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Friday, April 04, 2008

Ed Glaeser: "Taking a Hard Line on Rewriting the Bankruptcy Code"

Having disagreed with Ed Glaeser on several occasions, I should also note when we agree, and though I have a few questions, I do agree with the main message of this commentary that it's a bad idea "to give bankruptcy judges the power to rewrite mortgage terms":

Taking a hard line on rewriting the bankruptcy code, by Edward L. Glaeser, Commentary, Boston Globe: The average sales price of a Massachusetts home fell 4.6 percent last year to $310,000. The state's housing market is doing well relative to California, where average prices have fallen by 26 percent. ...

In places with fewer building restrictions, like Atlanta and Dallas, housing price volatility is moderated by a construction sector that supplies extra houses during booms and ratchets back building during downturns. In California and Massachusetts, where abundant land use restrictions keep new construction low, any uptick in demand translates into higher prices, which then come back to earth. If an area's prices go up by an extra $100,000 over five years, then, on average, those prices fall by an extra $32,000 over the next five years.

There are winners and losers in both booms and busts. Owners, who win during booms and lose during busts, get the most attention. We often ignore prospective home buyers, who lose just as much as owners gain during booms and gain just as much as owners lose during busts. Moreover, housing cycles don't pose huge risks to most homeowners, whose longer time horizons enable them to sit out downturns.

Housing cycles pose the most danger for deeply leveraged, short-term investors. No matter what the get-rich-quick-in-real-estate infomercials say, short-term bets on housing are a terrible, hard-to-diversify investment for the little guy. While I don't have much sympathy for speculators caught in the current housing downturn, there are plenty of homeowners who are in the same position as those speculators, despite the best of intentions. These owners got in trouble, either because their incomes fell or because their interest payments rose. Now they are looking at either foreclosure or large capital losses.

There are good and bad ways for the government to do something to help worthy, desperate owners facing foreclosure. The most honest and best way is to spend taxpayer dollars. The worst way is to change laws and regulations that don't need changing, so that money can be redistributed without raising taxes.

The current proposal for the Federal Housing Administration to increase its refinancing of troubled mortgages is an example of honest redistribution. The FHA can issue mortgages and resell them in a transparent way that aids those with the most need. Moreover, the FHA can access Social Security records so that it can avoid bailing out those borrowers who misrepresented their incomes on their mortgage applications.

By contrast, there is little to like about the proposal to give bankruptcy judges the power to rewrite mortgage terms. ... An abundance of economic data show that when you make it more difficult for lenders to collect, interest rates rise and borrowing falls. ...

Moving from the current system to one in which hundreds of judges make up the rules for millions of mortgages is a recipe for confusion, administrative waste, and higher interest rates. Ultimately, that will make housing less affordable to ordinary Americans.

Ed Glaeser's last column said that "the weaknesses of the housing market reflect[s] too much, not too little, regulation, especially those rules that stymie construction and make housing unaffordable." My response was that although regulation in the housing market may have amplified shocks thereby making business cycle peaks higher and recessions deeper, the regulations were not the source of the shocks and in that sense are not the cause of the problem.

I think a reasonable response to my comment is to argue that without the land-use and construction regulation, the shocks would have been absorbed with much, much less variation in output. Hence, any additional variation in foreclosures over and above the baseline no regulation outcome is, in fact, caused by the regulation. If most of the fluctuation in foreclosures comes from this additional, regulation induced movement, then there is a sense in which we can say that regulation caused the problems we are seeing in financial markets even though the shocks driving the process are unrelated to the regulatory structure (how much additional variation in foreclosures actually occurs in the presence of regulation is an empirical question).

The other comment I made in response to the previous column was that the actual mechanism driving the additional fluctuation was not specified making the claim hard to evaluate. This post fills in a lot of the missing details, but I still have question. It's about a topic discussed here recently, whether the source of foreclosures is falling prices or interest rate resets.

Above, it says:

Housing cycles pose the most danger for deeply leveraged, short-term investors. ... While I don't have much sympathy for speculators caught in the current housing downturn, there are plenty of homeowners who are in the same position as those speculators, despite the best of intentions.

I think housing cycles refers to the cyclical behavior of prices, and these cycles are amplified by regulation as described above ("those prices fall by an extra $32,000"). But foreclosures do not arise because of changes in prices, it says above that they come about due to changes in income or from interest rate resets:

These owners got in trouble, either because their incomes fell or because their interest payments rose. Now they are looking at either foreclosure or large capital losses.

I don't see how cycles in housing prices are causing foreclosures in this story. According to the article, it's the monthly payment going up relative to income that is the problem causing the foreclosures, and that is independent of the value of the house at a point in time. If the foreclosures are from interest rate resets and falling income rather than falling prices, then  I don't see how regulation is the causal factor in this story.

I think there are ways to tell a story about how falling prices cause foreclosures, and how regulation could make it worse, and as noted here and here, there is evidence that falling prices are a big factor in explaining foreclosures. I am just looking for more clarity on how land-use regulation and foreclosures are related, and since I'm skeptical about regulation being the major cause of foreclosures, for evidence on how important this relationship is in explaining the troubles we are seeing in housing markets.

I want to add one more thing. In a column last September, Glaeser proposed:

Another way is to make refinancing at lower interest rates more attractive for lenders by encouraging shared-appreciation mortgages. These mortgages ... offer lower interest rates in exchange for some of the upside potential on the house. For example, a lender might offer a 6 percent interest rate instead of an 8 percent rate, in exchange for 50 percent of the increase in the value of the house at the time of eventual sale. Most borrowers don't want to lose this upside, but for someone facing foreclosure, losing the upside may be a lot better than losing the house altogether.

The proposal doesn't have to work exactly like this, but I like the idea of having homeowners give something up in return for better terms on their loans or other types of help. That would help to ensure, for example, that only the people who really need help apply to the program. And, since making monthly payments is the problem, I also like that the payment is not directly out of pocket at the time the loan is renegotiated, or an additional monthly expense.

    Posted by on Friday, April 4, 2008 at 12:20 AM in Economics, Financial System, Housing, Regulation | Permalink  TrackBack (0)  Comments (34)

          

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