A couple of interesting pieces of research have been brought to my attention, and are worth sharing. In the comments of a previous post, Doug Pascover noted that he has heard the argument that a housing rescue is justified as a form of redress to buyers suckered in by predatory lenders — that in a sense, they do deserve a transfer from financial institutions. Along those lines, a friend emails a summary (by Howell Jackson) of a new paper (by Howell Jackson):
My recent article â€œThe Trilateral Dilemma in Financial Regulationâ€ analyzes a practice â€” which I label the trilateral dilemma â€” existing in many different sections of the financial services industry, including mortgage lending, retirement savings, investment management, insurance brokering and banking services. The practice arises in the context of a consumer seeking the recommendation of a financial adviser for the purpose of choosing financial products and services. With surprising frequency, these advisers receive side payments or other forms of compensation from the firms that provide the product or service the advisers recommend. Many times these payments are not clearly disclosed to the consumers; often they are entirely secret…
One specific â€” and highly controversial â€” example of the trilateral dilemma in the real estate context involves the payment of yield spread premiums by lending institutions to mortgage brokers for steering consumers towards particular loans. In a recent article entitled â€œKickbacks or Compensation: The Case of Yield Spread Premiumsâ€œ, Laurie Burlingame and I present an empirical study of approximately 3,000 mortgage financings of a major lending institution operating on a nationwide basis through both a network of independent mortgage brokers and some direct lending. The data for this study was obtained through discovery in litigation that was subsequently settled. The study offers a number of insights into the impact of yield spread premiums of mortgage broker compensation and borrower costs. In particular, the study suggests that for transactions involving yield spread premiums, mortgage brokers received substantially more compensation than they did in transactions without yield spread premiums. This estimated difference in mortgage broker compensation is statistically significant and robust to a variety of formulations.
An interesting new dimension to the debate, indeed. Another interesting finding comes from researchers at the University of Virginia:
National housing price declines and foreclosures have not been as severe as some analyses have indicated, and they are not as important as financial manipulations in bringing on the global recession, according to a new analysis of foreclosures in 50 states, 35 metropolitan areas and 236 counties by University of Virginia professor William Lucy and graduate student Jeff Herlitz.
Their analysis shows that most foreclosures have been concentrated in California, Florida, Nevada, Arizona and a modest number of metropolitan counties in other states. In fact, they claim that “66 percent of potential housing value losses in 2008 and subsequent years may be in California, with another 21 percent in Florida, Nevada and Arizona, for a total of 87 percent of national declines.”…
Although there are pockets of substantial declines, claims that overall housing values have tanked nationwide are exaggerated, they said. “In the Washington, D.C. metropolitan area, for example, prices have barely changed in the District of Columbia, Alexandria and Arlington County, and parts of Fairfax County in Virginia. The largest price declines (more than 30 percent in 2008) have been in Prince William County, Va., but even there, the range of price declines in its six zip codes ranged from 49 percent to only 6 percent.”
The number of foreclosures usually were lower in central cities than in some suburban counties, probably due to less demand in those suburbs, according to Lucy and Herlitz…
“[The president's new housing] policy will help homeowners where price declines have been modest, as they have been in most states, most metropolitan areas and most counties,” Lucy and Herlitz said.
On the one hand, this doesn’t necessarily square with much of the data out there. Case-Shiller, for instance, shows a 27% decline in prices for the 20-city composite index, and a 30% decline for the Washington metropolitan area as a whole. On the other hand, there is a point there. My condo has probably lost about 10% of its value from the peak of the market. That’s just miles away from the near 50% declines in places like Phoenix and inland California. While a 20% or so national decline in prices is going to have some very nasty effects, catastrophic market crashes are somewhat limited to a few markets, or to small areas within “normal” markets.
As the researchers note, the government’s policy may be geographically blind, but its effects will differ sharply by geography. Where price declines have been most sharp, struggling borrowers may find themselves owing something like 200% of the value of their homes. They won’t qualify for the government program, and because they’re so deep underwater, they’re also the most likely to simply walk away from their properties.
This suggests, then, that the rescue will not actually do much to address the foreclosure crisis. Rather, it will make things a bit easier for people who are probably not going to default in the absence of a household crisis, like the loss of a job. Given economic conditions, that’s probably enough to justify the policy. But if the goal is to address the waves of defaults that are basically a sure thing, based on the absurd differences in loan sizes and housing prices in hard hit areas, it will likely be wholly insufficient.