Joseph Stiglitz: House of Cards

Joseph Stiglitz says there's no joy in being right about the housing market. His bail-out proposal for homeowners won't make lenders very happy:

Houses of cards, by Joseph Stiglitz, Project Syndicate: There are times when being proven right brings no pleasure. For several years, I argued that America's economy was being supported by a housing bubble that had replaced the stock market bubble of the 1990's. But no bubble can expand forever. ...

There is a macro-story and a micro-story here. The macro-story is simple, but dramatic. Some, observing the crash of the sub-prime mortgage market, say, "Don't worry, it is only a problem in the real estate sector." But this overlooks the key role that the housing sector has played in the US economy recently, with direct investment in real estate and money taken out of houses through refinancing mortgages accounting for two-thirds to three-quarters of growth over the last six years.

Booming home prices gave Americans the confidence, and the financial wherewithal, to spend more than their income. America's household savings rate was ... either negative or zero. With higher interest rates depressing housing prices, the game is over. As America moves to, say, a 4% savings rate (still small by normal standards), aggregate demand will weaken, and with it, the economy.

The micro-story is more dramatic.

Record-low interest rates in 2001, 2002 and 2003 ... stimulated the economy by inducing households to refinance their mortgages, and to spend some of their capital. It is one thing to borrow to make an investment, which strengthens balance sheets; it is another thing to borrow to finance a vacation or a consumption binge. But this is what Alan Greenspan encouraged Americans to do. ...

Predatory lenders went further, offering negative amortisation loans, so the amount owed went up year after year. Sometime in the future, payments would rise, but borrowers were told, again, not to worry: house prices would rise faster, making it easy to refinance with another negative amortisation loan. ... All of this amounted to a human and economic disaster in the making. Now reality has hit: newspapers report cases of borrowers whose mortgage payments exceed their entire income.

Globalisation implies that America's mortgage problem has worldwide repercussions. ... America managed to pass off bad mortgages worth hundreds of billions of dollars to investors (including banks) around the world. They buried the bad mortgages in complicated instruments, buried them so deep that no one knew exactly how badly they were impaired, and no one could calculate how to reprice them quickly. In the face of such uncertainty, markets froze.

Those in financial markets who believe in free markets have temporarily abandoned their faith. For the greater good of all (of course, it is never for their own selfish interests), they argued a bailout was necessary. While the US Treasury and the IMF warned East Asian countries facing financial crises 10 years ago against the risks of bail-outs..., the US ignored its own lectures about moral hazard effects, bought up billions in mortgages, and lowered interest rates. ...

It is the victims of predatory lenders who need government help. ... What is required is to give individuals with excessive indebtedness an expedited way to a fresh start - for example, a special bankruptcy provision allowing them to recover, say, 75% of the equity they originally put into the house, with the lenders bearing the cost.

There are many lessons for America, and the rest of the world; but among them is the need for greater financial sector regulation, especially better protection against predatory lending, and more transparency.

Comments

[ken melvin]

I agree. There should be no bail out. Let the lenders make the best deal they can. If they have to reduce payments, so be it. If they have to reduce principle, so be it.

[James Killus]

What has bothered me about the aftermath of all this is the degree to which the expanded housing stock (which is the only silver lining in a housing bubble) is rapidly being allowed to deteriorate. Rather than take down housing prices by selling the houses at distressed prices, or similarly benefiting the rental market by expanding its supply, banks are often leaving the houses vacant, where they are often vandalized and in any case tend to decay more rapidly than when inhabited. This is similar to plowing under crops in the middle of hunger, in order to maintain high prices for food.

At the very least there should be some agency that takes possession of distressed housing and matches it with suitable inhabitants. But having seen a few areas with five or more "For Sale" signs to the block, I can see that getting the "right sort" of people into those houses is of paramount concern. I've heard from more than one person who would prefer to have the house next door burn to the ground than have it inhabited by the wrong sort of person speaking the wrong language and having the wrong color skin.

[anne]

Nicely done.

[anne]

Watching internationally, my sense has been that if commercail real estate holds a recession will be avoided as avoided internationally these last years as housing selectively faltered. I am cautiously hopeful. Low short term interest rates and assistance for homeowners are needed. Notice how robust international investment markets remain.

says...

Great post.

[esb]

In California, just about every immigrant extended family possesses its own personal "in house" real estate agent, usually a young daughter or niece. In the extended family of my "significant other," Madelene (Filipina and a daughter of a former Ambassador), that role is played by the 22-year-old daughter of one of Madelene's younger brothers.

Gina (actually Ginalyn) began to "practice" the profession two years ago, just at the top of the market out here. I had advised against her decision, but when do 20-year-olds ever listen to the advice of 57-year-olds? Better to complete the last two undergrad years immediately, select an area of profesional study and run on through grad school. I told her that my opinion was that residential real estate activity was being supported by a lending con game of "biblical" proportions. But she was full of the hope of being a "big player" in the "American dream business" and undeterred by me spent the last two+ years struggling.

Now she is leaving the business and returning to school. I spoke with her this evening to offer some encourgement, and one of her comments brought something of a smile to my face. "This was a lending con game of biblical proportions."

Lesson learned.

[Lafayette]

Article: Booming home prices gave Americans the confidence, and the financial wherewithal, to spend more than their income.

Going after the shysters

But, the Boom & Bust proved to be little more than Fool's Gold, didn't it?

When a speculative frenzy exists, it means -- as regards real estate -- that people on the accelerating carousel benefit. They are financially "going faster", if they can keep and reinvest their gains elsewhere they are, indeed, better off.

How many took out lower-paying credits, but used the savings to pay down their total loan amount? Meaning the payments were the same, but the shift was made from paying interest to paying down the principle. That would be worth knowing!

Still, what about those who have not got yet got on the realty carousel? What about "entry level" candidates, just out of university and able to finance (perhaps) their first purchase? Where are they?

The are stuck in a sub-prime loan, because they believed a shyster who said that they shouldn't worry because the bank would "relax" a rule that had become a banker's norm. The rule was simple: There must remain, after all other expenses, a net amount of 1/3 monthly income to permit payments on the loan. Ten percent will do, they were told. One percent will do. No percent will do.

So, either these people were not suckers and did not take the bait, or perhaps they did. The point is this: Suckers deserve no sympathy and certainly no bail out. They opted to learn the hard way -- by either choosing to neglect the obvious risk or being totally unconscious of it in the first place.

On the one side of this moral dilemma, we have the victims. We could say, well, "Caveat emptor" (let the buyer beware). True enough, buyers are supposedly mature adults who should know what they are doing.

On the other side of the coin is the responsibility of the professional -- that is, whoever sells a product/service -- to know and tell not only the benefits but the risks. They have not only a moral duty, but more than likely, a legal obligation to convey ALL the elements pertinent to the consumer's decision making process.

We should be going after the shysters, because they were committing fraud -- and, if we don't, it will happen again.

[Don]

The reason homes are left unoccupied after foreclosure is that the housing market is overbuilt. There are too many homes/condos/apartments for the level of population that needs them. The reason why is obvious--homes and condos were built for speculation/second homes/investors, not for occupancy. It will simply take a while for the population to grow enough to catch up to the housing overhang.

While that happens, and homes return to being places to live, instead of being places to speculate like a penny stock, hoping that some new fool will always pay more for it than you did, Stiglitz has a decent recommendation--some sort of adjustment to the bankruptcy code that allows people to get out of their mortgages more easily.

Here's the rub--limit lender recovery to foreclosure and repossession of the house. If the borrower willingly does gives up the house, do not allow the lender to dun them for the balance of the loan. In other words, let the lenders take the hit for making a bad bet about price appreciation, and let the homeowner walk away and find a better deal. It would put the burden of the risk on the party most willing and able to bear it. It would also take much of the sting out of so-called "predatory lending", since the borrower would, for the price of moving (if in fact the house is a primary residence, which many of them are not) have a shot at getting shelter much cheaper due to--all the foreclosure properties now available.

After that, the true problem of too much money chasing too few investment opportunities would be readily solved by a more, not less, restrictive fed monetary policy. The fed, with its recent rate cuts, and with more anticipated, has just started re-inflating the credit/excess liquidity bubble. Where the excess money goes this time around is anybody's guess, but don't be surprised to see a return of stock investing in internet companies with no profits.

It's hard for me to understand that the cure for the bursting of a bubble caused by too much money (credit) for too long is to add more money, but that is precisely what has just happened.

[Lafayette]

Don: ... hoping that some new fool will always pay more for it than you did, Stiglitz has a decent recommendation ...

Well, why not tax house resale as are short-term (less than one year) stock resales -- at a much higher rate than if kept more than one year by the owner?

Also, for the moment, there is no distinction -- as regards capital gains taxes -- if the property is primary or secondary residence. Why not institute that distinction?

[Don]

Lafayette...there is a distinction in tax treatment: Only the net gains from the sale of a primary residence can be excluded from capital gains (over a year held) or ordinary income (if less than a year). Primary residence means that one lived in the residence for at least two of the last five years, or in some certain instances (like divorce, job loss) at least one of the last five years. Any gain on the sale is excluded, up to $250,000 for a single, $500,000 for a married couple, from both income and capital gains tax. See why, in an appreciating real estate market, everyone wants to move every two years or so?

Tax-free income! But it doesn't work except for just one residence, unless you can jigger the time rather cleverly.

[cm]

"the US ignored its own lectures ..."

Not quite, there is nothing to be ignored as those lectures are intended to apply to others exclusively ...

[cm]

Don: It is hard to believe that the housing stock is (generally) overbuilt, at least by numbers, when scores of people are perched in let's say the lower end of the apartment rental "quality spectrum", here in the so-called "Silicon Valley", if you know where to look every few miles.

The problem is that most of the newer developments are in the wrong places (side question to ponder, why have those places not been built up earlier), and sustainable only either with debt or well-paying jobs that enable a commute-heavy lifestyle. In many of those development you don't just have to commute to the job, but to each and every necessity/amenity in life.

I don't think there is generally any difficulty in selling/reoccupying well-placed properties, unless the whole business in town goes under (in which case the well-placedness is lost).

[Patricia Shannon]

cm says...
Don: It is hard to believe that the housing stock is (generally) overbuilt, at least by numbers, when scores of people are perched in let's say the lower end of the apartment rental "quality spectrum", here in the so-called "Silicon Valley", if you know where to look every few miles.

The problem is that most of the newer developments are in the wrong places (side question to ponder, why have those places not been built up earlier), and sustainable only either with debt or well-paying jobs that enable a commute-heavy lifestyle. In many of those development you don't just have to commute to the job, but to each and every necessity/amenity in life.

Very true. A small, low-end apartment in the Atlanta metropolitan area is at least $600/month. A waitress or cook might make make $1000 a month. The Mexicans take the logical and necessary step of sharing housing, but the local Republicans, those staunch defenders of business deregulation, have passed laws restricting the number of unrelated people living in a house or apartment. But it is also illegal, in effect, to be homeless, unless you are able to get a berth in a homeless shelter, which cannot house all the homeless, many of whom have full-time jobs. It is even against the law in Gwinnett County to live in a travel trailer! Icarus would love it here.

[Don]

CM--

Granted, being overbuilt or underbuilt is a highly localized inquiry, but as a US aggregate, the housing stock growth has greatly exceeded population growth over the last several years. It's hard to imagine San Francisco, or even most of Silicon Valley, being overbuilt, but Detroit certainly is right now. Of course, have another tech-stock implosion, and Silicon Valley's vacancy rate might rival Detroit's. Housing, before it became a playground for speculators, was intimately tied to the local economy. The speculators got ahead of the economy in many places, over the course of these last few years.

[James Killus]

I quite agree that the housing market is "overbuilt" at the prices that are being demanded.

But let's ponder what would result if the prices of those "overbuilt" houses were allowed to slip to the market clearing price. The valuation of the surrounding housing would also then slip, and the value of the mortgage loans using those houses as security would also slip. The dominos would then continue onto reducing the value of banks that hold the loans or the value of the securities that have been created so that the banks could offload the risks.

In short, a portion of the housing supply is being allowed to rot, so that some people do not lose the money that they "made" during the housing bubble, money that was created by the loose money policies of the Fed. Heads they win, tails, well, they never lose, do they?

This of course ignores the other feature of the Kabuki play: the desire to maintain the "correct" makeup of neighborhoods. That has a great deal to do with why the population generally puts up with this charade.

Any sensible analysis would yield the result that the housing market is tightly controlled for the benefit of certain parts of the population, collusive and monopolistic in nature. What I don't want to hear is how this is somehow "the market in action." This is privilege controlling the market in order to maintain and advance privilege. It has nothing to do with "market forces" and everything to do with using banking and finance as coercive instruments.

[calmo]

'Like most of that view James and wish I could articulate the deflation threat that this housing correction represents.
Lemme try: So the recent auctions purport to claim that actual prices have dropped 30% in some cases...in an effort to establish a bottom --that baseline from which prices can start to escalate once more. But a larger percentage were not bid on and of those properties bid on, many were by "amateur" flippers (say the professional flippers who were waitin for a lower price) and the core problem of who can afford at what price still remains.
Now if we could identify some fledging New Thing that we could throw investment dollars at and build some hope that consumers might have jobs that could pay these high house prices...this hope gets bleaker by the moment, no?
So house prices must come down and, if we adopt the eva so popular habit of the investment banks ("write downs" for GDP) there goes all that growth we thought we measured in the last several years, no?
A retroactive recession? Isn't it a bit like "Oops, the fish caught was not as large as reported, and as registered" (except for OER, the CPI proxy which ironically might be a better measure)...the prizes already distributed and safe in Swiss banks or the Carib.

[James Killus]

calmo, it's conceivable that we could wind up in a situation like Japan in the 1990s, where the real estate market basically froze solid, because to revalue it (i.e. devalue it) would mean that an entire moneyed class would have been displaced, a loss of economic (and political) power that simply could not be allowed to happen. So the entire economy ceased to grow.

[Lafayette]

Don: See why, in an appreciating real estate market, everyone wants to move every two years or so?

Very interesting.

So, what can be possibly meant by “flipping a condo”. The press made it seem that one could do so profitably every three months in some areas (Miami, for example).

Anyway, modulating a speculative frenzy, whether it is a sub-prime loan fanned by fraudulent arguments of “no-risk” or stock-market, fed by a fools-goal promise of “future gains” is no facile art.

The only effective way to diminish it is by eviscerating the very short-term gain. If people have to wait two years to realize a gain, then at least they become a bit more level headed.

I was under the impression that people were profiting short-term from the speculative gain. Am I wrong?

[Lafayette]

PS: The Mexicans take the logical and necessary step of sharing housing, but the local Republicans, those staunch defenders of business deregulation, have passed laws restricting the number of unrelated people living in a house or apartment.

Contrast this to a French law passed recently, which allows vagrants (living in the streets) unable to find housing to prosecute the city for lack of their availability. This measure is founded upon the notion that a roof over one's head was a “basic human right”. Vagrancy is particularly the case in large cities where long term unemployment has pushed people out of tenant housing and into homelessness.

The two examples are the compete opposites of one another. In individualist America, the onus is on "self-dependency", so vagrants "who don wanna work" deserve to die on the streets in a freezing winter. Whilst in France, the lack of an effective durable-employment economic policy pushes the problem off onto city administrations to find housing for the destitute (the bodies of which they don't like picking up off the streets to put in pauper graves).

This is a good example of the lunacy of the Right versus the lunacy of the Left. Surely, sanity must be somewhere in between?

Admittedly, in isolation, each policy above cited looks idiotic. The problematic is much more complex, and I am sure that each legislation was intended to solve "the problem". But, "the problem", in both instances, is a derivative of a larger more complex challenge. (Insufficient low income housing in the face of a growing population of those who cannot afford it is a problem throughout the world.) Fixing the specific, most obvious problem by such measures is therefore only a palliative.

Ultimately, the problem will rear its ugly head once again -- it's only a question of time.

[Lafayette]

JK: This is privilege controlling the market in order to maintain and advance privilege. It has nothing to do with "market forces" and everything to do with using banking and finance as coercive instruments.

The trick

Pretty strong stuff, that.

It is useless to think of the market for housing in macro-terms. Housing is like any product, with a great deal of diversity in both its usage and offering.

Whether a market is over-priced or under-built, the inevitable correction is in the market pricing, which tends to solve itself over a sufficiently long period of time.

The engine of ANY real estate market is "first-time" buyers at entry-levels of any market. They are the sine qua non prime movers of the market; that is, the imperative "first-condition" of an upwardly mobile housing market.

The problem is therefore, "How do we nurture this entry-level clientele?" (Sub-prime lending not being the most healthy way to do so.) The government mortgage institutions were created to help those who cannot get a private mortgage. Let's face it, such mortgaging services have proven successful in putting a great number of people into their first homes.

And yet, there is housing that is bursting at the seams at the lower end. Latinos at ten to a hundred square feet of tenancy -- or some such foolishness. Housing in this "market", which we will call it for lack of any better term (such as the anathema of "socialized housing"), is insufficient in most large cities. Where the destitute are just a door-jamb away from living on the street.

Insufficient public housing is whose "problem"? The market's? Big Business? Federal government? City Hall?

Frankly, I think it's rightly City Hall. When people are scrambling just to eat, how can the price of housing be the problem? (That's not possible? Go talk to the poor and see.)

What is needed is a mechanism that allows people shelter themselves in decent housing in the first instance, whilst they get their employment situation solved. When and if they get a decent job, they will be able to afford housing.

Thus, they find themselves in a transitory situation. Public housing could be fee at first and with sufficient income could become a long-term lease-purchase. Given time and hard work, people will opt for a solution that builds their net work -- meaning transit from no-cost to rental to ownership. The trick is in facilitating that transition.

NB: If the housing problem is due to illegal immigrants, that is something altogether different. Illegal immigrants will take much longer before they become "legal" -- if ever. Many come and go. Others stay under the radar for decades.

[real person from the real world]

I respect Stiglitz, except I do resent his comment and implied complaints about the low savings rate or spending your home equity on a vacation. He apparently lives in another society, not mine. People I know, refinance to pay debt, usually MEDICAL debt. How can you save, when the majority of jobs barely pay a subsistence wage, and the service sector (car repair) or gas prices are high and getting higher? The guy I get to fix my car at 6:30 PM at a worknight, so I can get to work the next day, does not care I only make $10+/hr and he makes $90+/hr. Mr. Car repairman wants, and gets what he asks, because there are those few making bucks that can also afford the same services. Savings is taxed. I have to list my interest on my tax form. That I don't make enough to have to pay tax, not withstanding. Quit taxing savings up to a certain amount, or certain types of savings might help.

[calmo]

From Jamesit's conceivable that we could wind up in a situation like Japan in the 1990s, where the real estate market basically froze solid, because to revalue it (i.e. devalue it) would mean that an entire moneyed class would have been displaced, a loss of economic (and political) power that simply could not be allowed to happen. So the entire economy ceased to grow.And I appreciate the comparison to Japan, the exemplary country we don't want to emulate unless it's their manufacturing base, Gini coef, transportation systems, longevity...
But I do think it's more than "conceivable" that Japan's real estate picture for the 90s is ours for the next decade. Without that robust manufacturing base, (and generally robust, non-financial economy) I think this is a significant worry and that "stagnant" would be a hope. Hard to believe that Financial growth (cancerous) can continue with a deflating housing sector (cancer host) that crowded out so many others.