American Banker – October 8, 2009 Thursday
BYLINE: Harry Terris
If Arthur C. Nelson is right, the homeownership rate is headed for a seismic shift that will reduce it to levels not seen in a generation. That may be just as well in his view – and those of other experts who are likely to help shape the debate over housing policy. For Nelson, the director of the Metropolitan Research Center at the University of Utah, the devastation of foreclosures and demographic changes mean it is time to rethink the primacy of homeownership in housing policy. “We’ve pushed people into owning homes, and now we find out that some millions of them shouldn’t have purchased homes,” he said. “They’re going to be worse off for the next five to 10 years because their credit records are now blemished beyond repair.”
Nelson is one in a chorus of homeownership skeptics who are advancing sharp critiques as policymakers approach pivotal decisions on the foundations of the home finance system. In overhauling Fannie Mae and Freddie Mac, for example, and grappling with the much-enlarged role of the Federal Housing Administration, the way forward will depend on calculations about the government’s ability to price risk and how much money should be used to subsidize homeowners. According to the Census Bureau, the homeownership rate hit 69.2 percent in two quarters of 2004 – the highest marks ever – but had dropped to 67.4 percent by this year’s second quarter, to below where it finished the year in 2000.
Nelson forecast that the homeownership rate will fall by about half a percentage point a year, to about 63.5 percent by 2020. That would be a big drop – back to the range that prevailed in the late 1980s and the early 1990s. The decline, Nelson said, will be driven primarily by a growing percentage of minority households – who are generally poorer than their white counterparts and cannot afford homeownership at the same rate. Another factor behind his forecast is the expectation that a large number of elderly homeowners will move into rentals in the coming years.
Thomas Sugrue, a history and sociology professor at the University of Pennsylvania, cited other factors weighing on the homeownership rate, like the damage from the foreclosure crisis, tight lending conditions and “people’s fear of investing in a home that they don’t see as an appreciating asset.”
Should the government try to reverse such a decline? For skeptics, a key issue is the sheer cost of the policies that subsidize homeowners. “We’ve engaged, you could say, in a redistributive policy that benefits people who own homes over people who don’t,” Sugrue said. “The long-term subsidy – public encouragement of homeownership – and the irrational exuberance of the housing market over the last 10 years was a devastating combination.”
He advocated more support for renters and builders of rental housing. “A sensible policy response to the current crisis would be to expand options for folks who don’t, for whatever reason, want to buy.”
Dean Baker, the co-director of the Center for Economic and Policy Research, noted that, despite gyrations in the homeownership rate, one-third of households, in round numbers, have been renters for decades. “We should recognize the fact that for many people renting is going to be a better solution,” he said. “We’ve gone overboard, certainly, in the amount of subsidies we give people for homeownership.”
Baker questioned the wisdom of tax credits for first-time homebuyers, comparing them with sums of taxpayer money that have been allocated for other purposes, like health care and education.
Under the State Children’s Health Insurance Program, “we give something like $3,000 to pay for a kid’s health care for a year,” he said. “To hand someone $8,000 because they bought a home – why don’t we send them a congratulations note?”
Joseph Gyourko, director of the Samuel Zell and Robert Lurie Real Estate Center at the University of Pennsylvania’s Wharton School, argued that the proposition of offering a high amount of leverage to someone with little net worth as a way to build wealth “only holds if you believe prices always go up.”
“One of the more important things is probably going to occur naturally, which is, you’re going to have to put down real equity to own a home going forward,” he said. “That at least would discourage highly levered bets on housing. It’s really risky as we found out, and as many modest-income households have found out.”
Rajiv Setia, an analyst at Barclays PLC’s investment bank in New York, said he does not believe it is possible for the government to properly price the risk that a mortgage borrower will default.
“There’s always pressure to extend credit to every borrower,” he said. “If the answer is, fees should be 40 basis points or 50 basis points higher, and that means the rate for all Americans goes up – that may be the right answer, but that’s not something the government is really going to be willing to accept.”
Sugrue also highlighted the role of federal support for homeownership in creating what he has called suburban “sprawlscapes” that have spread at the expense of inner cities and damaged the environment by increasing car pollution and transforming “forest, farm, marshland on the periphery of metropolitan areas into low-density housing and commercial developments.”
In so doing, he said, “we undergird a real estate development process, a market that makes those choices for many people the most feasible financially, even if on many other levels it’s not necessarily the most sensible.” Nelson similarly criticized local zoning policies that block apartment developments in favor of detached, single-family homes. “We need to rethink the efficacy of exclusionary communities and maybe from the federal to the state levels force local governments, local communities to open themselves up to a variety of housing choices,” he said.
Other experts argued that the lessons of the mortgage binge can be taken too far. They highlighted the mountains of mortgage debt built up in the middle of the decade that represented borrowing against equity to chase home prices higher or to bridge over stagnant wages – not to open up homeownership to new classes of first-time buyers. Though the homeownership rate peaked in 2004, three years of bubble lending and borrowing ensued, suggesting that, though the most reckless mortgages have indeed taken households out of the ownership pool, their role in expanding it in the first place was an illusion.
For Dalton Conley, the dean of social sciences at New York University, now is the time to push to broaden homeownership because price declines and low mortgage rates have put homes within closer reach and homes are a unique avenue for poor people to accumulate wealth. “If we had done it the right way, the way we did it after World War II, where we had a huge expansion in homeownership to a” class of Americans with relatively modest financial resources, “it could have been sustainable,” he said. “But it wouldn’t have been this crazy rush of dollars for the financial industry.”
Conley argued that a home “certainly is a good investment when the government is really backing low-income homeowners, the way it did after World War II through the [Veterans Administration] and FHA. It really allowed for people to put very little money down and end up being able to own homes.” (The Veterans Administration became the Department of Veterans Affairs in 1989.) “If you look at the last 50 years or 60 years, folks have had an enormous windfall from [homeownership], even with the recent downturn,” Conley said.
Richard Green, the director of the Lusk Center for Real Estate at the University of Southern California, offered a variation on the wealth-building argument, one that Nelson acknowledged has some merit: homeownership as a form of “forced savings.” Green said that a home may not be “as good an investment long term as, say, the stock market,” but “when people have a self-amortizing mortgage, they build wealth” by making their monthly payments. “We know that people are much more likely to save if it’s a default that they save.”
Conley said that the focus on the excesses of the bubble will inhibit action to take advantage of favorable conditions for renewed gains in homeownership. “By not doing anything, I think it would translate into policy, in absence of a policy to take advantage of this moment,” he said.
Whatever policy shifts may lie ahead, the government’s interventions – not least a commitment to buy $1.25 trillion of mortgage debt – are for now firmly anchored in rescuing homeowners and stabilizing the housing market, whose fortunes are fundamental to the economy and the health of the banking industry.
The takeovers last year of Fannie and Freddie and the expansion of the FHA’s role dramatically increased the government’s direct support for homeowners. It seems likely that the government will maintain its nearly century-old role at the center of the nation’s mortgage architecture that was begun with the creation of the Federal Home Loan Bank System, FHA and Fannie Mae.
“The political will to change the current federal policies that favor homeownership will be impossible to muster with the real estate industry, the construction industry all lobbying to keep the current system in place,” Sugrue said. Phillip Swagel, who was an assistant secretary for economic policy in the Treasury Department from December 2006 through last January, said that the Obama administration is “not going to celebrate [homeownership] quite in the same way that” President George W. Bush did as a part of his conception of an “ownership society,” “but I don’t think they will ‘go negative’ on homeownership.”
Another focus of dissent, and a likely candidate for renewed debate, is the mortgage interest tax deduction. Though not clearly associated with broadening the tent of homeownership – since the tax break is of no use to low-income borrowers who use the standard deduction – it has been criticized for encouraging people to buy too much house, and overspending on housing in general.
“The mortgage interest deduction is regressive,” said Swagel, who is now a visiting professor at the McDonough School of Business at Georgetown University. “The higher your income, the higher your tax rate, the more valuable it is.” Swagel predicted that President Obama would renew calls to roll it back that have long preceded his administration. This will happen when, in the context of widening budget deficits, the White House joins “the debate on tax reform,” Swagel said. Even in Nelson’s forecast, a substantial majority of American households would live in homes they own and would for the most part require mortgages. But some experts disagree with Nelson’s outlook. Green, the USC faculty member, said that the decline in the homeownership rate may soon “overshoot” what he believes is a stable level – at around the mark that prevailed in 2000 or 2001, or roughly the same as now.
Foreclosures are sidelining potential homeowners who were secure until they overleveraged during the boom, he said. But the homeownership rate is poised to rebound because waves of people are entering the ages at which homeownership is typical, he said.
In its annual “The State of the Nation’s Housing” report published in June, Harvard University’s Joint Center for Housing Studies attributed the surge in the homeownership rate that began in the middle of the last decade to income gains, low interest rates and easier mortgage conditions. “If homeownership rates by age, race/ethnicity and household type had remained at 1995 levels, demographic trends alone would have reduced the homeownership rate by a full percentage point” through 2005, the report said.
Nicolas Retsinas, the director of the Harvard center, emphasized the role of the overall economy in determining the homeownership rate. “To some extent the future of homeownership, the future of any kind of housing policy will be in large measure determined by people’s ability to get and keep a job,” he said in an interview.
Much of the borrowing during the boom was not associated with households’ entering the population of homeowners but was rather simply borrowing against rising home values under loose underwriting terms, Retsinas noted. The total value of household mortgage borrowing grew by nearly three-quarters from 2002 to about $10.5 trillion in 2007, according to the Federal Reserve Board – a far greater change than in the homeownership rate. “In large measure, much of what happened can be as much attributed, if not more so, to overleveraging than … to over-owning,” said Retsinas, a former head of FHA and of the Office of Thrift Supervision and a current Freddie director.
Green drew a line between this decade’s bubble and the years that preceded it. “Between 1994 and 2000, 2001, people buying houses were getting real loans that were reasonably well underwritten, where they had down payments,” he said. Later, “people used their houses as piggy banks. They took out too much equity.” Homeownership remains a fundamental preference among Americans, Retsinas said. “There is still a bias among the public to own rather than rent,” he said. But a heightened awareness of the risks of homeownership will probably result in “a greater appreciation of the role of rental housing,” including in the policymaking arena. “The real governmental lesson is the need for a balanced housing policy,” he said, “and the need to understand that when this country pledged a decent home and a suitable living environment to every American” under the Housing Act of 1949, “it didn’t say, a ‘home that they could own for every American.’ “