Arnold Kling  

Difficult Facts About Housing

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It is interesting to go back and read of the papers delivered at a Fed conference in Jackson Hole in 2007. Tanta was on top of them.

For example, Robert Shiller wrote,

Dramatic home price booms since the late 1990s have been in evidence in Australia, Canada, China, France, India, Ireland, Italy, Korea, Russia, Spain, the United Kingdom, and the United States, among other countries.

He has charts suggesting that the Netherlands and Norway experienced greater booms than the United States. In his book The Subprime Solution, he has a chart that shows London house prices rising faster than prices in Boston.

What makes this a difficult fact is that so many explanations of the house price boom are U.S/ specific. It is hard to argue that the Community Reinvestment Act or the repeal of Glass-Steagall are what account for the home price booms in Norway or Spain. In fact, Shiller's view is that bubble/contagion is the only theory that can account for the multinational nature of the home price boom.

I want to argue that securitization helped stimulate the boom. However, securitization took off much less in other countries, as the paper by Richard K. Green and Susan M. Wachter points out. However, they do note that housing finance changed in a number of countries, moving from specialized institutions under tight government control to commercial banks. This reduced the extent of credit rationing in the housing finance systems.

Green and Wachter argue that up until the 1980's, housing finance in many countries was segregated from the overall capital market. Then,

In the 1990's, the integration of previously segmented mortgage markets into global capital markets allowed general interest rate declines to generate mortgage rate declines that both increased housing affordability and decreased the relative cost of housing.

The Green and Wachter paper offers hope to those of us who want to assign a role for financial market innovations in explaining the home price boom. Even the the boom took place in many countries, financial innovation took place in many countries as well. However, Shiller would argue that institutional changes are a response to housing boom psychology, rather than an exogenous factor.

They point out that from 1997 to 2005, the number of households with a mortgage increased by 20 percent, while the number of households increased by only 9 percent. Total mortgage debt increased by 250 percent, while nominal GDP increased by only 50 percent.

A second difficult fact, at least for me, comes from a more recent paper by Major Coleman, IV, Michael LaCour-Little, and Kerry D. Vandell.

The national average LTV for newly originated home loans over the observation period is provided by the Federal Housing Finance Board's Monthly Interest Rate Survey (MIRS) data. It provides evidence of considerable stability over the entire period at around 80% for first liens, thus suggesting that the notion of higher LTV's after 2003 due to increases in alternative mortgage densities was not consistent with the empirical evidence.

However, the authors do note that they are not looking at trends in second mortgages. If second mortgages and other forms of creative financing were increasing, then borrower down payments could have been falling. Also, additional risk factors were being layered on to mortgage lending. First, there was a rise in non-owner-occupied loans. Second, cash-our refinances are riskier than purchase loans, because with a purchase loan the buyer has an incentive to strive for a low price while with a cash-out refi the borrower wants to get the highest possible appraised value.

Comments and Sharing

COMMENTS (11 to date)
Dan W writes:

You're point about 2nd mortgages is right on. I worked at a bank for a few years and many, many loans were done as 80% 1st and and 2nd or HELOC for another ~ 25% and the buyer got a house for the $250 loan app fee as their only out of pocket expense.

Cyberike writes:

To add at least some minor confirmation about Mr. Kling's suspicion about down payments and second mortgages, we financed about 2/3 of the down payment on a investment property mortgage through a second mortgage on our homestead. I believe this was fairly common, although I think I had to sign something that claimed we did not do what we did.

We, however, are in no danger of defaulting.

Vasco writes:

"However, they do note that housing finance changed in a number of countries, moving from specialized institutions under tight government control to commercial banks. This reduced the extent of credit rationing in the housing finance systems."

There may be some truth to this. I live in Portugal, and housing finance here was always the province of commercial banks, which have developed a considerable expertise. There was no real estate boom during the last few years; this may however at least in part attributable to the economic stagnation we have experienced during that same time, when other countries were experiencing high growth.

David Strom writes:

Martin Wolf does an excellent job addressing the underlying causes of the mortgage boom in his book Fixing Global Finance.

He argues that a driving force behind this phenomenon was a global savings glut driven by countries with large current account surpluses and high savings rates such as China, Japan, and the oil producing countries.

Capital in search of returns flowed into the US, UK, and other countries with large current account deficits leading to a lending boom.

His book is well worth reading, and my few sentences don't do it justice. I believe that Wolf's analysis does explain why interest rates remained so low despite the US's huge fiscal deficit and increase in consumer debt.

parviziyi writes:

Green & Wachter say: "...allowed general interest rate declines to generate mortgage rate declines that both increased housing affordability and decreased the relative cost of housing.... From 1997 to 2005, the number of households with a mortgage increased by 20 percent, while the number of households increased by only 9 percent. Total mortgage debt increased by 250 percent, while nominal GDP increased by only 50 percent."

We should agree that the low rates were the essential enabler, though we may debate what factors in turn enabled the low rates. The rates were low throughout the developed world.

Portugal is anomalous so here's a quote about Portugal from an article you can find on the internet:

The house price boom that swept through most of Europe and the developed world from 1995 to 2006 missed Portugal. From 2001 to 2006, average property prices rose 100% in Spain, compared to a measly 17% in Portugal. Two main factors led to weak house price growth in Portugal: (1) Housing oversupply. In the 1980s [when Portugal wasn't part of a European monetary system] low interest rates encouraged housing investments. Dwellings per 1,000 inhabitants rose from 349 in 1980 to 482 in 2000, among the highest in Europe. The total housing stock increased 28% from 1981 to 2001, while population only rose 4.4%. (2) Weak economic growth. Portugal's average annual GDP growth from 2001 to 2005 was 0.8%. Growth in 2007 was 1.1% the lowest in all of Europe.

About Spain, where GDP growth has averaged around 3.5% a year over the past dozen years, the same website says: "Spaniards traditionally did not finance house-purchases through mortgages. But the liberalization of the mortgage market has changed all that. Outstanding mortgage debt has grown from 14% of GDP in 1990, to 32% in 2001, to 51% in 2005 and to more than 61% by end-2007."

Larry writes:

Low rates and the many other homeowner subsidies pushed prices up right, making homes affordable only in the very short term. The net was a market on crack, now undergoing withdrawal. So many want just one more hit...

Paul Power writes:

The British leftsh weekly newspaper The Observer has an article by Will Hutton today ( that states "The Bank of England revealed in its financial stability review last week that in the seven years up to 2008 British banks had lent £700bn more to their customers than they had saved, making up the difference from taking deposits from abroad via the now dead markets in securitised assets insured by credit default swaps".

Hutton's economics may not please readers herabout but he's almost certainly reporting this correctly.

Steve Sailer writes:

USA Today had a graph recently that showed that in California, the center of the Bubble, that the % of first time buyers who put no money down climbed from under 7% in 1998-2000 to 41% in 2006.

George W. Bush's 2002-2004 jihad against down payments as the chief barrier to achieving his goal of 5.5 million new minority homeowners likely played a role since the main part of the rise occurred during those years.

Steve Sailer writes:

California and Spain are pretty similar: same population, same climate, same high rates of immigration, same Housing Bubble.

Keep in mind that the Housing Bubble didn't actually happen in many American states. Judging by foreclosure numbers, the vast majority of the Bubble happened in just three regions:

- Greater California (CA, AZ, NV) -- 36% of the foreclosures and maybe about 60% of the foreclosed dollars are in these three states.

- Florida

- Greater Detroit (MI, OH, IN, IL)

Toss in a few random high default states like New Jersey, Kentucky, and Missouri, and you'll account for almost all the defaulted dollars.

Steve Sailer writes:

The future of analysis of the Housing Bubble will be localized studies.

For example, why did low interest rates at the national level set off a Bubble in California but not in Texas? (My guess is that looser land use laws in Texas allow the supply of housing to rapidly meet increases in demand for housing, whereas the lag time in California is more like a decade due to environmental and other restrictions on development).

Why are foreclosures so much higher in Ohio than Pennsylvania? (No clue.)

Why New Jersey but not Connecticut?

Vincent Benard writes:

From my personnal researches, in countries like France, USA, and UK, real estate bubbles occur when a conjunction of three factors is met:

- 1) Restrictive land use regulations, which make difficult to get new developpement authorizations; thus it's more difficult for housing supply to meet the demand. US smart growth policies in effect in some US States, but not all, Town and country planning act in UK, and Urbanism code in France, obviously belong to this category. But very flexible land use laws you have in cities like Houston, or Atlanta, don't. And there's nearly no bubble there, despite a huge demographic growth in these metro areas.

- 2) household demography: even if populations are growing slowlier than in the 60's, more divorces, and a higher proportion of older households, tend to diminish the mean number of people per household. From 1980 to 2005, the average number of people per household decreased from 3 to 2,45 in the USA, 3 to 2,35 in France.
In the Latter,the figure is expected to tend to 2,15 in the 30 next years. This has driven the household number from 19 to 26 Millions in the past 25 years in this country.

In the USA, a stronger immigration puts even more pressure on the demand.

- 3) Low credit rates, whatever the reasons are: central banks, titrization, ... The 95-2005 period showed a general decline in interest rates trends worldwide.

But not all real estate bubbles lead to such financial mess: there have been real estate bubbles before, who ended into a "soft landing". When credits are delivered on the sole basis of people solvability, with initial down payment, without regard to the expected worth of the purchased home, then, even if the borrower finds itself temporarily in "negative equity", he just doesn't care, keeps on paying his loan, and waits for better days for selling.

But, as another commenter said before, it doesn't explain why there have been so many foreclosures in Cleveland, whose demography is down and home prices not so high...

It makes me think the current crisis should be considered by examining separately the problem of credit expansion to households with high risk of insolvency, and the issue of distorted housing prices, which provided a signal driving people towards speculative behaviors.

(and sorry for my sometimes sub-standard english)

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