From happy homeownership to the end of our economy
Promoting homeownership remains a bad idea, as Felix Salmon reminds us here.
The last thing we need right now is a resurgence in homeownership. Too many people own their homes already, including a lot of families who really shouldn’t. Let’s start thinking in terms of affordable housing, and not in terms of home equity.
Houses are not investment vehicles, treating them as such is pretty foolish and potentially destructive. And the economy as a whole is far less flexible when too many workers are tied down in one spot with a home. And when fringe exurbs are developed to allow for more lower-income families to own, it leads to enormous inefficiencies and a massive amount of energy wasted on extreme commuting. Etc.
Conservatives seem to want to blame Fannie Mae and Freddie Mac for the crisis, but though they went broke in part by facilitating the mistaken ideal of the “ownership society,” they did not cause the current economic turmoil. Along with a choice quote from President Bush from 2004 in which he promotes “agggressive lending” to first-time borrowers—how surprising that this hasn’t worked out well—Barry Ritholtz has a good concise explanation of what did cause the crisis:
To repeat my prior arguments, the proximate cause of the Housing crisis were (1) Ultra-low rates; and (2) Abdication of traditional lending standards, thanks to (3) originators ability to resell mortgages for securitization purposes, and hence, (4) not have to worry about loan defaults.
The credit crisis was caused by (1) the above securitized mortgage paper, that was (2) rated triple AAA by Moody’s and Standard & Poors, which then (3) Which was then “insured” by credit default swaps (CDS)—the unreserved for, shadow insurance products (4) whose exemption was made possible by the Commodities Futures Modernization Act. That legislation exempted these derivatives from any supervision or regulation. The lack of reserve requirements is why there is now $62 trillion in CDS, many of which will never pay their counter parties the promised insurance.
Encouraged by the society-wide celebration of home ownership, mortgage lenders believed that their business was exempt from ethics or rational due diligence about the way funds were being distributed. So they lent to people without verifying whether they had any chance to pay off the loan, because that repayment was basically someone else’s problem. (In some instances, Fannie Mae and Freddie Mac, which would repurchase mortgages from the negligent bankers who originally made them as long as they “conformed”, i.e. were not “jumbo” loans for McMansions and the like, or subprime loans. These restrictions were supposed to protect Fannie and Freddie, only many borrowers turned out to be subprime, in effect, once house prices began to drop and they couldn’t refinance. When these people began to default in high numbers, Fannie and Freddie were on the hook, having resold the mortgages as high-rated securities to other, mainly institutional investors who expected them to be guaranteed by the U.S. government—hence bailout.) All these loans were made into securities, and they were rated highly because the rate of default was presumed to be low, and defaults were supposedly protected by the default-swaps, which provided for some other company to basically pay the mortgages if the lenders didn’t. But defaults were much higher than expected, and no funds were reserved to cover the losses by those who provided the insurance—instead, those insurers were leveraged to the gills. Hence A.I.G. gets nationalized, and banks stop lending to one another (aka Libor jumps astronomically), because they don’t know which ones will go broke next. Lots of consumer rates, unfortunately, are pegged to Libor, which ordinarily tracks the Fed Funds rate closely. Right now, though, it’s off the chart. So consumers can’t afford to borrow anymore, which means the rest of the economy scales down for a recession. Welcome to Great Depression redux, according to economist Nicolas Bloom:
So why is this banking collapse and rise in uncertainty likely to be so damaging for the economy? First, the lack of credit is strangling firm’s abilities to make investments, hire workers and start R&D projects. Since these typically take several months to initiate the full force of this will only be fully felt by the beginning of 2009. Second, for the lucky few firms with access to credit the heightened uncertainty will lead them to postpone making investment and hiring decisions. It is expensive to make a hiring or investment mistake, so if conditions are unpredictable the best course of action is often to wait. Of course if every firm in the economy waits then economic activity slows down. This directly cuts back on investment and employment, two of the main drivers of economic growth. But this also has knock-on effects in depressing productivity growth. Most productivity growth comes from creative destruction – productive firms expanding and unproductive firms shrinking. Of course if every firm in the economy pauses this creative destruction temporarily freezes – productive firms do not grow and unproductive firms do not contract. This leads to a stalling productivity growth.
But at least people got to live in their “own” homes for a few years. It really gave us such a sense of pride while it lasted.
Comments
What I’m wondering is this: the bailout package looks like a huge gift to irresponsible lenders and borrowers. What’s in it for those, like myself, who went deeply into debt in order to purchase a home near the height of the bubble, and continue to responsibly pay our mortgages? I suppose we’re stuck in our un-saleable homes for years to come, regardless whether we need to relocate? And we’ll just have to be content to live in an economy that’s slightly-less-terrible than if the bailout hadn’t gone through?
Comment by JK from Texas — October 10, 2008 @ 1:16 pm
I find your pro-renting argument quite perverse.
Firstly, you argue that people shouldn’t own their houses because they are “tied down” by them, and so can’t move closer to wherever the work goes.
What if the work goes to China/the Philippines/Vietnam?
How is being completely at the beck and call of your employer differ from slavery?
Secondly: the advantage of owning your own house is that the landlord can’t kick you out.
Many renters are finding right now that they’ve been dutifully & faithfully paying rent, but the owners haven’t been paying the mortgage, and it’s only even more recently that eviction notices are being withheld because mortgage companies are realizing that the renter is not to blame….
So that, thirdly: Until that moment, renters were being held responsible for the owner’s delinquency.
Comment by MF from Portland, OR — October 10, 2008 @ 5:46 pm
I’m sorry JK, but you make it sound like you’re one of the irresponsible borrowers if you say you had to go “deeply into debt in order to purchase a home”.
Comment by SusanO from Portland, OR — October 10, 2008 @ 6:31 pm
The obsession with homeownership is not going to change until the government starts taking renters’ rights seriously. A healthy dose of rent control would also help.
Comment by Erika — October 10, 2008 @ 6:52 pm
If you work as a freelance (such as myself) and have no pension or other privileges afforded to those who works as staff for a company i.e sick and holiday pay - buying into bricks and mortar is the only future investment you can rely on. I’m a renter and cannot presently afford to buy in London - but it is the only way I and people like me can guarrantee some form of financial security for ourselves once we get past working age. We have no choice!
Comment by Richard Bevan from London — October 11, 2008 @ 6:36 am
SusanO:
Perhaps I worded that post badly.
I thought I was making a reasonable financial decision at the time. A planned temporary cross-country relocation became effectively permanent. My wife and our three kids were very tired of our too-small “just for a year” apartment. I was careful to buy a home that I could afford. I didn’t have $140000 burning a hole in my pocket, so I borrowed a lot of money, hence “deeply into debt”. Isn’t that how most people pay for their first homes? I did not borrow more than I knew I could repay, my mortgage is fixed-rate, and my P&I payment is well under 20% of gross monthly income. I make additional principal payments each month, and there’s no reason I can’t continue to do so until the loan is paid off (barring loss of employment, which seemed practically impossible until the past couple of weeks; now it seems merely unlikely).
Unfortunately my wife and I separated three years after the purchase, and while I can certainly afford to stay in the house, it’s much too large for just me and my daughter. There are, IMO, better things I could be using my money for.
Comment by JK from Texas — October 11, 2008 @ 10:38 am
everyone always identifies him or herself as the exception in the home ownership scheme. no, really. it was good for us to buy. the landlord can’t kick us out. gives us some security in old age. eventually, we’ll only be paying the property tax. even if we only get what we paid for it, it’s as though we lived for free for the last x years. and what about the tax breaks, no?
home ownership, since 1997, has been repackaged and repositioned so that most people, far from being the equity holding homeowners of the past, are simply renting from the bank, without the fair terms of landlord-tenant court, and no lease. the bank won’t pay to fix your broken water main. and normally, your rent is a fixed amount that doesn’t “adjust” every month.
mortgages are the single most complicated financial transaction that most people will ever undertake. but nobody wants to admit they were taken, they didn’t understand exactly what was involved, or even what was negotiable. it’s a case of the emperors new clothes. if you own a home, you disagree with rob by default. if you wish to own a home, a lot of your reasoning is fantastical (the security argument has certainly been shown to be fantastical, at least).
Comment by ari from portland, oregon — October 12, 2008 @ 6:31 pm
Sorry, Ari: my mortgage costs less than rent for the same square footage would. Yes, in a sense you are renting from the bank until the mortgage is paid off - but that was always the case.
The bank has virtues that the landlord doesn’t: it’s not a coked-out libertarian who insists that holes in your roof were made by you (climbing the ladder you do not have) in order to create a vexation, for which vexation you will now pay extra rent; the bank does not refuse to replace your dead water-heater because (s)he has a friend who does them cheap, but can’t get to yours before next month; doesn’t take your security deposit because you hung a painting on a hook instead of a nice, civilized dried arrangement on a sewing needle, und so weiter.
Equity only starts disappearing when the price the house will sell for falls below your down + your princ+interest payments for the length of time you’ve been there. (I’m assuming no 2nd mortgage/HELOC.)
Of course I’ll be dispossessed if I lose my job. I’d be kicked out of a flat or apartment in exactly the same way.
Rob’s original argument against home owenership hinged on the notion that house prices would always rise, and so houses became “investments” like stocks, hedge-funds, and the like.
His argument was fundamentally against <i>your primary residence as a speculative investment</i>, not against ownership per se.
Comment by MF from Portland, OR — October 15, 2008 @ 6:07 pm
Oops - loss of equity begins when the sale-price dips below the original purchase-price. Equity = what you’ve paid (down + princ.) minus the amount remaining on the mortgage (+ int so far?).
Comment by MF from Portland, OR — October 15, 2008 @ 6:30 pm
I have reread this post a couple of times to try to figure out why you think the primary argument is “against your primary residence as a speculative investment.” I don’t get that at all here.
Lenders, not homeowners, were treating homes as investment vehicles, and to say homes is somewhat misleading, as it was repackaged mortgages that were being treated as investment vehicles, and were only loosely associated with the actual homes until borrowers began defaulting. And then you have to bring the CDS’s into the picture, which were supposed to insure against default, but for which there were no reserves. So, it really has very little to do with individual homeowners treating homes like investment vehicles.
In any case, you’ve made my point for me. You had to amend your response with some phony equations and a question mark in parentheses because mortgages are the single most complicated financial transaction that the vast majority of americans will ever undertake, and they aren’t very well understood. Equity is not the amount you paid minus the amount remaining on the mortgage. Rather, it is the value of your home above what you owe. Interest payments don’t build equity. But the rising value of your home does.
Comment by ari — October 16, 2008 @ 7:02 am
Yes, you’re right about the definition of equity - but because you don’t actually have it till you sell the house, the check has cleared and the proceeds are in some place where they don’t lose their value, home equity is the same kind of fantasy/paper wealth that shares on the stock market are.
Rob’s second paragraph (the 3rd on the post, after th first blockquite) begins: “Houses are not investment vehicles, treating them as such is pretty foolish and potentially destructive.”
It’s not ownership per se that’s being condemned here, it’s speculation in housing. Afterwards Rob suggests that owners “tied down” by homes can’t follow employers, leading to an “inflexible economy” - an observation that actually points urban sprawl. Sprawl isn’t a necessary consequence of ownership. It is a necessary consequence of dismantled public transport, unchecked development, and the stand-alone house.
It was Rob’s conflating ownership with extreme commuting and inflexibility was what gave his post the flavour of simply being anti-ownership.
De-regulation is the root cause of the sub-prime mess, not ownership. There is no real reason, except policy or ideology, why housing can’t be both affordable and owned.
Comment by MF from Portland, OR — October 16, 2008 @ 12:37 pm
Owning one’s own home is a risk in any ecomonic climate and as long as people protect themeselves with proper tenants contents insurance and <a href=“http://www.savoystewart.co.uk/”>landlord insurance</a>, there shouldn’t be a problem. Also, making sure that you can afford both the repayments and running cost of a property is also essential.
Comment by JoeChi from London, England — November 1, 2008 @ 1:41 pm
Some very excellent points! I have come to the same conclusion over the years and I always would like to add blame to media and how it was almost mandated to buy a house as part of any financial plan or personal finance advice.
Comment by stock market from MA — November 10, 2008 @ 10:56 am