be liable for the property taxes and other holding costs in the meantime). Back in August, I wrote a post about two groups of investors, in Bergen County, NJ and Orange County, CA, respectively, who were already doing this, "Profiting from the Credit Crunch/Real Estate Bust".
Proping up home prices is a bad thing for first time home buyers. The idea of wanting to waste resources to artificially raise costs of living (especially during a recession!) is retarded.
It would also only help banks in the short term. In the long run, I'm fairly certain the banks would rather have sustainable and somewhat predictable prices based on market fundamentals rather than unsustainable and unpredictable high prices based on the whims of Washington.
"It attempts to get around the moral hazard problem found in most of these ideas by allowing everybody to get their loan re-written if the property in question A) is worth less than the debt; and B) the property in question is situated in a zip code whose average decline meets the decided upon requirement (say, 15% or more average decline since the peak)."
I don't see how bailing out the over-extended AND their neighbors does anything to prevent moral hazard. How about we just call this the "California and Florida get to mug everybody else" plan.
Why are there tax breaks on mortgage interest deductions? Why are capital gains taxes on home sales allowed to be rolled into new purchases? Why is there accelerated depreciation of commercial property? The fact is, all of these things help rich people alot more than poor and middle class people. Unfortunately, by handing out these crumbs to homeowners, we've subsidized a real estate investor class who pay virtually no taxes while we pay Federal Income taxes of up to 35% of our money earned. How about we get rid of all these deductions and lower the income tax? Home ownership isn't that great.
I thought a certain poster had blamed it all on zoning:
[sarcasm]By that notable non-hack, Ed Glaeser[/sarcasm]
Also:
I don't think there's a solid cite for the authorship of this quote or anything similar to it. Regardless, this is simply factually untrue: I see that an overwhelming numbers of the voting public were against the financial bailout, yet it passed. It seems that 'the fall of democracy' dates to when the voters choices for elective office become irrelevant.
Mmmmm. Possibly. Or it might be a emblem of rugged self-sufficiency. Put less sarcastically, ownership conveys more freedom of action. We have three dogs, three cats, and a rabbit. At other times we've had other animals, such as chickens, that were given free reign of the yard and sometimes the house. I think it would be difficult to find a landlord who would permit this. There's also the 'home improvement' angle. Last year we took an 1/8" off all our floors, buffed them to a gloss, and sealed them up with several coats of polyurethane. We had other people do this, since the project was so large it would have taken us several weeks to do it ourselves, and at a cost of well over $2,000. Again, a landlord wouldn't really want to do this unless we spent the money ourselves, in which case they would be the ultimate beneficiaries of any improvements we made.
we have argued in a paper...[that]in most markets house values are today lower than what is consistent with the average level of affordability in the past 20 years.
If your analysis of "affordability" doesn't show a simple ratio of monthly payment to median income, then the analysis falls flat on its face. Affordability was, and remains, a function of income, and housing has been obscenely overpriced for well over a decade now. That it's dropped from "obscene" to "absurd" does not make it "affordable."
Why, oh why is it a terrible thing if the price of a crucial commodity falls? Why is it so horrible if people can actually buy homes AND make their retirement account contributions without having to live on peanut butter and pasta? What would be so terrible about people treating their houses as commodity purchases and not a source of short-term income?
And yes, the "you throw money away when you rent" meme is one that has been consistently debunked yet still gets tossed around as gospel, for reasons that completely lose me.
I don't see how bailing out the over-extended AND their neighbors does anything to prevent moral hazard.
It doesn't bail out "the over-extended" or "their neighbors" as such. It doesn't bail out anybody based on anything they've done (such as fall behind in their payments). Again, that's the beauty of it: with Roubini's plan nobody has an incentive to stop making payments, and nobody has cause to bitch because their irresponsible neighbor is getting government help "but I'm not!" Eligibility is based solely on 1) what your house is worth relative to the balance of the original mortgage; and, 2) how badly depressed real estate prices are in your area. If you've got equity -- or if most homes in your area are holding their value reasonably well -- you're out of luck -- no matter how far behind you are on your mortgage.
And yes, the "you throw money away when you rent" meme is one that has been consistently debunked yet still gets tossed around as gospel, for reasons that completely lose me.
Why would this be "competely lost" on anybody? It's obvious that a lot of people don't have the discipline to plow the savings from renting (as opposed to buying) into investments, so eschewing a home purchase indefinitely exposes one to the risk of house inflation in their old age. Of course, even if they do have the discipline to invest rent savings, there's no guarantee of the portfolio's performance, and you can't live in a worthless stock or bond. If your home's value goes down the toilet, at least you can live in it. I'd rather be a modest income 83-year old who owns outright a small house than a ripped off 83-old renter who plowed his savings over the years into a booming but now worthless Madoff fund.
So, although the "throwing money away when you rent" meme is inaccurate, it shouldn't be hard to understand how it got started, or why people repeat it.
I come back to two premises in thinking about this sort of personal bailout: 1) Nobody knows for sure what the economics of such a thing would look like. It's impossible to predict with any reasonable accuracy how ANY of these scenarios would actually play out. And 2) Our society rewards good economic actions and punishes bad ones. If I displayed prudence for the last ten years, and someone else was foolish, then going forward I should be richer than they are. If you demand impossible bargains and refuse to listen to common sense, you end up broke. It's glossing over a lot of people's pain, but if we lose sight of this second premise then what kind of society are we living in?
Oh and also, as for this discussion of how people think it's beneath their class to rent and not own a home...yeah, screw yourselves. You aren't too good for a shitty apartment, and now that's exactly what you're going to get...if you're lucky.
Jasper:
Ah, but you're assuming that the person who bought his home did so at a price that he could afford throughout the length of the mortgage. Yes, in such a case, why rent when you can buy? A house, as I said before, is a good commodity investment. Once you own it, you've got something tangible and useful, and you can always trade down to get some cash out of it.
However, this has not been the situation, at least for first-time buyers, for over a decade in most US housing markets. People put themselves into mortgage situation that were untenable in the long-term for the purpose of short term gain that was very clearly not possible. The same people who didn't have the financial discipline to save long-term didn't have the financial discipline to stay out of an overpriced housing market. Those who spent five minutes looking at their income vs. their potential monthly mortgage payments and said "no thanks, I'd rather rent at a reasonable price" did. Propping up home prices is going to do ZERO to address the fundamental imbalance, and only prolong the inevitable collapse.
efrex: I don't dispute your last points -- obviously getting a bad or unaffordable deal on house, or overextending oneself, doesn't make sense. Any more than it would make sense to rent an apartment you can barely afford. I just sensed a bit of disingenuousness accompanying your "how did this stupid meme get started?" comment. I was pointing out, in other words, that a house you own is obviously highly useful, as getting rained and snowed on really sucks, and as the conventional wisdom alternative - renting and investing the difference -- also carries risks (namely investment performance and housing inflation).