Posts Tagged ‘housing bubble’

Blame Canada?

17 June 2013

Unlike the USA and most of western Europe in 2008-2009, Canada did not have a financial crisis. Quite a few columns and articles were written about the superior stability of Canada’s financial system, which is much more concentrated but is apparently much more tightly regulated and has captured far fewer politicians and regulators than its US counterpart. I meant to blog about that but never got around to it.

Which makes Krugman’s recent post about Canada‘s still-raging housing bubble fascinating reading. In brief: housing prices in Canada experienced much the same run-up as US housing prices in the mid-2000s but instead of plummeting after 2007, have kept on rising. They are now more than double their 1975 level, whereas US house prices peaked at about 190% of that level. Canadian household debt as a percentage of income also never stopped rising and is now slightly above the US ratio.

Does this mean Canada is headed for a financial crisis? Not necessarily. Canada’s financial sector still looks sedate compared to its high-flying, reckless US counterpart. But you can have a collapsing bubble and severe recession without a financial crisis. Canada did not escape the worldwide 2008 recession and has made a fair recovery, but it is not hard to see where the next big blow could come from. Dean Baker has emphasized that the recent US financial crisis depended far less on subprime borrowing, securitization, credit default swaps, and the other usual suspects and much more on the collapse of a multi-trillion-dollar housing bubble, and the loss of all that wealth and wealth-driven consumption. Not surprisingly, Baker liked Krugman’s post. He adds that the collapse of the housing bubble could be even worse in Canada because 30-year fixed-rate mortgages never took hold in Canada (as they did in the US during the New Deal). The standard mortgage in Canada has to be paid off or refinanced in five years, so when interest rates rise from their current record lows (1% is the current benchmark short-term rate in Canada), millions of homeowners could see their monthly payments shoot up. The scenario is similar to the expiration of low “teaser rates” on adjustable-rate mortgages (ARMs) in the US in 2006-2008, but could be even worse, as the five-year limit appears more common in Canada than ARMs were in America. Could large numbers of defaults on “underwater mortgages” (where amount owed exceeds market value of house) happen in Canada, too?

I love Canada, but if I were to move there today, I’d rent.

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ARMageddon

5 July 2009

(Title semi-stolen from the Option ARMageddon site, whose views I disclaim.)

Although precise causes of the current crisis are still a matter of some debate, it’s generally agreed that adjustable-rate mortgages (ARMs) played no small part in the housing bubble and its subsequent bursting. ARMs, once very rare, because very common during the bubble, especially for subprime borrowers.  Dean Baker notes that in 2004-2006 ARMs made up 35% of all new mortgages, up from single digit levels previously.   And quite a few (though not necessarily most) mortgage defaults occurred after the “teaser rate” period of these mortgages ended and the “resets,” or higher, market-based interest rates became effective.  Some of the mortgage holders could not make the higher monthly payments and thus defaulted.  (Others could afford the higher monthly payments but didn’t deem them worth paying, especially if they were “underwater” in the sense of their mortgage debt being larger than the resale value of their house.)

Today’s NYT column by University of Chicago behavioral economist Richard Thaler, titled “Mortgages Made Simpler,” got me thinking about this. Thaler laments the often bewildering complexity of many mortgages today, but casually dismisses the notion of requiring all mortgages to be simple fixed-rate mortgages.  A little too casually, I’d say.  He just says that complexity is necessary for “innovation,” without providing evidence that mortgage innovation has been helpful. Fellow Chicago economist Austan Goolsbee (drawing on an NBER working paper by Kristopher Gerardi, Paul Willen & Harvey Rosen), provided a fair bit in a March 2007 NYT op-ed, arguing that mortgage innovation has made many more mortgages possible, especially for younger, poorer, and minority applicants. The argument now looks rather dated in view of the tidal wave of subprime foreclosures, as well as the increasing realization that tying oneself down with a mortgage is not a great idea for everyone (e.g., people with low and variable income, people who might want to relocate soon, people who live in cities where rent is cheap relative to house prices — which was a lot of cities during the housing bubble). It also raises the question, Why can’t banks just issue fixed-rate mortgages with higher interest rates to their riskier customers?

Thaler says they shouldn’t have to, but that they should be required to offer every customer a fixed-rate mortgages as an option, alongside whatever complex mortgages they want to offer them.*  I call it the Baskin-Robbins approach:  31 flavors, many of them quite unusual, but always including vanilla, chocolate, and strawberry for those folks who don’t get out much. The plain-vanilla-mortgage option is a good idea, but it raises another question:  Why weren’t banks doing that all along?

One big reason is surely that interest rates, including regular mortgage rates, were at historic lows in the first half of this decade, when the bubble began.  Banks and other lenders did not want to be locked into receiving such low interest rates for the next 15 or 30 years, so they pushed ARMs.  Fed Chairman Greenspan’s crazy-ass claim that ARMs made sense for American consumers likely fueled this fire.  Even so, ever since ARMs began in the 1970s and 1980s as a response to volatile interest rates, it’s been well known that ARMs transfer risk from the bank to the borrower.  Which makes them a dicey deal for all but the richest borrowers (who don’t actually need the loan but might want it to get the mortgage interest deduction on their taxes and can afford the risk of higher interest payments) and clairvoyants who know what interest rates are going to do in the next 15 or 30 years.  So why why why did so many people enter into ARMs?

My hunch is that ARMs were a form of predatory lending in many, perhaps most cases.  Banks seem to have actively pushed ARMs on many borrowers.  (A former student of mine told me that a bank actually pulled a bait and switch on her and her husband, substituting an ARM for a fixed-rate loan at the last minute. I suspect there are many other such cases.)  Others who would steer clear of the mortgage market because they know they can’t afford a particular fixed monthly payment might be suckered in with a low enough teaser rate and unctuous assurances that interest rates will still be low at the end of the teaser period or that they’ll have no trouble refinancing at a lower rate. This seems to me an area that needs more investigation.

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Should stupidity be a crime?

31 December 2008

First, two favorite quotes:

Never attribute to malevolence what can be adequately explained by incompetence. (author unknown)

It is better to fail conventionally than to succeed unconventionally. (-John Kenneth Galbraith)

And now the latest bit of excuse-making about the housing crisis, in the last two lines of an appraiser’s letter to the editor in The Washington Post, 30 Dec. 2008:

“Most people subject to foreclosures are good people who received good advice that they could refinance their homes when the adjustable rate changed. No one had a crystal ball buffed enough to know that values would fall below what their homes were purchased for.”

Good advice? “You’ll never have to pay more than the teaser rate?  Even if you got a subprime loan because you’re not a good credit risk, in a few years time you’ll be able to refinance at a super-low interest rate?  If you do refinance, the original adjustable-rate mortgage (ARM) won’t have a stiff prepayment penalty?  The market price of your home will rise so fast that you can borrow however much you need against it?”  (The mantra that “housing prices always go up” wasn’t even true  at the time — adjusted for general price inflation, housing prices were basically no higher in 1999 than in 1979, and they fell during the first halves of the 1980s and 1990s.  I think  “always” really meant “even during the stock-market collapse of 2000-2002.”  Kind of a short time horizon there.)

A crystal ball would have been nice, but a simple reading of past data about housing prices and interest rates and an understanding of why banks would issue ARMs in the first place would have been enough to produce some sensible advice.   (Or failing that, just pick up a money and banking textbook and look for “mortgages, adjustable-rate” in the index.   I’ll save you the trouble; you’ll find something like this:   “Changes in interest rates can be very risky for banks.  Adjustable-rate mortgages allow them to transfer that risk to the borrower.  Since borrowers are usually not in a good position to absorb such risks, they usually avoid adjustable-rate mortgages.”)  Granted, it seems true that all that crappy advice about how anyone can buy a home on cheap credit and bear no risk was considered good advice in much of the mortgage and housing markets up until about a year ago, and I’m sure many of the people giving that advice meant well.   But they were following the herd and were either unwilling or unable to look up basic information on house price trends or ARMs.  So don’t convict them of fraud.  But don’t consider them competent at their jobs either.

Dean Baker makes much the same point, but aims it at a different target: the “experts” who were blind to the housing bubble.

Two disgraced but insightful peas in a pod?

15 December 2008

I couldn’t resist posting these two items together:

Henry Blodget, the disgraced former equity analyst for Oppenheimer, busted by then-New York Attorney General Eliot Spitzer and the U.S. Securities and Exchange Commission for securities fraud, has a compelling, thought-provoking essay in the December 2008 Atlantic, titled “Why Wall Street Always Blows It.” To be sure, it’s often self-serving, especially his claim that we’re all guilty, not just financial professionals (shades of those great scenes on “The Simpsons” when Homer, after totally screwing everything up, says, “Now let’s not play the blame game”).  But it’s informative just the same, and a good read too.  I thought his point about a larger credit bubble was well taken:

“Why did the housing bubble follow the tech bubble so closely? Because both were really just parts of a larger credit bubble, which had been building since the late 1980s. That bubble didn’t deflate after the 2000 crash, in part thanks to Greenspan’s attempts to save the economy.”

Spitzer, the more recently disgraced former New York Attorney General-turned-Governor, has begun his rehabilitation just as Blodget did:  by writing a column for the online magazine SlateSpitzer’s first column is a critical look at the financial industry bailouts, which he sees as cascading from excessive consolidation in the industry, to the point where so many financial institutions become “too big to fail” that policymakers have almost no choice but to perform these lavish bailouts when things go bad.  It’s an interesting point, a bit different from the usual point about excessive deregulation, as the banking industry had been consolidating well before the Gramm-Leach-Bliley deregulation of 1998.  But I don’t buy Spitzer’s conclusion that antitrust action to break up the big banks is needed.  There do seem to be significant economies of scale in banking; I think it’s no coincidence that the banking industry is also highly concentrated, in fact more so, in the European social democracies.

(modified a bit on 18 December 2008 )

Robert Shiller on the bubble and the bailout

13 December 2008

A brief interview in Der Spiegel, from 7 October 2008, still timely.  Shiller says the policymakers’ biggest mistake was in failing to recognize or do anything about the housing bubble until it was too late.  Unfortunately, the interview does not include follow-up questions on what might have been done to gently deflate the bubble, but Shiller probably addresses that in his current book.  (I’ll post some words on that when I get it.)

Unlike most other economists I’ve read, Shiller actually kind of liked the initial bailout plan — i.e., for the government to buy up to $700 billion of toxic mortgage securities from banks.   Kind of:  “It’s like plugging holes in a sinking ship. You only have so many hours before the ship goes down. You can’t think about how the ship should be designed or nautical engineering.”  I wonder what he thinks of the revised plan for bank capital injections.