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“Private Markets, Risk, and the Housing Market Correction”
Summary of Remarks by
John Silvia
Chief Economist
Wachovia Corporation
July 12, 2007
Dr. Silvia gave an informative and highly entertaining talk on the current problem in the housing market with increasing delinquencies and foreclosures. He noted that economists develop frameworks to help them understand various markets. The current downturn in the housing market can be seen in part as cyclical, an issue of supply and demand readjusting to a new equilibrium. Home prices have risen over the past few years based on inflationary expectations; currently the demand for homes at such prices has fallen.
The housing market is also having problems because the traditional and current models of the home buying market differ. In the traditional model, there is a demand for housing and a demand for credit (mortgages). In this model, homebuyers make substantial down payments, secure traditional mortgages, and live in the properties they purchased for five years or more. This model held until the late 1990s. Now many people buy homes with zero down mortgages with the intention of living in them short-term, seasonally, or not at all. Indeed, many buy speculatively, hoping to “fix and flip” the properties as quickly as possible, earning money through short-term rapid appreciation. In addition, rather than viewing individual loans as long-term income streams, lenders are often more concerned these days about packaging mortgages into commercial mortgage-backed securities to sell to foreign investors.
Unfortunately, rather than developing new home buying tools and checks on abuse of the system, in this most recent housing boom various players in the housing market relaxed traditional standards to accommodate new purchasing behavior. Realtors in some cases encouraged prospective homebuyers to buy more expensive homes than they could afford. Some banks and lending institutions loosened underwriting standards, including not requiring credit checks or income verification. Moreover, some appraisers overvalued homes, making it more likely that banks would approve loans they otherwise might not have. Lastly, many homeowners were not sufficiently smart or educated enough to determine whether homeownership was right for them, and nor were they disciplined enough to make monthly mortgage payments or pay for other costs associated with homeownership.
Using a traditional model in the current non-traditional lending environment has led to various problems. By analyzing data from the Mortgage Bankers Association (MBAA) and the Office of Federal Housing Enterprise Oversight (OFHEO), it is possible to identify three distinct types of market failures. In California, Nevada, and Florida, homebuyers have been speculating, but sometimes unable to find new owners. In Ohio, Indiana, and Michigan, there is industrial restructuring, resulting in a depressed economy and migration, with many homeowners late on payments or unable to keep their homes. In seven states (most notably Maine), homebuyers have bought second homes as investment or seasonal properties on questionable terms. As they do not live in these homes, it is all too easy for them to walk away from their properties and their financial obligations.
Unfortunately, it is too late to fix the problems of those homeowners who are currently delinquent on mortgages or who are in foreclosure. Lending institutions are tightening underwriting standards, but those increased standards will only affect those trying to obtain mortgages going forward. As Dr. Silvia noted, “The time to be celibate is not after getting pregnant.” Standard and Poor’s has changed ratings on commercial mortgage backed securities (CMBS) and that has appeared to affect investment decisions.
In the future, though, it would be helpful if the various players had stakes in the outcomes of their actions, incentives to do the right things. If realtors, for example, reaped benefits – or had to pay fines – depending on the long-term outcome of the home sales they brokered, they probably would be more prudent. At the same time, those interested in correcting problems in the mortgage market have to recognize there are various types of problems (as described above) and one solution will not fit all. In addition, Congress needs to enforce the current rules in place that are supposed to stop risky home purchases. In the meantime, unfortunately, the brunt of current delinquencies and foreclosures will be born by the mortgagees and society.
Dr. Silvia fielded various questions from the audience. One member of the audience asked whether it was possible to quantify how many delinquent mortgages and foreclosures fell into the various scenarios described above. Dr. Silvia replied that it is possible by looking at county level data. Another question had to do with the role of banks in current housing market problems. Dr. Silvia notes the banks had a major role; banks could have started tightening underwriting standards several years ago when this situation began to unfold.
Dr. John Silvia joined Wachovia Corporation in February 2002 as Chief Economist. Previously, he worked on Capitol Hill as a senior economist for the Senate side of the Joint Economic Committee and Chief Economist for the Senate Banking Committee. John holds a BA and a PhD in economics from Northeastern University and has a Master’s degree in economics from Brown University.
Rapporteur: Richard Levy
