As inflation rises, the cost of buying a home is also going up even more because the 30-year residential home interest rate has increased from less than 4% to almost 5.5%. Rising inflation is also causing Americans to spend more on basic staples, such as food and gasoline, and Americans have fewer savings available than at any time in the last three years, with the average savings rate decreasing every month but one since July 2021. The result of these and other trends means homeownership is increasingly out of reach for many working-class and middle-class Americans. 

The biggest changes to housing policy need to be made at the local level, where governments need to make changes to zoning laws, building-approval processes, and height limits that prevent more housing from hitting the market. 

The Washington, D.C., region is a prime example of how harmful housing regulations reduce supply and drive up prices. The region has the fourth most expensive housing stock in the country, despite lacking the oceans and the mountains that serve as natural geographical barriers in the other metropolitan areas— San Francisco, New York, Los Angeles, and Honolulu—that make up the rest of America’s five most expensive housing markets. 

The first step is to relax Euclidean zoning regulations. Despite the demand for townhouses and smaller houses, Prince George’s County, Maryland, still has a preponderance of single-family homes zoned on a one-acre or larger lot. Local planners should allow mixed-use zoning as long as there are no public health problems (the original justification for Euclidean zoning).

The region should allow buildings to be set closer to the road, stop requiring that developers include a minimum number of parking spaces for residential developments, and allow multiple housing types to be constructed in the same development.

In suburban areas, single-family homes, cottage courts, and side-by-side duplexes might be a good fit. In central cities, cottage courts, side-by-side duplexes, and small multiplexes might be appropriate. Let all options and choices bloom.

The region also needs to eliminate onerous restrictions for the reconstruction of multi-family housing. Arlington County, Virginia, likes to fashion itself as one of the most progressive communities in the country. But its zoning code reads like it was written in 1922 instead of 2022. Arlington Now spotlighted how Arlington County’s zoning process is making multi-family housing too expensive to build. Renovating multi-family housing on an existing lot requires a community review, a planning commission approval, and county board approval. Yet, renovating a single-family home requires a board of zoning appeals review only. The multi-family review process should be streamlined. 

Fast-growing areas also need to eliminate growth restrictions, such as large lot zoning, agricultural reserves, height limitations, and floor area ratios. 

Suburban Loudoun County, Virginia, has a de facto urban growth boundary along U.S. Route 15 preventing growth in the western half of the county.

Montgomery County, Maryland, has set aside a third of its total land area as an agricultural reserve limiting growth northwest of D.C., even as the region’s metropolitan planning organization (MPO), the Washington Metropolitan Council of Governments, reports that there is virtually no agricultural activity in this “agriculture reserve.”

Meanwhile, the District of Columbia imposes a height limit of 130 feet. The height limit was not enacted to prevent structures from being taller than the U.S. Capitol but is a 19^th-century relic that was intended to ensure a fire truck’s ladder could access the top floor of a building and could clearly be done away with now.

Fairfax County, Virginia, has a strict floor-area-ratio (FAR) limit—the ratio of a building’s floor area to the lot, of 0.25. This ratio prevents building on 75% of a property. Similar suburban districts across the country have FARs of 0.40 or higher. 

In addition to getting rid of these bad policies, leaders also need to fight back against Not In My Backyard (NIMBY) activists. Many NIMBYs make bogus claims, such as building more housing will lead to more crime, less tree cover, and negatively change neighborhood character. While some of these concerns are understandable, they are often exaggerated and can almost always be reasonably addressed or debunked.

For example, key environmental areas can be protected without preserving all of the nation’s abundant farmland. It would take about 30% of existing U.S. farmland to feed all of America.

Eliminating unnecessary restrictions that are driving up housing prices would enable regions to build the amount of housing that metro areas need. This would help ensure housing and the American dream of owning a home doesn’t continue to become a luxury good only available to upper-income Americans. Eliminating the housing shortage, which would put downward pressure on housing prices in metro areas, would help solve one of the biggest problems facing American cities and the workers under the age of 40 they hope to attract.

The post Steps metro governments can take to address housing affordability, skyrocketing prices appeared first on Reason Foundation.

In 2017, the city of Los Angeles and Los Angeles County had the second-highest total homeless population (55,188 total),  with almost 75 percent of those people unsheltered. Between 2016 and 2017, individual homelessness grew 9 percent (15,540 people) in major U.S. cities. Los Angeles accounted for 60 percent of the increase.

Homelessness impacts many vulnerable communities in Los Angeles, including veterans. According to the Los Angeles Homeless Services Authority, a total of 4,828 veterans experienced homelessness on a given night in 2017, up 57 percent from the 2016’s figure of 3,071. In February 2018, the Los Angeles Times reported 500 homeless veterans had housing vouchers with nowhere to redeem them.

In May 2018, the Veterans’ Administration (VA) issued a request for information (RFI) seeking private contractors to potentially fulfill the role of Housing Specialist/Landlord Liaison for homeless veterans in the Greater Los Angeles area.

To help find permanent housing for homeless veterans, the U.S. Department of Housing and Urban Development (HUD) and the U.S. Department of Veterans Affairs Supportive Housing (VASH) currently run a combined program (HUD-VASH).

The HUD-VASH program combines Housing Choice Vouchers (HCV), which can be used for privately-owned housing for veterans with VA case management and clinical services to eligible homeless veterans. Since 2008, HUD-VASH has allocated more than 85,000 vouchers to veterans experiencing long-term or repeated homelessness.

However, with increased demand in housing units and decreased housing inventory, landlords across Los Angeles are becoming more cautious with respect to underwriting and leasing evaluations, creating new challenges for the program. Insufficient landlord participation in the HUD-VASH program has resulted in long delays in finding housing for veterans.

To help make the program more effective, HUD-VASH is looking to public-private partnerships (PPPs) for help and the RFI would provide the framework for the private sector to work with HUD-VASH in a combined effort to ending homelessness.

According to the RFI, contractors would work closely with HUD-VASH program staff, providing assistance with marketing, recruitment, relationship development, and tenancy management support of landlords in the community to expand the availability of apartments for veterans accepted into the HUD-VASH program of the Greater Los Angeles Healthcare System.

The objective is to secure long-term relationships with landlords wishing to rent their units to HUD-VASH participants using HVCs. The RFI contractor performance requirements include provisions such as identifying 10 new landlords who are not familiar with the HUD-VASH program and 30 new prospective units for rent, as well as providing education for landlords.

Contractors would also have reporting requirements through monthly written reports and are required to notify the VA of any negative incidents involving a veteran, any pending evictions and to provide any necessary documentation.

The RFI also seeks contractors with a proven track record of experience involving property management for populations served by social assistance programs. The contractors would also be expected to collect performance improvement feedback from landlords and present that information during quarterly staff meetings with HUD-VASH staff. The contractors would also create ways to honor landlords through special events and award ceremonies.

The lengthy requirements for governments wishing to engage in PPPs to ensure private sector accountability in providing a good or service are not uncommon. Combing government and nonprofit resources to achieve a greater good such as ending homelessness has had historical success when executed correctly.

In addition to the Los Angeles-area HUD-VASH program, many other municipalities are using public-private partnerships to address homelessness:

• A Seattle-based nonprofit known as Building Changes has shown promising results by pooling together government, nonprofits and philanthropy to employ an approach to ending homelessness known as ‘diversion’—an early engagement tool that, while not a fit for all homeless cases, works for many and saves money when it does by avoiding more costly approaches.
• Community Shelter Board (CSB), a charity organization in Columbus, Ohio, uses the combined resources of government, nonprofits, and philanthropic organizations to fight homelessness. By managing the funding for local homeless programs and permanent supportive housing, CSB has also demonstrated successful results using PPPs.
• Your Way Home in Montgomery County, PA, is an award-winning program that brings together county government, nonprofits, and other philanthropic groups to work together in a unified, coordinated way to combat homelessness in the county. The success in reducing their homeless populations can also be attributed, in part, to PPPs.

Public-private partnerships are a valuable tool in leveraging collective resources to accomplish the goal of reducing homelessness. The HUD-VASH program’s collaboration with Los Angeles-area landlords provides another example of how PPPs can help solve some of the persistent problems that traditional approaches have left behind.

The post Public-Private Partnership Program Is Helping Serve Homeless Veterans and Their Families appeared first on Reason Foundation.

As this case demonstrates, however, municipalities and counties have devised schemes to evade the prohibition on uncompensated takings. Here, the City of West Hollywood implemented a zoning ordinance that requires developers who build multi-unit housing either (1) to sell or rent a percentage of that housing at below-market prices or (2) to pay an “in lieu” fee that West Hollywood calculates using a formula created by statute.

616croftave_v_cityofwesthollywood_case_16-1137

The post 616 Croft Ave. v. City of West Hollywood, Case No. 16-1137 appeared first on Reason Foundation.

But that forum also highlighted some of the myths about affordable housing I keep seeing pop up:

1. Average salaries and average home prices in a city need to be aligned, and policymakers need to address the gap;
2. We can create affordable housing by mandating that developers sell some new units in every development at much lower prices.

These myths are at best a distraction from tackling affordable housing, and at worst actually make housing more expensive.

Housing and labor markets are not the same market

I have repeatedly seen graphs showing that average salaries paid for many good jobs in Sarasota are not sufficient to pay average home prices in the area. Usually the graph is part of an argument that the region will have a hard time employing workers who can’t afford to buy a home here. But let’s break that issue down.

For starters, the market for labor and the market for housing are very, very different. Labor is very mobile, as people move to chase jobs or better pay all the time. Supply and demand for labor change a lot and rapidly with changes in the national, regional and local economy. Housing is not mobile, and supply and demand change much more slowly — especially supply.

If businesses have a hard time finding certain professional workers at the salary they are offering, they will raise salaries to attract the workers they need. Meanwhile, if demand for housing is high, developers will start working on new projects and eventually supply more housing.

The fact that salaries for so many jobs in Sarasota are less than that needed to afford to buy a house is a clear indication that a number of things are going on. Clearly enough workers are willing to come to Sarasota for that level of wages. And they are clearly able to find a place to live. People who can’t afford to buy a home—or simply don’t want to—rent one. There is nothing wrong with that and no reason to say everyone needs to be able to buy a home, especially early in their career. Finally, many people have a partner who also works, and the combined household income is enough to afford a home. Comparing average salaries to housing prices assumes only single-worker families are trying to buy homes, which is usually not true at the affordable housing level.

Put simply, the labor market in Sarasota is adjusting all the time, and fairly quickly. If we allow the housing supply to adjust too, even if slower, things will balance out. Especially if we let go of the strange notion that everyone needs to be able to buy a house, rather than embrace the idea that everyone needs to be able to find a good place to live.

Wealth vs. youth

A special version of the concern about Sarasota area incomes vs. housing prices is the concern about a “brain drain” of young people leaving Sarasota because they can’t afford housing here, which surveys by the Sarasota Chamber of Commerce indicate is a real problem.

But this is a harsh reality of living in a place that is so desirable, especially to those with wealth. Wealthy, older individuals are competing with young workers for housing, and the wealthy can simply outbid them. As long as supply of housing is less than demand, the willingness of the wealthy to pay more will drive up housing prices.

Young people who want to live in Sarasota will have to be creative. Just like young people who want to live in Manhattan, they can’t expect to live like the wealthy, many of whom are reaping the benefits of decades of hard work themselves. Renting, roommates, longer commutes, smaller housing, older fixer-uppers, etc. are all part of the mix.

Affordable housing mandates don’t work

Too many people think we can just force builders to build housing and sell it at “affordable” prices. But the data from places that have done this show it results in fewer homes being built and raises average prices of homes. For example, in the Los Angeles region affordable housing mandates led to 770 affordable units being sold over seven years, while during the same period reducing the total number of new units built by more than 17,000 and raising the average home price by about $50,000.

Just think about it logically. In a market where homes are selling well, if a developer has to sell some units at below market prices, he will have to simply raise the price of the other units to pay the difference. That price hike means some people who could afford to buy a new home at market prices now cannot. So the mandate makes some people able to afford housing while making others unable to do so.

Worse, many developers just go to the next county to build, reducing the local supply of housing, again driving up average prices, and spreading regional housing over a broader area. It is a vicious spiral that makes housing less affordable, not more.

Stick to our knitting

The most important way to reduce the cost of housing in a region is allowing the supply of housing to keep up with demand. This does not mean new housing has to be cheap housing either, because cheap housing tends to be the older, smaller homes, freed up for young workers or lower income families when wealthier people move into new, higher-priced homes. That is how the housing market has worked in modern times, and too many people forget that and think the young and lower earners need to be able to buy new houses.

At the same time, the city and county governments need to work with developers who want to build affordable housing projects, especially rental units. Again, the historic reality of housing markets shows that this is where people entering the market, or having hard times, get their housing. Adequate supply that grows with demand is vital here as well to keep prices reasonable.

Finally, city and county governments need to ensure the regulatory process for new development flows smoothly. A well-functioning process for working with developers is crucial to allowing the supply of housing to keep up with demand and keeping prices in balance.

Adrian Moore, Ph.D., is vice president of Reason Foundation, co-author of the book “Mobility First: A New Vision for Transportation in a Globally Competitive 21st Century,” and lives in Sarasota.

The post Affordable Housing Myths appeared first on Reason Foundation.

What is missing from our affordable-housing discussion is the age-old concept of the “housing ladder.” Affordable housing is created when homeowners sell – maybe upgrading, moving to a bigger home for the kids, or downsizing, as they get older. These home sales are supposed to open up older, more modest homes for first-time, often younger homeowners.

Thirty years ago, no one thought a young couple just getting started should be shopping for a brand new, just-built home. Everyone understood that your first home would probably be 20-to-30 years old. After a few more years of saving money and a promotion or two at work, the young couple might look to upgrade.

Today, local governments in Orange County and neighboring counties have ignored the housing ladder and pursued many ruinous policies in pursuit of building new “affordable housing,” believing that everyone should be able to afford a brand new, large home right now.

Subsidizing housing has long been popular in California policy circles. But, in most cases, subsidies have distorted the housing market, created more demand for purchases and driven home prices up. And then they lock recipients into their homes – owners can’t afford to sell and buy another home without further subsidies. Thus, fewer homes hit the market, and prices soar for available homes.

The most popular affordable-housing policy in Orange County has been mandating developers to sell some new homes at below-market rates. Typically, developers must sell a percentage of units at “affordable” prices in return for approval of a development, and sometimes developers are allowed to build more units in return for selling some at below-market prices. These policies are called “inclusionary housing.”

Reason Foundation studied these policies a decade ago and found that they reduced the supply of housing and raised average home prices – the exact opposite of the desired effect.

In the Los Angeles region, inclusionary housing policies led to 770 affordable units being sold over seven years, but reduced the total number of new units built by more than 17,000 and raised the average home price by about $50,000 during the same period.

Researchers at Harvard and the University of Pennsylvania have found that housing price differences between cities are not attributable to variation in land prices or construction costs but to regulatory differences, primarily zoning and building restrictions. Similar research from the Lincoln Land Institute found that “house prices in cities with stricter regulatory policies rose 30 percent to 60 percent relative to less-restrictively regulated cities over a 15-year period.” And according to National Association of Home Builders every “$1,000 increase in home price leads to about 232,447 households priced-out of the market for a median-priced new home.”

Creating more affordable housing requires deregulating markets for land and allowing market-driven densities and development, especially in the suburbs. It means simplified and reasonable building codes that serve real public safety concerns rather than special interest goals. It means setting impact fees sensibly to mitigate the real effects of more housing, such as increased traffic, not to extort design or aesthetic concessions from builders. When developers incur fees, home buyers are the ones who really pay them.

What ultimately drives housing affordability is supply and demand. Orange County has no shortage of demand for housing; supply is the problem. Everyone who buys a parcel of land should have an equal right to build a home or homes on it, so long as he doesn’t impose an undue burden on any others in the process.

We have decades of experience showing that interfering with housing markets makes homes less affordable, while working with the markets can put owning homes within reach for more people.

Adrian Moore is vice president of policy at Reason Foundation. This article originally appeared in the Orange County Register.

The post Orange County’s Affordable Housing Mandates Keep More Homes Out of Reach appeared first on Reason Foundation.

Many people seem to have forgotten about the age-old concept of the “housing ladder.” Affordable housing is created when homeowners sell to buy a newer or nicer home, opening up older and less nice homes for first-time, often younger, homeowners.

Thirty years ago, no one in his right mind thought a young couple just getting started should be shopping for a new home. Everyone understood your first home would be 20 to 30 years old, hopefully well maintained. Your first newly built home would come after a few promotions.

The housing ladder is still a very real part of the actual functioning housing market, yet it has almost disappeared from our public discourse on, and cultural perceptions of, affordable housing.

Subsidies are a popular policy option, but

Local programs to subsidize home purchases severely distort the market, creating more demand for purchases in a market where high demand is already driving prices up. In markets where some get subsidies to buy homes, the cost of homes for everyone else goes up. And that means people who were just barely able to buy a home on their own can no longer do so.

Another really bad but popular idea is to mandate developers sell some units below cost–so called “inclusionary zoning”

First, this falls right into the trap of trying to make new housing into affordable housing, rather than letting the housing ladder work. But even worse, it simply does not work.

A detailed empirical research project on the effects of these policies found that they reduced the supply of housing and raised average home prices – the exact opposite of the desired effect.

In the Los Angeles region, inclusionary housing policies led to 770 affordable units being sold over seven years, while during the same period reducing the total number of new units built by more than 17,000 and raising the average home price by about $50,000.

The reason is that developers need to cover their costs when they build homes. If they are forced to sell some below market, the remaining ones need to be priced above market.

Again, many potential homebuyers who could have afforded to buy a home on their own were priced out of the market by that $50,000 increase. When some are subsidized, others – typically those just barely making it on their own – take the brunt of it.

The only thing that actually works is to let the development and housing market work

Read the whole column here and see Reason’s work on affordable housing here.

The post No simple answers on affordable housing appeared first on Reason Foundation.

But generally, public policy about affordable housing stems from a combination of concerns about homelessness and about working-class families not being able to buy homes in the city.

As I speak to people about this issue, I am struck by how many suggest that “we need to build more housing that young workers can afford to buy,” or “look at all these high-end developments and large new homes. Regular workers can’t afford to buy those.”

The simple fact is new housing near downtown Sarasota is expensive housing. Land is expensive there, and lots of people with lots of money want to live there, and they will bid up the price of housing. But many owners of those multimillion-dollar condos didn’t start out being able to afford them either.

Many people seem to have forgotten about the age-old concept of the “housing ladder.” Affordable housing is created when homeowners sell to buy a newer or nicer home, opening up older and less nice homes for first-time, often younger, homeowners.

Thirty years ago, no one in his right mind thought a young couple just getting started should be shopping for a new home. Everyone understood your first home would be 20 to 30 years old, hopefully well maintained. Your first newly built home would come after a few promotions.

The housing ladder is still a very real part of the actual functioning housing market, yet it has almost disappeared from our public discourse on, and cultural perceptions of, affordable housing.

While ignoring the housing ladder, local governments all over the United States have pursued many ruinous policies in pursuit of “affordable housing,” believing that everyone should be able to afford a brand-new, large home.

Subsidizing housing has long been one of these often ruinous, albeit popular, policies. If these policies that target helping people rent homes are well designed with careful screening of recipients, are time-limited and are tied to other programs to help individuals succeed in escaping the need for assistance, such programs can be beneficial. But if they become a permanent entitlement, they neither help the housing market nor the individuals involved.

Worse by far are subsidies for home purchases, especially for young people. Young workers tend to have high-turnover, lower-skilled jobs because they don’t have the experience yet or simply don’t want to secure more stable circumstances. Many like being able to move on short notice to take advantage of better job or life opportunities.

When we subsidize housing for younger workers – for whom renting is often a better lifestyle match – we are communicating two wrong ideas: 1) that renting is less desirable for everyone than buying; and 2) that they should buy homes they cannot afford.

Local programs to subsidize home purchases severely distort the market, creating more demand for purchases in a market where high demand is already driving prices up. In markets where some get subsidies to buy homes, the cost of homes for everyone else goes up. And that means people who were just barely able to buy a home on their own can no longer do so.

Even more disastrous are government-owned housing projects. America’s cities are dotted with horrible public housing projects, many of which have been closed and bulldozed in recent decades. Managing housing is simply not a core competency of democratic local government.

At the same time, alongside the larger issue of housing affordability, we need effective efforts to address shelter for the homeless, domestic violence victims and similar situations. The best models are those with community-based and nonprofit housing units partnered with city and county social services.

This capitalizes on the city’s strengths at coordinating diverse services that are aimed at promoting self-sufficiency. By partnering with these services, the city stops managing housing itself.

When cities manage housing, they tend to regard their efforts as permanent entitlements instead of helping families become self-sufficient. Indeed, in many cities, housing projects support several generations of families. This is where nonprofit community organizations can help foster change for the families that need it most to end the cycle of government-supported housing.

The most popular affordable housing policies these days are mandates or restrictions on developers to sell some units at below-market rates. Typically, policies require a percentage of units to be sold at “affordable” prices in return for approval of a development, and sometimes developers are given “density bonuses” – allowed to build more units in return for selling some at below-market prices.

These policies are often called “inclusionary housing.” The Sarasota City Commission has discussed inclusionary housing policies, so understanding their inevitable failings is crucial.

First, this falls right into the trap of trying to make new housing into affordable housing, rather than letting the housing ladder work. But even worse, it simply does not work.

A detailed empirical research project on the effects of these policies found that they reduced the supply of housing and raised average home prices – the exact opposite of the desired effect.

In the Los Angeles region, inclusionary housing policies led to 770 affordable units being sold over seven years, while during the same period reducing the total number of new units built by more than 17,000 and raising the average home price by about $50,000.

The reason is that developers need to cover their costs when they build homes. If they are forced to sell some below market, the remaining ones need to be priced above market.

Again, many potential homebuyers who could have afforded to buy a home on their own were priced out of the market by that $50,000 increase. When some are subsidized, others – typically those just barely making it on their own – take the brunt of it.

What really drives housing affordability is supply and demand. We have no shortage of demand in Sarasota. Supply is the problem. Like so many places, Sarasota has throngs of people who have moved here, purchased their home and now want to put a stop to any more growth. They got theirs, and now they want to shut the gate on everyone else.

This stance is unfair and morally bankrupt. Moreover, it simply violates the property rights enshrined in our Constitution, which are crucial to our way of life.

Everyone who buys a parcel of land has equal right to build a home on it, so long as he doesn’t impose an undue burden on any others in the process. The fact that the economy involved developers to make this process more efficient doesn’t make the rights any less fundamental.

High home prices outside of downtown and on the keys can be squarely laid on the shoulders of land-use restrictions. Over the past decade, researchers at Harvard and the University of Pennsylvania studied this problem and found that housing price differences between cities are not attributable to variation in land prices or construction costs but to regulatory differences, primarily zoning and building restrictions.

Similar research for the Lincoln Institute of Land Policy found that “house prices in cities with stricter regulatory policies rose 30% to 60% relative to less restrictively regulated cities over a 15-year period.”

There are some rays of light in Sarasota’s affordable housing landscape. City commissioners have considered allowing more housing to be built in both downtown and on the city fringes.

Indeed, the recipe for affordable housing is to deregulate markets for land and allow market-driven densities and development, especially in the suburbs. It means getting rid of costly elements, such as building codes that serve arcane interests rather than measurably improving public health and safety. All those do is result in higher home prices.

It also means setting impact fees sensibly. These fees are supposed to mitigate the effects of more housing, such as increased traffic, but they have become a way for government to force builders to do their bidding. Remember, whenever developers are forced to pay more fees, that cost is eventually passed down to the homebuyer. So these impact fees should not be a bargaining chip, but a data-driven assessment of unusual impacts with fees set commensurate with addressing those impacts.

Those fees should be spent only on addressing those impacts effectively. Using high fees to limit growth or waiving or reducing fees to incentivize certain developments only distorts the market and makes the affordability problem worse.

There is no silver bullet. The lack of a clear definition of affordable housing means it will always be a messy policy area. But we have decades of experience showing that interfering with housing markets makes homes less affordable, while working with the markets puts homes in the reach of ever more people. That is my definition of affordable housing policies.

Adrian Moore is vice president of policy at Reason Foundation. This article originally appeared in the Sarasota Observer.

Correction: This article originally referred to the Lincoln Institute of Land Policy as the Lincoln Land Institute.

The post Market-Driven Solutions Can Help Create Affordable Housing in Sarasota appeared first on Reason Foundation.

Now the question is whether this means housing is on a sustainable path or if we’re in another bubble of artificially high prices and demand that’s bound to burst.

Typically, we hear housing prices are going up and think that means recovery. But that assumes there is something inherently good about housing prices being high. Homeowners looking to sell always want higher prices, but homebuyers don’t. Beyond the consideration of housing sales, to understand whether booming home prices really are a sign of market recovery it is critical to consider why prices are increasing.

If the cheap mortgages provided by low interest rates – hat tip to outgoing Federal Reserve Chairman Ben Bernanke – were the source of increasing demand over the past few years then the growth in housing prices may be temporary. When interest rates return to natural levels, the artificially cheap mortgages will disappear too, reducing buyers’ purchasing power and driving down housing prices.

At the same time, as long as Southern California remains a desirable place to live and work, strong demand to live here could continue to drive home prices and sales up.

So how do we determine if Southern California is experiencing the birth of a new bubble or a true recovery? The ratio of home prices to rental costs in a given area is a measure often considered when studying housing bubbles. Rents are closely tied to market supply and demand and are rarely susceptible to bubbles, so they serve as a baseline in determining if housing prices are inflated.

Between 1991 and 1999, the Federal Housing Finance Agency reports that home prices in the Anaheim-Santa Ana-Irvine metropolitan statistical area increased 11 percent (unadjusted for inflation). During the same period, renters in the same area saw their housing costs grow 12 percent, according to the Bureau of Labor Statistics. Translation: the price of homes was not inflated during the 1990s in Orange County – and in fact might have been undervalued a bit.

The story quickly changed, though. From the first quarter of 2000 to the same time in 2006, housing prices in Orange County jumped 155 percent. In the greater Los Angeles area prices spiked 178 percent. But BLS rental prices rose just 38 percent. Translation: the price of homes was significantly inflated relative to rents, signaling the housing bubble.

The year 2006 marked the top of the housing bubble for Southern California, and prices quickly collapsed for more than three years, according to FHFA data. Both Orange County and Los Angeles saw prices stabilize in 2009, and from the summer of 2012 through 2013, prices steadily climbed back to 2004 levels.

The warning sign for today’s market is that housing prices are once again growing much faster than the BLS rental market trend. Entering 2014, homes in Orange County are 20 percent higher than rents by BLS standards. In Los Angeles, home prices are 6 percent higher than rents.

In its most recent Bubble Watch Report, housing price monitor Trulia.com named Orange County and Los Angeles as the two most overvalued housing markets in the United States. And with the Federal Reserve beginning to throttle back on its quantitative easing policy that helped create lower mortgage rates, the air could be let out of Southern California’s new housing bubble quickly.

If the data looks like a bubble and acts like the last bubble, it’s probably a bubble. Orange County homeowners and buyers should consider the recent housing market crash before jumping onto the real estate “recovery” bandwagon.

Anthony Randazzo is director of economic research at Reason Foundation. This column originally ran in The Orange County Register.

The post A Housing Bubble in Orange County? appeared first on Reason Foundation.

Despite its popularity among voters, the mortgage interest deduction has long been a target for elimination. Most recently, President Obama’s deficit reduction commission (Simpson-Bowles) had it in its sights. While there is general sentiment among voters that the mortgage interest deduction is a good idea, there is little understanding of its effects. In order to understand the potential effect of closing this loophole, this study examines specifically who benefits from the MID and how much they benefit. It also provides an estimate of how much tax rates could be reduced if the deduction were eliminated but revenues were held constant.

The post Unmasking the Mortgage Interest Deduction: Who Benefits and by How Much? 2013 Update appeared first on Reason Foundation.

A. BCFC Outlines $795 Billion in Federal Budget Savings

B. Congress Takes on Postal Service Reform-Again

C. Space Privatization Update

D. ANALYSIS: Google, Facebook, Antitrust and the “Public Good”

E. ANALYSIS: Private Sector is Best-Positioned to Lead Cybersecurity Policy

F. ANALYSIS: Privatization of Financial Regulation is Not Impossible

» Return to Annual Privatization Report 2013 homepage

The post Federal Privatization Update appeared first on Reason Foundation.

Privatization of Financial Regulation is Not Impossible

By Anthony Randazzo and Victor Nava

Introduction

In July 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, the single largest expansion of rules for banking and financial markets since the Great Depression.1 Federal regulators have worked since then to begin implementing the law, though through 2012, only 30 percent of the final rulemaking required by Dodd-Frank has been completed. Still, 848 pages of legislation have already grown into a staggering 8,883 pages of rules and regulations.2 Intense debates have broken out over nearly every Dodd-Frank rule proposal, and such disagreements have severely delayed the implementation of the most controversial parts of the legislation.

There have been many suggestions that Congress revisit the Dodd-Frank Act and repeal some of the powers given to regulators in the wake of the financial crisis, not least because government regulations are already estimated to cost American taxpayers and businesses $1.8 trillion annually.3 The Government Accountability Office puts the cost of implementing the Dodd-Frank bill alone at $2.9 billion.4 Other critics of Dodd-Frank cite the failure of regulators to prevent or even anticipate the financial crisis-why, they ask, should we give more power to organizations that have manifestly failed to carry out their core functions effectively?

A more prescriptive argument is that private oversight, on an industry basis, with properly aligned incentives and detailed bankruptcy rules in the case of failure can be a cost-efficient, robust, and effective approach to bringing about the world that Dodd-Frank is seeking to achieve. This chapter presents three Dodd-Frank rules that could be taken out of the hands of regulators, and privatized with minimal risk.

1. Title V of the Dodd-Frank Act: Federal Insurance Oversight

Title V of the Dodd-Frank Act establishes the Federal Insurance Office (FIO), which monitors all aspects of the insurance industry.5 The new office is tasked with identifying issues or gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry or the financial system. The FIO is intended to coordinate and develop federal policy on international insurance matters, including representing the United States in the International Association of Insurance Supervisors. Further mandates for the FIO include monitoring access to affordable insurance by traditionally underserved communities and consumers and taking charge of administering the Terrorism Risk Insurance Program-a reinsurance program that acts as a safety net for insurance companies in the event of a terrorist act through 2014, when the terror insurance program is slated to expire.

The FIO is the first federal agency involved with virtually all aspects of the insurance industry (except health and crop insurance).6 The statute does not technically give any direct regulatory power to the FIO, but even without it, the FIO can greatly influence how insurance is regulated. For instance, as a nonvoting member of the Financial Stability Oversight Council, the FIO can identify insurance companies as non-bank systemically important financial institutions, which would lead to enhanced standards for capital requirements and stress tests which the FIO would coordinate with the Federal Reserve in administering.

The first problem with the FIO is that it raises costs for consumers. The FIO’s data-gathering authority raises the compliance costs for insurance companies, that will inevitably pass those increased costs along to consumers. Another source of increased compliance costs is that the FIO duplicates oversight provided by the National Association of Insurance Commissioners (NAIC), a group of state-level regulators that suggests rules and regulations to state governments, while setting industry standards to be followed by insurance companies.

The second problem with the FIO is that it puts taxpayers at risk. Consider state-run insurance programs, like Florida’s Citizens Property Insurance Corporation, which, despite being designed as an insurer of last resort, has ended up issuing over 1.3 million policies and over $400 billion in coverage.7 The result is that Florida is only one bad hurricane away from state bankruptcy. Similarly, the National Flood Insurance Program (NFIP) has wound up encouraging growth in hazardous areas, by shifting the associated costs from insurance providers to taxpayers. More than one-third of the 6.6 million buildings located in the one-hundred-year floodplains of participating communities have been built since the start of the NFIP-subsidized flood insurance program in 1968.8 In addition, repetitive-loss properties (properties that suffer repeated flooding, but generally receive subsidized policies) absorb a large percentage of the NFIP funds.9

One alternative to the current FIO/NAIC model that increases consumer costs and puts taxpayer dollars at the mercy of insurance risks is the privatization of rule-making and oversight in the insurance industry. Such an approach is not unprecedented in the financial sector. The accounting industry, for example, operates based on privately established Generally Accepted Accounting Principles (GAAP). Likewise, the industry standards used by all publicly traded companies, as well as many private companies, were created by the private, non-governmental Financial Accounting Standards Board (FASB), rather than the Securities and Exchange Commission.10 A similar model could be applied to the insurance industry-a private body could be tasked with establishing and enforcing industry standards nationwide, and publicizing any deviations from them. Companies that shrink away from such transparency would have to deal with that reputation in trying to attract customers, creating an incentive toward openness and compliance with established standards.

The FIO’s Terrorism Insurance Program can also be handled by the private sector. Reinsurance need not be a function of government; if insurance companies feel the need to take out insurance on their insurance, they can buy it on the private market like everyone else. While 9/11 did represent the largest claims payout in global insurance history, producing $32.5 billion in insured losses, the losses were well dispersed and paid across several lines of insurance, including property, business interruption, aviation, workers comp, life and liability.11 They were not solely concentrated on one entity or one form of insurance. The FIO is clearly not needed to run the Terrorism Insurance Program when the private sector has already proven its ability to handle such a terrorist catastrophe.

2. Title XI of the Dodd-Frank Act: Capital Requirements

A main goal of the Dodd-Frank Act is to curb systemic risk in the banking sector. Bank failure contagion is an issue that the federal government has been attempting to remedy since 1933 when, as a response to Great Depression bank-runs, the United States created the Federal Deposit Insurance Corporation (FDIC) to insure commercial bank deposits.12 The creation of deposit insurance came with a nasty side effect, however: moral hazard. If banks don’t bear full risk for their activities it may encourage them to gamble with the money depositors leave on hand. Regulations in different forms have sought to fix this glitch, including bans on particular business activities (such as the Glass-Steagall Act that separated investment and commercial banking) and capital requirements to ensure banks keep enough reserves relative to their risk.

Two major international agreements were reached prior to the financial crisis, the Basel Accord and Basel Accord II, each coordinated by the Basel Committee on Banking Supervision in Switzerland.13 The first agreement failed to prevent global financial ruin in the 1990s, and the second agreement created rules that encouraged banks to invest heavily in mortgage-backed securities-a major contributor to the crisis.14

In spite of these failures, Title XI of the Dodd-Frank Act mandates the FDIC, Treasury Department, and the Office of the Comptroller of the Currency to establish new minimum risk-based capital requirements for banks. These will be modeled on Basel III, which seeks to limit systemic risk in the banking system by forcing banks to have more capital buffers for riskier assets, higher liquidity requirements, and stricter leverage limits. This is despite the fact that the revised agreement is from the same body that has twice failed to get capital requirement rules right.

In September 2012, member of the FDIC Board of Directors Thomas Hoenig blasted the old Basel capital requirements, stating:

It turns out that the Basel capital rules protected no one: not the banks, not the public, and certainly not the FDIC that bore the cost of the failures or the taxpayers who funded the bailouts. The complex Basel rules hurt, rather than helped the process of measurement and clarity of information.15

He then turned his sights on the new Basel rules and had similarly harsh words of warning:

The poor record of Basel I, II and II.5 is that of a system fundamentally flawed. Basel III is a continuation of these efforts, but with more complexity.16

The root of Hoenig’s complaint is that Basel depends too much on estimating the risk of a particular asset and then weighting the capital requirement based on that risk. The goal is to keep banks from over-leveraging by forcing them to hold more capital if they buy riskier assets. The problem in the recent crisis was that these risk estimates turned out to be flawed. Sovereign debt was assumed to have no risk at all, and just look what has happened in Europe over the past few years. Triple-A rated mortgage-backed securities were considered to be among the safest form of capital. In fact, a group of 100 mortgages could be given a 50 percent cut in risk-weight just by packaging the loans into a security-and look at what happened in the financial crisis. The only significant changes for the new Basel capital requirements are adjusted risk weightings-banks must now hold a 2.5 percent extra capital buffer in case of another crisis, and the banks can no longer rely on credit rating agencies to determine the soundness of assets. The liquidity standards remain loose and certain mortgage-backed securities are even eligible to be counted as high quality assets towards a bank’s coverage ratio. The new rules are essentially the same as the old ones except with some new, arbitrary risk weights thrown in.17

On the flip side, if regulators set liquidity standards too tight it could dry up lending and freeze financial markets. This is the conundrum for regulators who need some kind of capital requirement regime to mitigate the moral hazard created by deposit insurance. Yet there is a remarkably simple solution to this problem: privatize the FDIC.

Without the FDIC, private deposit insurers would create their own standards for capital requirements, risk weights, and anything else that they want to require of banks. The insurance providers would base premiums and fees on the level of risk that the banks are willing to take on, much like auto insurers would charge more if you drove an accident-prone car, and health insurers would charge you more if you smoked. Competition between private insurers would discourage them from overburdening the banks with regulatory requirements, and also create a strong commercial disincentive for banks to use their customer deposits recklessly.

At present, the FDIC in effect offers a subsidized insurance rate to banks by charging lower premiums than would be found in the private sector. It is this underpricing of risk that has given banks an incentive to behave recklessly. A private deposit insurance system, charging true market rates, would force banks to also take stock of themselves and their use of customer deposits. Just as importantly, without the FDIC guaranteeing every depositor their money back up to $250,000, depositors would need to shop around for the bank they really trust with their money. This too would create competition, driving a race to the top for banks seeking a reputation for safety and security.

State-chartered credit unions, whose customer deposits are called “shares,” already use private insurers such as American Share Insurance (ASI), the nation’s largest provider of private share insurance, to provide peace of mind to depositors.18 Indeed, this idea is nothing particularly new at the national level-the German deposit insurance system was completely privately funded and managed from 1975 thru 2008, a span which saw no private account holder lose money due to a bank failure.19 (The Germans nationalized the deposit insurance system as a “precautionary” measure to “boost confidence” during the financial crisis, but the move was unnecessary: no German banks failed, and no deposit claims were made.) A system where private insurers compete for bank business, and banks compete for customers demonstrating increasingly safe practices would not only allow the free market to determine the best set of banking regulations, it would also transfer risk to the private sector and away from taxpayers.

Banks would still fail from time to time with privatized deposit insurance, and deposit insurance would still have to be paid out, but the competition among insurers would eventually lead to a better regulatory framework than Dodd-Frank. The privatization of deposit insurance ultimately means the privatization of risk, so that banks themselves share personally in the risk for their activities, and customers recognize the importance of choosing the right company to help keep their money safe.

3. Title XIV of Dodd-Frank: Mortgage Finance

The federal government has long provided subsidies for the mortgage market and incentives to buy a home, both of which played a key role in the financial crisis. Yet, Dodd-Frank does little to address the role of Fannie Mae and Freddie Mac in federal housing policy.

Instead of directly addressing the need for federal housing policy reform, Title XIV of Dodd-Frank focuses on standardizing data collection for underwriting mortgages, requiring mortgage originators to only lend to borrowers who are likely to repay their loans, and calls for standards in defining which mortgages can be securitized. The legislation also creates new property appraisal requirements, establishes the Office of Housing Counseling, and gives power to the Consumer Financial Protection Bureau to design mortgage lending forms and paperwork. Thus, Dodd-Frank seeks to tightly control the mortgage finance market, rather than address the flawed structure of federal housing policy, and by so doing discourages private sector involvement in mortgage finance.

From a business perspective, as government increasingly manages risk via regulation, the mortgage finance market holds less attraction for the private sector. Since the credit-rating agencies destroyed so much of their own credibility, the private sector lacks confidence in the rating of mortgage-backed securities and other mortgage investments. High conforming loan limits originally designed to control risk end up causing more competition from the government for market share in the mortgage finance market. Dodd-Frank-driven requirements that banks keep part of the loans they issue on their own books ties up capital that might otherwise be better deployed. And complex legalities governing residential mortgage-backed securities undermine the private sector’s ability to flexibly maneuver within the market.

While intended to prevent risky ventures, these regulatory walls have discouraged private sector engagement in the housing finance market, creating a tight environment that leads to even more government intervention. Not surprisingly, over the past three years, Fannie Mae, Freddie Mac, the Federal Housing Administration (FHA), and Ginnie Mae have collectively purchased or insured over 90 percent of new mortgage business.

The best way to get the private sector back into mortgage finance and reduce the harm that could be caused by Dodd-Frank rules on housing would be to give the mortgage industry incentives to take on more liabilities but at the same time police itself through privatizing the whole mortgage oversight system. In a May 2012 paper, Reason Foundation proposed companies in the mortgage industry come together to create a Mortgage Underwriting Standards Board (MUSB).20 This self-regulating body would take on all the roles that would otherwise be handled by regulators.

Consider, for example, two housing-related Dodd-Frank regulations: the “qualified mortgage”, which requires lenders to ensure borrowers can repay loans and makes lenders liable if borrowers with weak credit get a loan but then can’t repay it; and the “qualified residential mortgage”, which defines the characteristics of a super-safe mortgage, and then only allows lenders to securitize those mortgages, or otherwise compels them to keep a percentage of non-qualifying, and therefore presumably risky, mortgages on their books. Instead of regulators designing and enforcing these rules, the MUSB would create categories of mortgages, with various established standards. As new mortgages are issued, they would be classified to one of these categories established by the MUSB. These classifications would better reflect industry risk pricing, while also helping to establish liquidity through more-transparent lending practices. While these particular underwriting standards would not be legally required, and there would be no prohibition on securitizing mortgages that fall outside MUSB categorization, there would nevertheless be a strong market incentive to adhere to established industry standards of this sort: compliant institutions would find their bond issues far more marketable.21

The same logic can be applied to the credit rating agencies. The existing oligopolistic system fails to create incentives to keep up with the complexities of rating residential mortgage-backed securities (RMBS) and other types of assets. It prevents new companies from entering the ratings market place and competing with established firms, like Moody’s and Standard Poor’s, in coming up with better ways to rate securities. For this reason, the government’s Nationally Recognized Statistical Rating Organization (NRSRO) model appears to be fatally flawed.22

Immediate steps that can be taken to foster a more competitive environment among ratings agencies include allowing non-NRSRO agencies access to prospectuses and loan-level data files prior to the date on which the bonds are first sold.23 Currently only NRSROs are privileged with this sort of information. Another simple reform would be for Congress to authorize underwriters to include property-level address data in RMBS disclosures. This reform would be another step in the direction of allowing for more and higher quality information available on the market, which would allow investors and independent analytics firms to perform more-accurate and lower-cost risk assessments. And Congress can clear the path to allow the creation of a Mortgage Underwriting Standards Board by repealing the mortgage-related sections of Dodd-Frank.

Conclusion

Just as government crowds out private industry when it gets involved in aspects of the economy, government tends to crowd out incentives for private governance when it regulates. When incentives are properly aligned and proper bankruptcy rules are in place in case of failure, the private sector is more likely to construct a more effective regulatory framework than the federal government might try to engineer.

Capital requirements for banks sound like an effective solution to the moral hazard created by deposit insurance, but as became clear during the crisis, Basel capital requirement regulations were misguided attempts to preserve the deposit insurance system, and they remain a problematic way to preventing another crisis.

Similarly, state-level intervention in insurance markets has already proven problematic, leaving consumers and taxpayers worse off. Private industry groups setting standards and monitoring insurance companies is a better way to go about regulating insurance providers than the approach laid out in Dodd-Frank.

Finally, the mortgage finance industry and consumers would be better served by origination standards established by an industry assigned group rather than federal regulators. There are also private solutions to mortgage ratings, which don’t require nationally recognized statistical ratings organizations.

The capital requirement, insurance oversight, and mortgage finance provisions in Dodd-Frank are just three aspects of the legislation that the private sector could handle more effectively than federal regulators. In its quest to manage all risk, federal regulation of housing finance has contributed to the stagnation of the American housing market today that drives so much of our economy. Private governance would be a much better alternative to the bureaucratic behemoth that is Dodd-Frank.

» Return to Annual Privatization Report 2013: Federal Government Privatization
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Endnotes

1 Damian Paletta and Aaron Lucchetti, “Law Remakes U.S. Financial Landscape,” The Wall Street Journal. http://online.wsj.com/article/SB10001424052748704682604575369030061839958.html.

2 Davis Polk and Wardell LLP, “Dodd-Frank Progress Report.” http://www.davispolk.com/files/uploads/FIG/071812_Dodd.Frank.Progress.Report.pdf.

3 Paul Bedard, “$1.8 Trillion Shock: Obama Regs Cost 20-Times Estimate,” The Washington Examiner. http://washingtonexaminer.com/1.8-trillion-shock-obama-regs-cost-20-times-estimate/article/2508466#.ULPq_IZPLWM.

4 Victoria McGrane, “GAO: Implementing Dodd-Frank Could Cost $2.9 Billion,” The Wall Street Journal. http://blogs.wsj.com/economics/2011/03/28/gao-implementing-dodd-frank-could-cost-2-9-billion/.

5 U.S. Department of the Treasury. http://www.treasury.gov/about/organizational-structure/offices/Pages/Federal-Insurance.aspx.

6 Matthew S. Brockmeier, “Beginning of the End of State-Based Insurance Regulations,” The Hill. http://thehill.com/blogs/congress-blog/healthcare/251311-beginning-of-the-end-of-state-based-inusrance-regulation.

7 Jeffrey J. Pompe and James R. Rinehart, “Property Insurance for Coastal Residents: Governments’ Ill Wind,” The Independent Review. Volume 13, Number 2, Fall 2008. http://www.independent.org/pdf/tir/tir_13_02_2_pompe.pdf.

8 Ibid.

9 Ibid.

10 Lynn Westergard, “Private Companies Need Modified Standards, Not Separate Rules,” Schmidt Westergard & Company, PLLC. http://www.sw-cpa.com/bottomline/articles/2011-10/gaap.htm.

11 http://www.claimsjournal.com/news/national/2011/09/09/190969.htm.

12 Jeffrey Friedman, “A Perfect Storm of Ignorance,” Cato Policy Report, January/February 2010. http://www.cato.org/pubs/policy_report/v32n1/cpr32n1-1.html.

13 Ibid.

14 Anthony Randazzo and Mürat Yulek, “Refining the Story of the Financial Crises in Europe and the USA,” Insight Turkey Vol. 14, No. 2, 2012 pp. 59-81. /wp-content/uploads/2012/04/insight_turkey_vol_14_no_2_2012_yulek_randazzo.pdf

15 David Benoit, “FDIC’s Hoenig Wants Simpler Rules Than Basel III,” The Wall Street Journal. http://blogs.wsj.com/deals/2012/09/14/fdics-hoenig-wants-simpler-rules-than-basel-iii/

16 Ibid.

17 Anthony Randazzo, “Basel III Misses the Point; Bankers Will Still Cheat the Rules,” Minyaniville. http://www.minyanville.com/businessmarkets/articles/basel-ii-basel-iii-credit-risk/9/16/2010/id/30114.

18 http://www.mycreditunion.gov/about-credit-unions/Pages/federal-vs-privately-insured-credit-unions.aspx and http://www.americanshare.com/Public/Home.aspx.

19 http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ayQUgBTLYJEc&refer=germany and http://www-wds.worldbank.org/servlet/WDSContentServer/IW3P/IB/2001/03/30/000094946_01032007445638/Rendered/PDF/multi0page.pdf.

20 Marc Joffe and Anthony Randazzo, “Restoring Trust in Mortgage-Backed Securities: How the Private Sector Can Return to Mortgage Finance,” Reason Foundation Policy Study 402, May 2012. /wp-content/uploads/2012/05/study_restoring_trust_in_mbs_final.pdf.

21 Ibid.

22 Ibid.

23 Ibid.

24 Ibid.

The post ANALYSIS: Privatization of Financial Regulation is Not Impossible appeared first on Reason Foundation.

In a new policy summary, Reason Foundation offers a update to the 2011 study “Unmasking the Mortgage Interest Deducton” and takes a look at who is currently benefiting from the MID.

Joint Committee on Taxation data shows households making $100,000 or more a year constitute 55 percent of those claiming the MID, and they receive 78 percent of the deduction’s total benefits. The last two columns of our table of the JCT data show the average tax savings that households in each income group receive from the MID, and what those savings represent in monthly savings. For example, the MID saves middle-class households making between $40,000 and $75,000 a year around $80 a month. The MID is not the middle-class savior it is made out to be.

Attachments

• Policy Summary: Unmasking the Mortgage Interest Deduction: Who Benefits and By How Much? – Update 2012

The post Unmasking the Mortgage Interest Deduction – Update 2012 appeared first on Reason Foundation.

The reality is that foreclosures are far from having hit their bottom. They declined after the “robo-signing” scandal in late 2010, which revealed that banks were processing foreclosures too quickly. But this slowdown was the result of procedural changes, not resurgent market strength. A recent Barclay’s forecast estimates foreclosures will be rapidly picking up steam going into 2013 and peaking in 2014 before they actually start to dissipate towards the end of 2014 and beyond. We have replicated their forecast to show a few key events that impacted the numbers, below.

One of the main reasons that we have been bearish on housing while many others have been declaring a recovery is in motion is that this new wave of foreclosures is certain to put downward pressure on housing prices. The pressure will be highly localized to areas with more heavily concentrated delinquencies-such as South Jersey, South Florida, Mississippi, and Nevada-meaning some areas will be less effected and see price recoveries in the near-term. The nation as a whole, on the other hand, will have to contend with rising foreclosures and the ripple effect that results-unless of course there is some new intervention in the markets to slow down foreclosures again.

Consider, for example, a little talked-about Massachusetts law that will go into effect November 1, 2012 which gives judges in the Bay State the power to determine whether a bank can foreclose on a distressed home, or if it will be forced to modify the homeowner’s mortgage to avoid foreclosure. As we wrote at Reason.com last week:

Signed on August 3 by Gov. Deval Patrick, the “Act Preventing Unlawful and Unnecessary. Foreclosures” creates a series of new hoops for banks and other mortgage creditors to jump through in order to foreclose on borrowers who aren’t making their payments.

Under the new law, lenders will have to demonstrate to a Massachusetts court that they made “a good faith effort” to work with delinquent borrowers, and that they took “reasonable steps” to avoid foreclosing. Such “steps” would include considering whether the borrower could make a lower “affordable monthly payment” relative to their current delinquent loan.

These terms are ridiculously arbitrary: “reasonable steps” and “affordability” will be defined very differently by a bank trying to get its shareholder’s money back, versus a homeowner desperately clinging to a roof over his head. Furthermore, they will be interpreted differently by different judges…

The law also requires lenders to prove that they will reap more revenue from foreclosing on the home and selling it in a distressed sale than from modifying the mortgage. At first glance, this provision seems redundant. Presumably a bank would modify a mortgage if they thought they would take fewer losses relative to a foreclosure, even without the government telling them to do so. But the point of the law isn’t to encourage banks to figure out how to profit most from delinquent homeowners, it is to empower judges to tell banks that their estimates on value are wrong.

And though judges will soon have that power, they will be far less qualified to determine value than the banks. For instance, implicit in any assessment of whether a foreclosure will be more valuable than a mortgage modification is an estimate of how much selling the home as a bank-owned property would generate. Banks then compare that to the value of a mortgage modification. Not only will a bank and the court likely have different estimations, but from bank to bank there is rarely a concurrence of opinion on housing market futures. This is just the tip of the iceberg in terms of complicating factors for judges and regulators getting into the mortgage value assessment game.

The new Massachusetts law, similar to legislation passed in states like Nevada and California and drafted in others, distorts market signals in both housing supply and demand, and less obviously in financial lending. If a bank is in fact making erroneous estimates on the value of foreclosures, and taking more losses than it needs to rather than modifying mortgages, then judicial intervention will keep the bank in business that should (and prior to this law, would) be allowed to fail. This hurts future financial institutions that would out-compete the bad banks of today, and means poorer quality service for the local areas those banks serve.

More to this newsletter’s particular point, this intervention in the foreclosure system slows down the process unnecessarily. Rather than bringing a housing recovery to the near-term, slowing down foreclosures delays the inevitable and pushes any real recovery further off into the future. As long as there is a steady stream of foreclosures in the system, there will be downward pressure on housing prices, and that does not characterize a recovery (at least how I would define one). Whether housing price and sales data over the next week are “positive” or “negative”, what really matters is what is going on with the supply of housing and the rate of foreclosures.

The post Thinking about Foreclosures and the Fauxcovery appeared first on Reason Foundation.

President Obama has tried a number of programs to address the struggling housing market, including the Making Home Affordable programs to refinance mortgages and use taxpayer funds to pay banks to write down principal. Neither Romney nor Ryan has been very vocal about these programs in detailing how they have backlogged the foreclosure process, thus hurting homeowners and dragging out the price decline timeline. And neither has used their platforms to point out how these programs served as a back door bailout to banks by encouraging trial mortgage modifications that were never designed to succeed; instead implemented to simply delay when banks had to register losses on their balance sheets to soften the blow to earnings.

However, on the campaign trail, Romney has said that he thinks the best way to address the housing problem is to let foreclosures process through and let prices bottom out. So a Romney-Ryan administration would be likely wind down these programs and take a new approach. But what would this new approach look like? Moreover, what does Ryan’s ascendance to the ticket bring in terms of substantive discussion on new approaches to housing finance and property markets in the presidential race?

Looking at housing finance, Romney and Ryan have been similarly vague on reforming the role of Wall Street in homeowners’ lives. Ryan has raised questions about allowing banks to become so big they need taxpayers to bail them out if they begin to fail. Many have suggested Ryan’s comments imply support for breaking up the big banks. On the other hand, Ryan is an ardent critic of the Dodd-Frank regulatory reform bill and has advocated for limiting the federal government’s ability to take over and dismantle failing financial institutions – no matter how beneficial such an outcome might be.

Most of the attention has focused, understandably, on Ryan’s tenure as the conservative point man in Congress on the federal budget. And while discussions of spending priorities and entitlement reform paths are valid discussions on their own, they also frame important questions like how to bring market forces back to housing.

Unfortunately, a brief pass through the Ryan budget turns up little commentary on the future of Fannie Mae and Freddie Mac, the proverbial 800 pound guerrillas in the housing finance room. The two mortgage giants, taken into conservatorship in August 2008, are now essentially wards of the state. They continue to draw taxpayer money from the Federal Reserve to cover their losses and, with around $5 trillion in mortgage-related liabilities, some accounting methods would ascribe those as potential losses to the taxpayers. The Ryan budget does not account for them when considering a baseline, nor does his plan give many details about ending the ongoing bailout beyond loose acknowledgement of a bill from Rep. Jeb Hensarling (R-TX).

How to stop a bailout that has blown past $200 billion from continuing to grow is certainly something a budget focused leader – like Ryan – should be pushing his party to address, and that a presidential candidate – like Romney – should articulate as part of a main message to the public that Washington is wasting too much money. Yet, Ryan has done little publicly to support efforts in the House Financial Services Committee to advance the cause of ending the government-sponsored enterprises (GSE), or advancing ideas that could help restore housing finance. And unfortunately his budget is not much different from Obama’s budget relative to the scope of irresponsible spending and entitlement problems.

At most, Romney economic plans offer a paragraph to say he’ll address the GSE issue, though without details suggesting how. Here it’s certainly true that many good ideas have been floated (see Reason Foundation’s paper “Restoring Trust in Mortgage-Backed Securities” by Mark Joffe and Anthony Randazzo for a list of recommendations), and even introduced as legislation in the House.

The Obama campaign is similarly guilty of limiting the substantive discussion of housing finance, the GSEs, and restoring the mortgage-backed securities market (including both the questions of how and whether it should even be done).

The separation between Romney-Ryan and Obama-Biden is in the intellectual traditions they claim to support, particularly on tax policy.

Both Romney and Ryan have argued for a streamlined tax code with a broader base that allows for tax rates to be lowered overall. Ryan has consistently argued for a system in which markets sort out which private institutions fail and which ones thrive. Romney, a successful product of the private investment community, recognizes the inherent if sometimes traumatic value of an economy that creates value through profit and loss. Indeed, this was the bedrock bet of companies like Bain Capital that specialized in identifying undervalued assets and bringing them back to profitability.

We know from the first term of the Obama administration what their approach to housing policy would be in a second term. As for Romney/Ryan, unfortunately the record of substance thus far from their camp has been rather underwhelming. Nevertheless, what would be the implications of taking the pro-growth, pro-investment framework for economic policy the GOP purportedly supports and using it to guide policy for property markets and housing finance?

First, we would expect to see reforms that reduce distortion in housing markets. Tax loopholes and targeted tax incentives are likely to have a rough road in a Romney-Ryan administration. Corporate tax deductions and investment tax credits are likely to become targets as fiscal conservatives look for ways to lower overall tax rates without appearing like they are sops for the well healed. This may well translate into a critique and rolling back of the home mortgage tax deduction, particularly since research shows the benefits accrue mainly to the wealthy while having little impact on the overall health of the housing market.

Second, there could be fewer attempts to use government programs to fix the housing market. Ryan infamously voted for the Toxic Asset Relief Program (TARP); admittedly going against his core principles. But the intellectual tradition Romney and Ryan are defending would arguably reject this path in the future. A hard landing is better than a prolonged, drawn out, soft economy incapable of creating the jobs necessary to keep Americans financially solvent and independent. And Romney has said, accurately, that the best thing for the housing market is a hard landing and letting the market clear out toxic debt before things get better.

Bringing substantive ideas to the debate and challenging the Obama administration on its poor housing record would be the “substance” pundits are predicting from the new VP nominee. However, in order to accomplish this, Romney and Ryan will need to sketch out more detailed plans for how they will approach the housing mess if they want there to be a real debate. Otherwise, their record suggests their approach to the struggling housing market will either be to ignore the problem or follow loosely in the path of the Obama administration.

Samuel R. Staley, Ph.D. is a senior research fellow at Reason Foundation and Managing Director of the DeVoe L. Moore Center at Florida State University. Anthony Randazzo is director of economic research at Reason Foundation.

The post Does the Paul Ryan Choice Ensure a Real Housing Debate? appeared first on Reason Foundation.

As terrible as this idea is, the debate cannot focus on just the problematic nature of reducing principal for some families, or on the complexities of eminent domain. That would miss the larger, philosophical statement being made by this idea’s supporters-it is on the underlying framework of thought that the debate should focus.

This innovative approach to principal reduction, initially proposed by Cornell University law professor Robert C. Hockett, went mainstream recently when news broke that city officials in San Bernardino County were considering implementing the idea and after famed housing economist Robert Shiller promoted the proposal in a New York Times op-ed in late June. Shiller’s piece argued that the housing debacle has been caused by a collective action problem and if municipal officials were to just leverage their eminent domain authority, they could clean up the housing mess and ride off into the sunset as heroes.

This collective action view is the philosophical underpinning of the idea to use eminent domain to write down mortgage principal. As long as this argument stands, then any critique of the ideas merits or functions will be somewhat futile.

Consider first the theory of reducing the principal balance for homeowners whose homes have fallen in price below the mortgage they took out to buy the house.

There is still a substantial debate over whether writedowns are actually better for investors than foreclosure. Shiller argues that it is “well known” that lenders lose more in foreclosures because of legal costs and having to sell the home in a depressed market, tacitly claiming that any investors that don’t write down principal are making the wrong business decision.

Consider further that principle writedowns can seem like a silver bullet for solving the housing mess. For the most part, there is widespread agreement on what the problem in the housing market is:

• Household debt remains at unsustainably high levels, making a housing market recovery impossible, and in turn weakening consumption which has created a trickle-down effect throughout the economy;
• Underwater mortgages remain a persistent problem, creating unstable household financing, making it difficult for families to sell their homes, which has led to increasing default rates;
• These challenges exacerbate an already clogged foreclosure pipeline that still has to wrestle through millions of homes left in the shadow inventory; and
• Collectively households are left in a pessimistic state, needing to readjust their expectations for housing values, and future wealth growth.

I call these the Four Horsemen of the Housingocalypse. They have thus far laid waste to a once thriving housing market and will continue to march back and forth across America for the next several years.

It doesn’t take a genius to see how principal writedowns are such an appealing solution to these problems. Reducing principal balances would lower household debt and reduce the number of underwater mortgages at the same time. This would mean fewer defaults and a faster clearing of the foreclosure pipeline while also boosting the spirits of homeowners.

But this is too simplistic of an understanding for how principal writedowns would work. Consider that the federal government’s Home Affordable Modification Program has had re-default rates of over 50 percent. Sometimes a family that is in a home worth less than the face value of their mortgage won’t be able to make payments even if the principal balance is reduced. Sometimes a family that gets a principal writedown recognizes that they still have no equity in the home and can walk away just as before. Sometimes lenders can get more money for their shareholders or investors by taking a home into foreclosure and selling it, rather than taking a loss by offering to reduce the principal balance owned by the borrower.

So in contrast to Shiller’s view, many MBS investors have expressly refused to modify loans because their analysis shows there is more financial upside to foreclosures than principal reduction. They have clients and shareholders to protect, many of whom are teachers, firefighters, and grandparents, not just greedy bankers and overseas investors.

This does not matter though, because the idea that eminent domain is necessary for principal reduction rests on the idea that these investors are incapable of doing their own analysis because of the collective action problem. So pointing to the strong incentive that MBS investors have to get their analysis right and suggesting that the just course of action is to allow investors to make their own choices, whether they turn out profitable or not, is an argument that falls flat at the walls of the Hockett/Shiller philosophical framework.

The second element of the Hockett/Shiller argument is that eminent domain would be an effective way to pursue principal reduction. This is where academia runs into the usual trap of devilish details. Using eminent domain to “condemn” mortgages would create a highly complex, legal nightmare worse than the foreclosure mess, and take years, if not decades, to process through the court system.

In a traditional case of a county wanting to build a highway through a farmer’s field, the landowner can either accept the offer from the county to buy his land, get a friendlier appraisal and counter offer in court, or contest the condemnation in court. Very few people take the first option.

So the courts would be dealing with hundreds of thousands of cases with mortgage investors fighting for government officials to give them a better price or to stop the taking all together. Those prices would not be market established prices-i.e., an actual buyer saying he would buy the reduced mortgage at the lower than face value price, and would not be guaranteed to be sold back to investors creating liabilities for the municipal government engaging in the abusive use of eminent domain. But National Association of Real Estate Appraisers would certainly find a way to explain away this problem with campaign donations to existing county board members or city councilmen.

Professors Hockett and Shiller both have impressive resumes and are certainly world class thinkers making substantive contributions in the fields of jurisprudence and finance. However, this idea has exposed some naivete about the world of eminent domain. Unfortunately, this again is a secondary argument, relative to the philosophical framework’s perspective on rule of law and property rights.

A relatively mainstream view of eminent domain is that it is justified only if the governing body is taking private property for necessary public use, with no alternative courses of action, and full compensation is granted.

Using eminent domain to take mortgages may not satisfy any of these criteria. Shiller might argue that writing down mortgages would ultimately help the economy as a whole and provide a public good, but this is the same logic that was applied in Kelo v. New London (where the condemning authority argued that the economic benefit of taking private land to allow for a business development justified the use of eminent domain). Using this dangerous road of logic, anything that has the potential to boost economic growth would be cause for taking private property away from the hands of the citizenry.

The second criteria is that there are no alternative courses of action, but obviously that is not the case as the MBS investors have suggested a clear second option to writedowns: the foreclosure process.

The third leg of the justified eminent domain use stool is fair compensation. This is particularly important because the mortgages to be seized would explicitly be taken with the intention of paying the investor less than the face value of the mortgage as a part of forcing the reduction of principal. As Shiller writes in his New York Times piece: “Governments could seize underwater mortgages, paying investors fair market value for them… The true fair market value for these mortgages is arguably far below their facevalue, given the likelihood of default, with its attendant costs.”

The question becomes what really constitutes fair value? A standard free market view would be that fair market value is actually what someone will pay for a good or service, not what a judge determines as the worth of an underwater mortgage. And this could create complications for a condemning authority trying to figure out how to price the underwater mortgage.

Consider that if the price the investor would demand to sell the mortgage is not what the market is buying at (which is presumably the case, otherwise there would be no need for the eminent domain), then the government could buy at a price that it will be unable to later sell the mortgage for; thus creating financial liabilities for taxpayers. On the other hand, if the government forced the investor to sell at a lower price than desired, has the investor truly been compensated justly to meet the criteria for eminent domain to be legal?

Ultimately, Shiller is able to over look the potential for eminent domain abuse that violates property rights and misconstrues fair value because he is looking at the housing mess as a collective action problem.

“At the moment, the trouble in our real estate markets and the drag these markets are placing on our entire economy may be understood as a collective action problem,” Shiller wrote as the foundation for his argument. “In the current real estate market, the relevant group is enormous and complex… These people live all over the world and have no way of communicating with each other, let alone coming to an agreement to give homeowners a break.”

Shiller’s view is that there is no way the investors caneffectively or efficiently respond to housing market problems because of constraints of collective action. Therefore, ignore the problems of this proposal as argumentative nitpicks and focus on the short-term picture.

Today’s housing troubles are not a collective action problem, though.

The reason so many homes remain underwater is because of intentional, subjective investment decisions made by banks, hedge funds, and institutional investors. Many of them could act, many of them choose not to. Just because the investment choice is undesirable doesn’t mean investors are incapable of doing their own analysis. It is certainly likely that some principal has not been written down because of paperwork backlogs, poorly trained customer service reps, incompetent managers, and other unfortunate problems. But this is not cause for Shiller to make a utilitarian argument that what is good for the whole should be valued over the good of the few and rights trampled for a supposedly righteous cause.

Why not apply Shiller’s logic to the environment? If coal pollutes the air and it is taking a long time for renewable energy products to develop because coal-fired power is still so cheap, then the same logic suggests the government should seize all coal mines and coal burning energy plants to preserve the air and use eminent domain for the good of the public. Sure some people would be hurt along the way, like coal miners, the town businesses that depend on coal miners, and citizens who have to pay more for energy. But we’d be better off. Shiller takes the same attitude of indifference towards MBS investors. And it is very poor reasoning.

At a certain level there is a measure of compassion in the mix for households beset by debt, needing to make medical payments or just buy healthier food. But if that is ultimately the source of support for this idea then don’t call it a collective action problem, call it a human rights crisis (as some have done) or something similar. Then we can have a debate about the value of homeownership for families and the nature of debt as a prisoner. Those are topics for another column, but at least then we’d be talking about the same thing, instead of debating past each other.

For now, the reality is that sometimes write-downs are helpful, other times they are not. There is no universally accepted, objective, single course of action that the masses just have not seen. And that is the argument which should win the debate. The only collective action problem here is that the collective have not acted as Shiller would prefer.

Anthony Randazzo is the Director of Economic Research at the Reason Foundation. He can be reached at anthony.randazzo@reason.org. This is an updated version of a commentary that ran at RealClearMarkets on June 28, 2012.

The post Cities Taking Mortgages with Eminent Domain is a Bad Idea appeared first on Reason Foundation.

As terrible as this idea is, the debate cannot focus on just the problematic nature of reducing principal for some families, or on the complexities of eminent domain. That would miss the larger, philosophical statement being made by this idea’s supporters – it is on the underlying framework of thought that the debate should focus.

This innovative approach to principal reduction, initially proposed by Cornell University law professor Robert C. Hockett, went mainstream over this past weekend when famed economist Robert Shiller promoted the plan in a New York Times op-ed. Shiller’s piece argued that the housing debacle has been caused by a collective action problem and if municipal officials were to just leverage their eminent domain authority, they could clean up the housing mess and ride off into the sunset as heroes.

This collective action view is the philosophical underpinning of the idea to use eminent domain to write down mortgage principal. As long as this argument stands, then any critique of the ideas merits or functions will be somewhat futile.

Consider first the theory of reducing the principal balance for homeowners whose homes have fallen in price below the mortgage they took out to buy the house.

There is still a substantial debate over whether writedowns are actually better for investors than foreclosure. Shiller argues that it is “well known” that lenders lose more in foreclosures because of legal costs and having to sell the home in a depressed market, tacitly claiming that any investors that don’t write down principal are making the wrong business decision.

Consider further that principle writedowns can seem like a silver bullet for solving the housing mess. For the most part, there is widespread agreement on what the problem in the housing market is:

• Household debt remains at unsustainably high levels, making a housing market recovery impossible, and in turn weakening consumption which has created a trickle-down effect throughout the economy;
• Underwater mortgages remain a persistent problem, creating unstable household financing, making it difficult for families to sell their homes, which has led to increasing default rates;
• These challenges exacerbate an already clogged foreclosure pipeline that still has to wrestle through millions of homes left in the shadow inventory.; and
• Collectively households are left in a pessimistic state, needing to readjust their expectations for housing values, and future wealth growth.

I call these the Four Horsemen of the Housingocalypse. They have thus far laid waste to a once thriving housing market and will continue to march back and forth across America for the next several years.

It doesn’t take a genius to see how principal writedowns are such an appealing solution to these problems. Reducing principal balances would lower household debt and reduce the number of underwater mortgages at the same time. This would mean fewer defaults and a faster clearing of the foreclosure pipeline while also boosting the spirits of homeowners.

But this is too simplistic of an understanding for how principal writedowns would work. Consider that the federal government’s Home Affordable Modification Program has had re-default rates of over 50 percent. Sometimes a family that is in a home worth less than the face value of their mortgage won’t be able to make payments even if the principal balance is reduced. Sometimes a family that gets a principal writedown recognizes that they still have no equity in the home and can walk away just as before. Sometimes lenders can get more money for their shareholders or investors by taking a home into foreclosure and selling it, rather than taking a loss by offering to reduce the principal balance owned by the borrower.

So in contrast to Shiller’s view, many MBS investors have expressly refused to modify loans because their analysis shows there is more financial upside to foreclosures than principal reduction. They have clients and shareholders to protect, many of whom are teachers, firefighters, and grandparents, not just greedy bankers and overseas investors.

This does not matter though, because the idea that eminent domain is necessary for principal reduction rests on the idea that these investors are incapable of doing their own analysis because of the collective action problem. So pointing to the strong incentive that MBS investors have to get their analysis right and suggesting that the just course of action is to allow investors to make their own choices, whether they turn out profitable or not, is an argument that falls flat at the walls of the Hockett/Shiller philosophical framework.

The second element of the Hockett/Shiller argument is that eminent domain would be an effective way to pursue principal reduction. This is where academia runs into the usual trap of devilish details. Using eminent domain to “condemn” mortgages would create a highly complex, legal nightmare worse than the foreclosure mess, and take years, if not decades, to process through the court system.

In a traditional case of a county wanting to build a highway through a farmer’s field, the landowner can either accept the offer from the county to buy his land, get a friendlier appraisal and counter offer in court, or contest the condemnation in court. Very few people take the first option.

So the courts would be dealing with hundreds of thousands of cases with mortgage investors fighting for government officials to give them a better price or to stop the taking all together. Those prices would not be market established prices-i.e., an actual buyer saying he would buy the reduced mortgage at the lower than face value price, and would not be guaranteed to be sold back to investors creating liabilities for the municipal government engaging in the abusive use of eminent domain. But National Association of Real Estate Appraisers would certainly find a way to explain away this problem with campaign donations to existing county board members or city councilmen.

Professors Hockett and Shiller both have impressive resumes and are certainly world class thinkers making substantive contributions in the fields of jurisprudence and finance. However, this idea has exposed some naivete about the world of eminent domain. Unfortunately, this again is a secondary argument, relative to the philosophical framework’s perspective on rule of law and property rights.

A relatively mainstream view of eminent domain is that it is justified only if the governing body is taking private property for necessary public use, with no alternative courses of action, and full compensation is granted.

Using eminent domain to take mortgages may not satisfy any of these criteria. Shiller might argue that writing down mortgages would ultimately help the economy as a whole and provide a public good, but this is the same logic that was applied in Kelo v. New London (where the condemning authority argued that the economic benefit of taking private land to allow for a business development justified the use of eminent domain). Using this dangerous road of logic, anything that has the potential to boost economic growth would be cause for taking private property away from the hands of the citizenry.

The second criteria is that there are no alternative courses of action, but obviously that is not the case as the MBS investors have suggested a clear second option to writedowns: the foreclosure process.

The third leg of the justified eminent domain use stool is fair compensation. This is particularly important because the mortgages to be seized would explicitly be taken with the intention of paying the investor less than the face value of the mortgage as a part of forcing the reduction of principal. As Shiller writes in his New York Times piece: “Governments could seize underwater mortgages, paying investors fair market value for them… The true fair market value for these mortgages is arguably far below their facevalue, given the likelihood of default, with its attendant costs.”

The question becomes what really constitutes fair value? A standard free market view would be that fair market value is actually what someone will pay for a good or service, not what a judge determines as the worth of an underwater mortgage. And this could create complications for a condemning authority trying to figure out how to price the underwater mortgage.

Consider that if the price the investor would demand to sell the mortgage is not what the market is buying at (which is presumably the case, otherwise there would be no need for the eminent domain), then the government could buy at a price that it will be unable to later sell the mortgage for; thus creating financial liabilities for taxpayers. On the other hand, if the government forced the investor to sell at a lower price than desired, has the investor truly been compensated justly to meet the criteria for eminent domain to be legal?

Ultimately, Shiller is able to over look the potential for eminent domain abuse that violates property rights and misconstrues fair value because he is looking at the housing mess as a collective action problem.

“At the moment, the trouble in our real estate markets and the drag these markets are placing on our entire economy may be understood as a collective action problem,” Shiller wrote as the foundation for his argument. “In the current real estate market, the relevant group is enormous and complex… These people live all over the world and have no way of communicating with each other, let alone coming to an agreement to give homeowners a break.”

Shiller’s view is that there is no way the investors caneffectively or efficiently respond to housing market problems because of constraints of collective action. Therefore, ignore the problems of this proposal as argumentative nitpicks and focus on the short-term picture.

Today’s housing troubles are not a collective action problem, though.

The reason so many homes remain underwater is because of intentional, subjective investment decisions made by banks, hedge funds, and institutional investors. Many of them could act, many of them choose not to. Just because the investment choice is undesirable doesn’t mean investors are incapable of doing their own analysis. It is certainly likely that some principal has not been written down because of paperwork backlogs, poorly trained customer service reps, incompetent managers, and other unfortunate problems. But this is not cause for Shiller to make a utilitarian argument that what is good for the whole should be valued over the good of the few and rights trampled for a supposedly righteous cause.

Why not apply Shiller’s logic to the environment? If coal pollutes the air and it is taking a long time for renewable energy products to develop because coal-fired power is still so cheap, then the same logic suggests the government should seize all coal mines and coal burning energy plants to preserve the air and use eminent domain for the good of the public. Sure some people would be hurt along the way, like coal miners, the town businesses that depend on coal miners, and citizens who have to pay more for energy. But we’d be better off. Shiller takes the same attitude of indifference towards MBS investors. And it is very poor reasoning.

At a certain level there is a measure of compassion in the mix for households beset by debt, needing to make medical payments or just buy healthier food. But if that is ultimately the source of support for this idea then don’t call it a collective action problem, call it a human rights crisis (as some have done) or something similar. Then we can have a debate about the value of homeownership for families and the nature of debt as a prisoner. Those are topics for another column, but at least then we’d be talking about the same thing, instead of debating past each other.

For now, the reality is that sometimes write-downs are helpful, other times they are not. There is no universally accepted, objective, single course of action that the masses just have not seen. And that is the argument which should win the debate. The only collective action problem here is that the collective have not acted as Shiller would prefer.

Anthony Randazzo is the Director of Economic Research at the Reason Foundation.

The post Eminent Domain to “Condemn” Underwater Mortgages: Another Bad Idea appeared first on Reason Foundation.

Sounds like a scam, right?

Well, that’s how most mortgages are financed in the U.S. Investors in private, residential mortgaged-backed securities (or RMBS) are prevented by law from knowing the address for the mortgages they purchase. Naturally, a bank wouldn’t want to lend a few hundred thousand without knowing this information. We argue in a recent study by Reason Foundation that mortgage investors should be allowed the same privilege. It’s an important part of getting the housing market on a path toward recovery.

The market for mortgage-backed securities collapsed as a result of high foreclosure rates, particularly on subprime mortgages. Investors lost considerable sums on AAA rated mortgage-backed bonds and have been suing rating companies ever since.

Critics of these lawsuits are correct in suggesting that many investors failed to perform due diligence, blindly trusted the ratings system and ignored prospectuses. But even greater investor attention probably wouldn’t have prevented the financial crisis. Since RMBS investors were given only partial details about the properties backing their bonds, and the borrower address wasn’t among them, they could conduct only a limited risk analysis.

Details, Details

Before the mortgage meltdown began in 2007, some had argued that investors shouldn’t have to worry about the exact details of underlying mortgage loans, because the large number of loans in a given portfolio reduced the risk posed by individual borrowers. Clearly, that logic was flawed.

Many investors would prefer to do more research on their own, or work with analytic firms to do so. But ignorance of the borrower’s address and identity is a substantial disadvantage. Perhaps the single-most-important predictor of a mortgage default is the ratio between all mortgage debt on a property and its current value, the so-called combined loan-to-value ratio, or CLTV. Loan-level data provides the CLTV at the time a deal is originated, but this value isn’t updated over the life of the deal.

When prices were soaring at the peak of the bubble, a mortgage in Phoenix or Las Vegas might have had a relatively safe CLTV, even on a mortgage with little down payment. But as prices rapidly declined, many of those homes began to slip “underwater” with a risky CLTV. Without address-level data, it’s impossible to get a precise fix on a mortgage’s value in real time. As a result, it was challenging for investors to understand how rapidly the value of their mortgage-backed bonds was declining.

As we point out in our study, zip codes can contain several thousand properties and may also include large, often heterogeneous areas. For example, single-family homes recently listed on Zillow.com in zip code 20002 (in Northeast Washington) ranged from $250,000 fixers in the Little Trinidad neighborhood to a $2.8 million upscale townhouse on Capitol Hill. Zip codes simply don’t provide enough data to give more than an imprecise estimate of a change in property value.

Lawmakers, regulators and industry leaders want to keep identifying information out of investor reports to protect borrowers’ confidentiality. The language of the Fair Credit Reporting Act of 1970 — the foundation of consumer credit rights — is a bit hard to interpret, but giving out borrower addresses to investors probably violates its intent. Doing so also clearly violates a nonessential clause of the proposed Private Mortgage Market Investment Act now pending before the House Financial Services Committee.

Cheaper, Easier

Protecting privacy is important. But mortgages are typically recorded in county registers and made available to anyone visiting a county clerk’s office. This is one reason why mortgagors receive refinance offers in the mail: A lender has obtained publicly available mortgage records that he then uses to solicit refinancing business.

If another lender can see that you owe money on your house, why shouldn’t investors in the bonds that back your mortgage see that, too? Clearly some investors value this information because they pay companies such as CoreLogic to match data in RMBS portfolios against these public records. The matching process can be costly and isn’t totally reliable.

It would be cheaper and easier for investors to receive this publicly available information with their mortgage listings. This would encourage more due diligence and give investors more confidence to jump back into the market.

One way to address privacy concerns would be to allow borrowers to choose during the mortgage-origination process whether to allow disclosure of their addresses to investors. In exchange, those who provide authorization could be compensated with reduced closing costs or lower interest rates since their mortgages would be easier to securitize. Privacy would ultimately be the borrower’s choice.

Having access to address-level data wouldn’t solve all the problems in the housing-finance market. But it would make risk analysis substantially more accurate. Combined with a few other reforms — such as encouraging a common format for RMBS collateral data and creating a Mortgage Underwriting Standards Board to compete with ratings companies — it would lead to private capital taking back a sizable chunk of credit risk from the government.

And that would be good news for taxpayers. If the mortgage- backed-securities market rebounds, government-backed Fannie Mae (FNMA) and Freddie Mac (FMCC) could be scaled down without simultaneously shutting down housing finance. Taxpayers, homeowners and investors would all win.

(Marc Joffe is a principal consultant at Public Sector Credit Solutions. Anthony Randazzo is director of economic research at the Reason Foundation. The opinions expressed are their own.)

This article first appeared at Bloomberg View on June 3, 2012.

The post To Help Fix Housing, Disclose Mortgage Addresses appeared first on Reason Foundation.

There has certainly been welcome news over the past weeks. Thanks to the Federal Reserve Chairman Ben Bernanke, interest rates remain at historical lows, with 30-year fixed rate mortgages hitting a mind blowing 3.67 percent earlier this month. In slightly related news, housing “affordability” metrics are at record highs. Combined, these two factors have households flooding banks with mortgage applications.

It is somewhat naïve to conclude from this that housing is back. (Unless you live in the greater Washington D.C. area where construction is booming like its 2005.) Just this week the Federal Housing Finance Agency reported to congress that Fannie Mae and Freddie Mac are still in “critical condition” because of poor performance and the legacy of their bad loans in the last decade.

Three months ago I outlined in this space reasons why we are not seeing a recovery yet. A surge in housing over the past quarter contradicting these claims would have helped start lifting Fannie and Freddie out of their mire (subsequently taking a lot of pressure off taxpayers), but unfortunately the reality has not changed.

Part of the challenge in this debate is how a recovery is defined. I argue that it will be when foreclosures have been worked out of the system, negative equity is cleared away, and prices have stabilized. By that standard, we still do not have a housing recovery.

To back up this claim, let’s consider the strongest arguments that we are witnessing a housing recovery to see if they stand up to the long-term analysis.

Argument #1: With record low interest rates everyone will be looking to get back into homeownership.

The Federal government’s goal of lowering long-term rates has been successful. Led by the Federal Reserve’s quantitative easing program and the Treasury’s continued bailouts for Fannie and Freddie, mortgage rates are lower than ever before. Unfortunately, low rates do not always translate into demand.

There have actually been “record” low rates for several years now, but the cheapness of a mortgage is only one factor in the home-buying process. Consider while mortgage applications are up with super low rates, nearly four out of five of those have been for refinancing, not home purchases. That is because household debt is still a massive deadweight on the capacity of families to buy a new home. At the same time, household wealth has been crushed over the past few years. Refinancing is not recovery, and low rates are not a sign of a positive future.

Argument #2: Housing starts and sales of new and existing homes all went up in April and May.

Optimists might respond to the points above by pointing out that housing starts jumped 2.6 percent in April and sales of new homes increased 3.3 percent the same month. Not only that, but existing homes came off the market in April at a rate of 3.4 percent, up 10 percent from last year.

But you know what else has been increasing? Foreclosures.

Data released this week shows that foreclosures have increased to a rate of more than 200,000 a year, an increase of 9 percent from April to May. This means that as much as increased demand is reducing inventories, the banks finally getting through their backlog of delinquencies will keep adding to the pile.

The shadow inventory still has millions of homes to clear away, and this means that prices will likely continue falling for the next several years, even if at a slow rate. Falling prices and continued foreclosure rates don’t qualify as a recovery, no matter how many homes people are buying relative to previous months.

Argument #3: The historically positive correlation between the Wells Fargo Housing Market Index (HMI) and Case-Shiller Housing Price Index suggests we are heading into recovery.

Wells Fargo publishes an index charting the demand for new homes. Albert Sung points out at SeekingAlpha that this HMI is a leading indicator for where housing prices will go. The HMI fell in 2006 and Case-Shiller declined in 2007. The same thing happened in 1989 and 1991. In a vacuum this analysis could be right. However, demand for new homes does not a recovery make.

We had a massive oversupply of new homes built in the middle of the last decade that have taken a while to sell. There are plenty left in Las Vegas if you’re in the market for an unlived-in-house, but the inventory of new homes is about the lowest level on record (going back to 1963). Naturally the HMI would register an increase in demand for new homes from here. But at the same time there are waves of foreclosures that are putting downward pressure on housing prices. And let’s not forget that interest rates can basically only go up from a 3 percent to 4 percent range, so the future is full of downward pressure on housing prices.

Demand for new homes is not the benchmark for recovery, so reaching a bottom on the HMI is also not the bottom of the housing market. The reality is that this recovery will be different than those in the past, and there is going to be a significant gap between when the Housing Market Index climbs and when Case-Shiller prices follow it.

Argument #4: Homebuilder profits are up, leading to improved builder sentiment

The argument for happier builders is prominently preached by real estate analyst Lou Basenese, who pointed out last month that the top two American homebuilders-D.R. Horton and Lennar Corp.-have been crushing their earnings estimates. He then suggests that the increasing HMI reading (see Argument #3) indicates improving builder sentiment. The problem is that someone forgot to tell the builders they are feeling good about the housing market.

Construction companies have been voicing their negative sentiment with their wallets and shedding jobs- about 50,000 since January. You would think will all that positive sentiment that builders would be gearing up for their great summer. But in fact, according to the Bureau of Labor Statistics, nearly 30,000 of those construction jobs dropped this year were lost in May, right when the housing market was supposedly taking off again.

So where are we on this long road to recovery, if we are not there yet?

Start with the fact that outstanding household mortgage debt is still twice the level it was in 2000. And add to that that one in five homes are still worth less than the mortgage that was taken out to buy it. Combined you get very limited amounts of money for buying new homes at this moment.

Next, consider that mortgage rates will be going up in the future (though when is anyone’s guess), meaning it will cost more to get a mortgage and that housing prices will be pushed down by decreased demand. CoreLogic reports the shadow inventory has fallen to 1.5 million homes. Some would say the figure is much higher but even at that level there is still substantial pressure on housing prices.

As I wrote back in March, the limited money for housing and subsequent low price for housing is not necessarily a bad thing. However, as prices fall underwater housing situations get work or homes that were in positive equity slip into negative equity, and that puts increased pressure on the fact that homeowners still have a lot of debt.

In addition to the limited money and falling prices, add on the continued woes for the labor market. Unemployment impacts the ability of families to afford homes, and in particular as the unemployment rate for college graduates remains high, it will translate to fewer than normal buyers of homes in the coming years, also negatively impacting the sector.

Finally, don’t forget that historically, housing prices always go past their “historical norm” when declining from a bubble. The bubble has dissipated to the point that housing prices are about where they should be for today, but there is going to be an “over correction” with all the downward pressure on prices from limited demand and future foreclosures.

Even if you put the good news into this calculation, the result is still nothing close to a recovery. At best there is light at the end of the tunnel. That light is several years away, though. It is absurd to think that housing prices have reached their bottom. It is equally absurd to think that foreclosures and underwater debt will not create massive headaches for the years to come. Don’t be deluded by a few positive stories. Stay buckled in, because destination recovery is still a ways down the road.

Anthony Randazzo is director of economic research at the Reason Foundation. This article first appeared at Reason.com on June 17, 2012.

The post 4 Reasons Why the Housing Market Still Hasn’t Recovered appeared first on Reason Foundation.

Despite these programs, the American housing market remains stalled. This is because there are still millions of mortgages with missed payments waiting to go through foreclosure, while U.S. household debt has not fully deleveraged from its peak in 2006 and 2007.

Once these corrosive elements run their course, though, the housing industry will need to shift from being reliant on the government for financing (currently taxpayers are guaranteeing over $5.8 trillion in housing credit risk) to relying on private sector assumption of mortgage risk. This is one of the few issues in American politics where there is a modicum of bipartisan agreement – both the Obama administration and House Republicans want the private sector to be the primary financer of American mortgages, they disagree, however, over whether there should also be a government guarantee program for extreme mortgage loss scenarios.

While the prevailing view is that private capital should be shouldering the majority of mortgage default risk, there are at least three roadblocks that will severely limit the pace and scope of mortgage finance risk returning to the private sector.

First, the private sector cannot compete with taxpayer-subsidized government-sponsored mortgage institutions (GSEs), i.e., Fannie Mae, Freddie Mac, Ginnie Mae, and the Federal Housing Administration.

Since 2008, Congress has authorized GSEs to purchase mortgages as high as three times the $234,500 S&P/Case-Shiller median housing price in the U.S., using taxpayer bailouts to offer the lowest guarantee rates for mortgage investors. That is a major reason why GSEs have a 90 percent market share. Restrictions will have to be put on these GSEs to reduce their dominance of the housing market.

Even worse, banking regulators plan to exempt the GSEs from new risk retention requirements placed on mortgage-backed securities issuers by the “qualified residential mortgage” provision of the 2010 Dodd-Frank Act. This will give GSEs a significant cost advantage over private issuance of mortgage-backed securities, reducing the pace of private capital taking on mortgage risk.

Second, the legal framework governing residential mortgage-backed securities in the U.S. is highly complex. When the MBS market was flying high, no one much cared about the ambiguity in securities contracts regarding how losses would be distributed. Now that heavy losses in collateral pools have proven to be a reality, tranche warfare – the fight among various classes of investors as to who shoulders these losses – has come to the fore. Until regulatory, judicial, or legislative action is taken to provide clarity, mortgage investors will be reluctant to jump back into the MBS game.

Bills have been introduced in the U.S. Congress to address each of these roadblocks and there has been considerable intellectual capital devoted to these problems in academic circles.

However, a third, critical roadblock has not been satisfactorily addressed: the profound lack of confidence in the models used by credit rating agencies to assess residential mortgage-backed securities and in the rating agencies themselves. In a newly published Reason Foundation policy study we propose a series of legislative policies, industry-led reforms, and regulatory changes to overcome private sector skepticism. Here are two of them.

First, currently residential mortgage-backed securities investors are not given the addresses of the mortgaged properties in which they are investing. Congress should authorize mortgage-backed security underwriters to include property-level address data in MBS disclosures so that investors or independent analytic firms can perform affordable, detailed, and accurate risk assessments completely without even having to depend on the ratings agencies.

Second, the mortgage-finance industry should create an organization – a Mortgage Underwriting Standards Board – to provide self-regulation against misrepresentation and to define categories of mortgages in an effort to enhance liquidity. This would offer less sophisticated investors a simple alternative to agency ratings. (See our study for the full details on this proposed group.)

There are several more ideas in our paper, including standardizing the formatting of loan-level data, and authorizing third parties to challenge ratings provided by the ratings agencies when they are used for capital adequacy purposes.

These proposals would encourage investor due diligence and facilitate the availability of third-party analysis. By increasing access to information and insight, they should encourage investors to buy private-label residential mortgage-backed securities, enabling the government to scale back its involvement in residential mortgage finance without precipitating a collapse in home prices. Attracting private capital to residential mortgage finance is challenging. But perpetuating government control of housing finance in today’s era of high deficits is unaffordable.

Marc Joffe is a principal consultant at Public Sector Credit Solutions. Anthony Randazzo (anthony.randazzo@reason.org) is director of economic research at Reason Foundation. Their study can be found here.

This commentary first appeared in The Daily Caller on May 7, 2012

The post How to Restore Trust in Mortgage-Backed Securities appeared first on Reason Foundation.

The solution to this crisis in the making is the wholesale transfer of housing credit risk back to the private sector. While an asset sale akin to the post savings and loan crisis clean up effort may not be possible, the U.S. can work down these guarantees by reawakening the private mortgage finance market from its post-crisis slumber. The objective would be to replace government mortgages with private loans as owners move or refinance (on average, mortgages are refinanced every seven to eight years). To accomplish this, however, and remove this liability from the taxpayers, there are four large roadblocks that have to be removed before private capital can take on residential mortgage risk.

Three of these roadblocks have widely discussed remedies. The first roadblock is the high conforming loan limits for Fannie Mae and Freddie Mac (266 percent of the current Case-Shiller median mortgage price), and an even higher conforming loan limit for the rapidly-increasing-in-market-share-duo FHA and Ginnie Mae (311 percent of median mortgage price). These high caps on the mortgages eligible for their subsidized guarantees mean that the private sector can’t compete on nearly all mortgages in the U.S.

The answer here is simply to lower conforming loan limits gradually to give the private sector more room to compete.

The second roadblock is a combination of mortgage provisions in the Dodd-Frank Act, the most restrictive of which is the risk retention requirement. While well intended, there are a host of unintended consequences in this requirement that residential mortgage-backed securities (RMBS) underwriters hold five percent of risk on all mortgages except those determined to be super safe – the yet to be finalized “qualified residential mortgage” (QRM). The worst is that with Fannie, Freddie, and FHA exempted from these requirements they will have a cost advantage against which the private sector can’t compete.

The remedy to this and related problems is to repeal the QRM and risk retention provisions of Dodd-Frank and instead have strict resolution and bankruptcy procedures established for those that take on too much mortgage-backed security risk.

The third roadblock is the complex legal framework governing RMBS. The high level of defaults following the subprime meltdown have exposed an industry that never prepared (legally or emotionally) for losses on this scale, resulting in years of “tranche warfare” – the fight among various classes of investors as to who shoulders these losses.

The solution to this process is evolving, with a combination of legislative clarity, new regulatory frameworks, and judicial review. One private issuer – Redwood Trust – has already demonstrated the ability to create RMBS that investors can trust, having successfully launched five jumbo deals since 2010.

But to move beyond small scale RMBS issuance, the U.S. must clear the fourth roadblock to private capital returning to housing finance: a profound lack of confidence in the models used by credit rating agencies to assess residential mortgage-backed securities and in the rating agencies themselves.

Two tools to overcome this roadblock can be found in our newly published Reason Foundation study, “Restoring Trust in Mortgage Backed Securities,” which outlines a series of policy initiatives in regards to ratings problem for mortgage assets.

To start, we suggest that Congress authorize underwriters to include property-level address data in RMBS disclosures so that investors or independent analytic firms can perform more detailed and accurate risk assessments at lower cost. Currently, it is both illegal and taboo for mortgage investors to receive the addresses for the properties backing their bonds. Without address level data it is impossible to get a precise fix on a mortgage’s value in real time.

Prevailing wisdom has suggested that the zip code is enough to perform loan level analysis, but the build up of toxic debt and subprime crash demonstrated this view to be mistaken. Consider that zip codes can contain several thousand properties and may also embrace large, often heterogeneous areas. For example, in northeast D.C.’s 20002 zip code, Zillow.com recently listed a price range of $250,000 to $2.8 million, depending on whether you want to live in Little Trinidad or in an upscale townhouse on Capitol Hill.

We also suggest that the mortgage-finance industry enforce common formatting of RMBS collateral data and the inclusion of cashflow-waterfall models with prospectuses to make investor due diligence easier, more competitive, and less costly. This would enable more third party analysts and research firms to more readily analyze the risk of an RMBS offering, providing more competition for the major rating agencies.

This, combined with the availability of address level data, would enable investors to perform their own in-house risk assessment and track the value of their investment over time without having to rely on an outside ratings assessor.

In the spirit of finding alternatives to letter grades from ratings agencies, we further propose the mortgage finance industry should create a Mortgage Underwriting Standards Board loosely based on the Financial Accounting Standards Board (FASB) model. This organization would provide self-regulation against misrepresentation and could even replace the QRM standards with industry established categories of mortgages that are transparently defined by risk appetite – as compared to the status quo binary standard of AAA, BB-, CCC+ that conveys little information about the true nature of a product.

We recognize our proposals are just the beginning of addressing the confidence problem that plagues the private sector. Our study has more proposals including standardizing the formatting of loan level data, and authorizing third parties to challenge ratings provided by the ratings agencies when they are used for capital adequacy purposes. But we do not suppose this is the perfect solution (we are fallible economic analysts like many others after all). Our fear, though, is that without a debate about the best ways to tear down this roadblock, the pace of private capital’s return to mortgage finance will be sluggish at best. We hope this contributes to the conversation.

Last year, over 90 percent of mortgage originations received some form of federal backing – either from the dominant giants Fannie Mae and Freddie Mac, or from the new rising-star, FHA, recently granted an increased conforming loan limit. Taxpayers will remain at substantial risk as long as these entities remain the bedrock of American housing finance.

Anthony Randazzo is director of economic research at Reason Foundation. Marc Joffe is a principal consultant at Public Sector Credit Solutions and former senior director at Moody’s Analytics.

This commentary first ran at RealClearMarkets.com on May 3, 2012.

The post How to Reduce the Government’s Trillions In Housing Credit Risk appeared first on Reason Foundation.