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« The Unemployment Severity Index | Main | ETF Update: Time for Inverse Index Positions? »

June 19, 2008


gaius marius

"Looking at housing prices versus income, for example, is not the same as looking at payments versus income. I suspect that any measure that supported borrowing by the many who want to own homes, and/or limited the forced selling by those who want to own homes, would dramatically change the intersection of supply and demand."

agreed, jeff, at least temporarily -- examining payments is essential to understanding what we've seen. while prices vs income ballooned in the bubble period, payments vs income (though it did rise significantly) rose much less thanks to ARMs, interest-only and negative-amortization loans.

if a way can be found to manufacture lower payments on a given loan amount durably, then prices can be sustained. (this was, iirc, the way out proffered by the FHLBs in the 1930s, refinancing then-standard 5-year mortgages into 30-year mortgages.)

but this is a strategy of diminishing returns. the average residency in a home is something like seven years in our labor-mobile economy. on some level, it's questionably risky for bank and borrower alike to be offering 30-year financing on assets that the mortgagee won't (on average) own in ten. we're seeing an episode of such risk manifest right now, with high loan-to-value driving foreclosures in a downturn.

moreover, at some level 40-, 50- and 75-year year mortgages begin to look a great deal like sharecropping. these are loans designed never to be paid off through income -- minsky would have called them speculative, as opposed to hedge. and the proportion of cash paid as interest to the bank begins to approach a perpetual rent paid not to a landlord but a bank (or government agency). the economic incentives of ownership are severely diluted.

while i agree with you that if a way could be found to support greater debt loads with lower demands on cash flow then refinancing could avert some of the crisis for homeowners, it was exactly that dynamic which caused the bubble (and its reversal in rate resets and full amortization conversely is helping to precipitate the crash). such a mitigation of servicing costs would have to be durable.

the only two ways i see to actually support house prices durably, then, are either 1) to standardize 50+ year mortgages, or 2) substantially increase government mortage subsidies in perpetuity (and at terrific expense). the former is likely to undesirably increase risk and volatility in the mortgage market; the latter will drive private credit out of mortgages and turn the whole affair over to the soon-to-be-explicitly-nationalized FNM/FRE.

there's also the question of whether the american government can (pragmatically) or should try to (morally) afford to finance such an extensive handout to homeowners and the housing industry. i won't debate the morality, but pragmatically -- china has been gradually ending the yuan-dollar peg since 2005. at the current rate of change, over the next 3-4 years the need of china to finance american consumption will end as currency revaluation closes the current account deficit. this likely means, among other things, a reconciling of the american books, which have run deep in the red more or less since the election of reagan. it also likely means higher long-term interest rates across the board. no one can predict the future, of course, but i think it highly questionable as to whether the united states government can continue to finance, much less expand, its cash flow deficit long-term in a way that such a handout implies.

sorry for the long comment -- but we're really discussing the question of our times, and it certainly merits the kind of thought and discussion you're providing a forum for. thanks!


RB --
I am curious about your statement that "houses are unaffordable by historical standards."

Do you have some evidence for this?

My sense is that affordability differs dramatically by region and price range. Supply and demand and curves, not point-specific numbers as most pundits suggest. They are also regional.

But I am interested in your evidence.

Thanks for taking the time to comment.



"Looking at housing prices versus income, for example, is not the same as looking at payments versus income."
Absolutely -- and houses are unaffordable by historical standards.

And, this otherwise incompetent adminstration has at least for political reasons found good reasons to question the principal behind the Countrywide deal given that Mr. Dodd stood to gain $75000 over the lifetime of the loan.

The blogosphere has been calling Mr. Dodd a tool of the real estate industry for much longer than this policy proposal.


Gaius --

Thanks for a great comment. As you understand, my objective is not to recommend the bill (although I do think it is a good idea). What I am trying to do is help investors to see the consequences of the decision.

Essentially, I agree with everything you say, as I often do on your blog.

Where I still see a question is the issue of where housing prices "should be." You seem to think you know the answer to this question, and I am not convinced.

Looking at housing prices versus income, for example, is not the same as looking at payments versus income.

I suspect that any measure that supported borrowing by the many who want to own homes, and/or limited the forced selling by those who want to own homes, would dramatically change the intersection of supply and demand.

You are wise in considering the concept of "latent supply" which is much like the oft-quoted inventory overhang.

Thanks again for a provocative comment.


gaius marius

i continue to wonder what the intended effect of such legislation could be.

as far as the market goes -- do we not need to get to a point where the relation of house prices to incomes returns to a level where people can sustainably afford standard mortgages again? how does this legislation gets us closer to that?

i do understand that there is a significant need to recapitalize the financial sector to avoid very heavy economic damage.

but i think it is essential that the recapitalization be constructed in a way that does not continue to distort prices at artificially high multiples of income because of government grants or loan pricing. prices must fall considerably further if sustainable, unaided demand (not to mention private credit supply) is to emerge.

i think the concept of a 'latent demand' is real -- i'm one of those people, though there's certainly very few of us and a whole lotta houses on the market -- but i'm certainly not looking for stabilization alone. i'm looking for positive carry -- the ability to finance a property at less cost than the rental income i could generate from it. until i get that, i'm very happy to continue renting my mcmansion at a fraction of the cost of ownership and pocketing the difference. 'latent demand' only becomes truly actionable once positive carry emerges; THEN i'll look for stabilization and loosening private credit standards, so as not to get caught in the undertow of overshooting price correction.

just one man's opinion, of course, but efforts to stabilize house prices here are certain to be futile -- unless of course the government is going to provide a slice of capital toward every purchase ad infinitum, artificially supporting pries in perpetuity, in effect nationalizing the american mortgage market.


WRT the last paragraph - What is "strange" about this?

It is well known that owners take better care of their possessions than renters, lessors, managers or caretakers. One can come up with several examples from daily life: renting a car, leasing an apartment, managing a company, running a country.

The implications of this to democracy should be fairly clear with some thought, see for instance:

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