Author Archives: David Reiss

Couples Leave Money on Closing Table

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photo by Dustin Moore

Geng Li, Weifeng Wu and Vincent Yao, three Fed economists, have posted a research note, Do People Leave Money on the Table? Evidence from Joint Mortgage Applications and the Minimum FICO Rule. The authors state that there “is mounting evidence that households make suboptimal savings and investment decisions” and find that

many mortgage borrowers appear to have failed to apply for mortgages that give the lowest interest rates. Specifically, we find that nearly 10 percent of prime borrowers who applied for their loans jointly could have lowered their mortgage interest rate at least one eighth of 1 percentage point if the mortgage was applied for by the applicant with a higher credit score and an income high enough to qualify for the mortgage. Furthermore, among the joint applicants with a lower credit score below 740, for whom mortgage interest rates are most sensitive to credit scores, more than 25 percent could have significantly reduced their borrowing cost by having the individual with a higher credit score apply. This is due to the fact that when lenders price mortgages with joint applications, the interest rates are determined by the lower score of the two–often known as the minimum FICO rule. We estimate that such borrowers could reduce their annual interest payment by between $220 and $1,400. Consistent with the existing literature, we find that couples who appeared to have left money on the table tend to have lower credit scores and be much younger and less financially sophisticated. (1, emphasis added)

This note provides an example of just how complicated the mortgage underwriting process is, particularly for less financially sophisticated borrowers.

One wonders if the CFPB should take a look at this. Should lenders be required to evaluate if joint mortgage applicants would get a better rate if only one of them ended up taking out the mortgage? And when the answer is yes, should lenders be required to share that information with the applicants? I can think of a variety of reasons why that should not be the case (not the least of which is that it could leave just one member of the family holding the bag if things go south), but it might be worth exploring this question more systematically.

The Land Use Report of the President

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The Economic Report of the President contains an important analysis of local land use policies in a section titled “Constraints on Housing Supply:”

Supply constraints provide a structural challenge in the housing market, particularly in high-mobility, economically vibrant cities. When housing supply is constrained, it has less room to expand when demand increases, leading to higher prices and lower affordability. Limits on new construction can, in turn, impede growth in local labor markets and restrain aggregate output growth. Some constraints on the supply of housing come from geography, while others are man-made. Constraints due to land-use regulations, such as minimum lot size requirements, height restrictions, and ordinances prohibiting multifamily housing, fall into the man-made category and thus could be amended to support more inclusive growth. While these regulations can sometimes serve legitimate purposes such as the protection of human health and safety and the prevention of environmental degradation, land-use regulations can also be used to protect vested interests in housing markets.

Gyourko and Molloy (2015) argue that supply constraints have worsened in recent decades, in large part due to more restrictive land-use regulations. House prices have risen faster than construction costs in real terms, providing indirect evidence that land-use regulations are pushing up the price of land.

According to Gyourko and Molloy (2015), between 2010 and 2013, real house prices were 55 percent above real construction costs, compared with an average gap of 39 percent during the 1990s. Several other studies note that land-use regulations have been increasing since roughly 1970, driving much of the real house appreciation that has occurred over this time (Glaeser, Gyourko, and Saks 2005; Glaeser and Ward 2009; Been et al. 2014). This pattern is noteworthy because of the positive correlation between cities’ housing affordability and the strictness of their land use regulations, as measured by the Wharton Residential Land Use Regulation Index (Gyourko et al. 2008). Cities to the lower right of the figure which include Boston and San Francisco, have stringent land-use regulations and low affordability. Cities at the upper left, which include St. Louis and Cleveland, have low regulation and high affordability. Supply constraints by themselves do not make cities low in affordability. Rather, the less responsive housing supply that results from regulation prevents these cities, which often happen to be desirable migration destinations for workers looking for higher-paying jobs, from accommodating a rise in housing demand.

In addition to housing affordability, these regulations have a range of impacts on the economy, more broadly. Reduced housing affordability—whether as an ancillary result of regulation or by design—prevents individuals from moving to high productivity areas. Indeed, empirical evidence from Molloy, Smith, and Wozniak (2012) indicates that migration across all distances in the United States has been in decline since the middle of the 1980s. This decreased labor market mobility has important implications for intergenerational economic mobility (Chetty et al. 2014) and also was estimated in recent research to have held back current GDP by almost 10 percent (Hsieh and Moretti 2015).

Land-use regulations may also make it more difficult for the housing market to accommodate shifts in preferences due to changing demographics, such as increased demand for modifications of existing structures due to aging and increased demand for multifamily housing due to higher levels of urbanization (Goodman et al. 2015). A number of Administration initiatives, ranging from the Multifamily Risk-Sharing Mortgage program to the Affirmatively Furthering Fair Housing rule, try to facilitate the ability of housing supply to respond to housing demand. Ensuring that zoning and other constraints do not prevent housing supply from growing in high productivity areas will be an important objective of Federal as well as State and local policymakers. (87-89, figures omitted and emphasis added)

It is important in itself that the Executive Branch of the federal government has acknowledged the outsized role that local land use policies play in the economy. But the policies that the Obama Administration has implemented don’t go very far in addressing the problems caused by myopic land use policies that favor vested interests. The federal government can be far more aggressive in rewarding local land use policies that support equitable housing and economic development goals. It can also punish local land use policies that hinder those goals.

Edward Glaeser and Joseph Gyourko get much of the credit for demonstrating the effect that local land use policies have on federal housing policy. Now that the President is listening to them, we need Congress to pay attention too. This could be one of those rare policy areas where Democrats and  Republicans can find common ground.

Principal-ed Forgiveness

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photo by Vic

The Federal Housing Finance Agency announced a new program to implement principal reduction for seriously delinquent, underwater homeowners who meet the following criteria:

  • Are owner-occupants.
  • Are at least 90 days delinquent as of March 1, 2016.
  • Have an unpaid principal balance of $250,000 or less.
  • Have a mark-to-market loan-to-value ratio of more than 115% after capitalization. (1)

The program’s “modification terms include capitalization of outstanding arrearages, an interest rate reduction down to the current market rate, an extension of the loan term to 40 years, and forbearance of principal and/or arrearages up to a certain amount to be converted later to forgiveness.” (1) Once the borrower completes three timely payments, the principal forbearance amount can be forgiven.

This program can help just a small proportion of homeowners who have been underwater on their mortgages. Most importantly, it is being implemented years after the foreclosure crisis swamped the nation’s housing markets. But as can be seen from the criteria above, it is targeted just to homeowners with below-average principal balances on their mortgages and who are severely underwater. There are all sorts of political reasons that principal reduction was not a key component of the post-crisis housing finance reform agenda. But it is worth asking now — should we deploy it more quickly in the next crisis? What would be the principled reasons for doing that?

Many argued that principal forgiveness would reward homeowners for making bad, even immoral, decisions. With the benefit of hindsight, it would have been better to put that questions aside and ask what the best policy option for the country would have been. If outstanding principal balances could have been aligned more closely to the new normal of the post-financial crisis economy, the recovery could have proceeded more quickly.

Now would be the time for the FHFA to implement regulations to deal with the next great recession. If principal forgiveness makes sense under certain conditions, let’s identify them now and then have an easier time of it down the road.

Goldman’s $5B Mortgage Settlement: If They Only Knew

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The news reports about Goldman’s $5 billion settlement over its boom-time securitization practices have focused on whether Goldman would really have to pay all $5 billion at the end of the day. It is important to focus on the size of the deal: does it do justice? I am not sure whether I have an answer to that question though. With these billion dollar settlements, it is hard to tell whether the punishment fits.  Should it have been a billion more? A billion less? What is the right metric?

I leave these questions for others to wrestle with and turn to something a bit more prosaic: what exactly did Goldman do that was so wrong? The Settlement Agreement incorporates a Statement of Facts, attached as Annex 1 to the agreement. The answer, contained in the Statement of Facts, is that “Goldman received information indicating that, for certain loan pools, significant percentages of the loans reviewed did not conform to the representations made to investors about the pools of loans to be securitized, and Goldman also received certain negative information regarding the originators’ business practices.” (1) More specifically,

In various RMBS offerings, Goldman provided representations, or otherwise disclosed information, in certain offering documents, about the loans it securitized, telling investors that:

  • Certain loan originators applied underwriting guidelines that were intended primarily to assess the borrower’s ability and, in some cases, willingness to repay the debt and the adequacy of the mortgage property as collateral for the loans;
  • Loans in the securitized pools were originated generally in accordance with the loan originator’s underwriting guidelines;
  • Exceptions to those underwriting guidelines had been made when the originator identified “compensating factors” at the time of origination; and
  • The securitization sponsor or originator (which, in many instances, was Goldman) represented that the loans had been originated in compliance with federal, state, and local laws and regulations. (2, emphasis added)

This is what it told investors, but in fact, Goldman was accepting many, many mortgages that were rated EV3 — an unacceptable risk — into its mortgage-backed securities. In one proposed MBS transaction,

Although Goldman dropped 25 percent of the loans in the due diligence sample because they were graded as EV3s, including all the loans graded as EV3s for unreasonable stated income, which comprised at least 2.5 percent of the loans in the due diligence sample, Goldman did not review the portion of the pool not sampled for credit or compliance due diligence, which comprised approximately 70 percent of the total pool, to determine whether there were similar exceptions in the unsampled portion. (8)

In other words, Goldman knew that it had serious problems in the sample mortgage files it reviewed, but ignored the fact that those same problems were likely to be found in the files that were not sampled. That amounts to willful ignorance if the problem.

It seems that every big financial crisis lawsuit has that embarrassing note that management wishes had never seen the light of day. Here, “Goldman’s head of due diligence, who had just overseen Goldman’s due diligence on six Countrywide pools that closed during a two-day period at the end of March, responded to [a] research report by saying: “If they only knew . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .” (11) Turns out, they did find out — just much later than the Goldman folks.

 

Consumer Survey Surveillance

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As I had noted previously, The Consumer Financial Protection Bureau had issued a notice and request for comment on the Financial Well-Being National Survey.  My submitted comments on it are below:

The Consumer Financial Protection Bureau has solicited comment on whether this collection of information is necessary for the proper performance of the functions of the Bureau, including whether the information will have practical utility.  While the Bureau has increased the rigor it has brought to its financial education mission over the last few years, it is unclear what the Financial Well-Being National Survey is meant to measure and it is unclear what it, in fact, will measure.  Specifically, one of the goals of the Survey is to measure the level of financial well-being of American adults, but the survey relies too heavily on the subjective responses of participants to achieve that goal.  We have reason to believe that subjective assessments of financial literacy are suspect.

 Much of the academic literature around financial literacy and financial education is very depressing as it reveals that Americans are not very financially literate at all. Lusardi, Annamaria, Financial Literacy: Do People Know the ABCs of Finance? (November 30, 2014). Global Financial Literacy Excellence Center Working Paper No. 2014-9. Available at https://ssrn.com/abstract=2585246.

Not only is financial literacy in bad shape, but efforts to improve it have not proven to be very effective.  Lauren Willis has provided a sobering, even depressing, overview of what we know about the efficacy of financial education.  Willis, Lauren E., Financial Education: Lessons Not Learned & Lessons Learned (January 31, 2013). Life-Cycle Investing: Financial Education and Consumer Protection 125 (Zvi Bodie et al., eds. 2012); Loyola-LA Legal Studies Paper No. 2013-4. Available at SSRN: https://ssrn.com/abstract=1869313 or https://dx.doi.org/10.2139/ssrn.1869313.

Willis asks, “Does financial education work as hoped?” (125) She answers her own question:  “Empirical evidence does not support the theory. Some (but not all) studies show a positive correlation between financial education and financial knowledge or between financial knowledge and financial outcomes. But no strong empirical evidence validates the theory that financial education leads to household well-being through the pathway of increasing literacy leading to improved behavior.” (125)

Even worse, Willis finds that some people who would have reason to think they are more financially literate because of their participation in financial education initiatives, do even worse than those who did not participate:  “the only statistically significant effect of mandatory personal financial training on soldiers was that they adopted worse household budgeting behaviors after the training than before it.” (126) Some of Willis’ other important conclusions (based on a thorough review of the literature) include

  • “Youth who took a personal finance course in high school do not report better financial behavior several years later than youth who did not take the course.  Adults who attended public schools where they were required to take personal financial courses were found to have no better financial outcomes than adults who were not required to take such courses.” (126, citations omitted)
  • One “reason financial education is unlikely to produce household financial well-being is that consumers’ knowledge, comprehension, skills, and willpower are far too low in comparison with what our society demands.” (128)

Willis’ conclusions about the efficacy of financial education initiatives are bolstered by a meta-analysis of the literature on financial education that was conducted by researchers at the World Bank.  Their abstract reads,

This paper presents a systematic and comprehensive meta-analysis of the literature on financial education interventions.  The analysis focuses on financial education studies designed to strengthen the financial knowledge and behaviors of consumers. The analysis identifies188 papers and articles that present impact results of interventions designed to increase consumers’ financial knowledge (financial literacy) or skills, attitudes, and behaviors (financial capability). These papers are diverse across a number of dimensions, including objectives of the program intervention, expected outcomes, intensity and duration of the intervention, delivery channel used, and type of population targeted. However, there are a few key outcome indicators where a subset of papers are comparable, including those that address savings behavior, defaults on loans, and financial skills, such as record keeping. The results from the meta analysis indicate that financial literacy and capability interventions can have a positive impact in some areas (increasing savings and promoting financial skills such a record keeping) but not in others (credit default).

Miller, Margaret and Reichelstein, Julia and Salas, Christian and Zia, Bilal, Can You Help Someone Become Financially Capable? A Meta-Analysis of the Literature (January 1, 2014). World Bank Policy Research Working Paper No. 6745. Available at https://ssrn.com/abstract=2380391

My first instinct is that there is no harm in conducting the Financial Well-Being National Survey. It asks reasonable questions, such as “How would you assess your overall financial knowledge?” and “How confident are you that the way you are managing money today is getting you to the results you want?” (5) There are also questions that ask concrete questions about the respondents’ financial situation, but they rely on self-reporting.

The key question that remains, then, is will the answers to such questions actually help shape consumer protection policy in a productive way? The Bureau should be sure that the answer to that question is yes before proceeding with the Survey.

I do not suggest that the Bureau jettison this survey, but I do suggest that the Bureau clarify what the Survey is meant to measure and that it ensures that it does measure those things.  To do so, the Survey should be supplemented with studies that attempt to determine how accurate the subjective assessments contained in the Survey are.  For instance, if respondents report that they are confident that they are managing their money effectively, targeted follow-up studies could determine whether that confidence is warranted.  If the respondent reports that his or her home is valued at a certain level (and homeowners are wont to overestimate the value of their homes), follow-up studies can determine whether that valuation was accurate.  Indeed, a well-designed follow-up study could determine the extent to which people overestimate their financial literacy and their financial situation.

It is of great importance that the Bureau gets its financial education initiatives right from the start.  It is worth investing heavily at the outset to ensure that it does.

Co-signing: Smart or Stupid?

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Realtor.com quoted me in Co-signing a Mortgage: Smart or Stupid? It opens,

There’s no doubt about it: Buying a home these days is hard. Even if you’re lucky enough to be a homeowner yourself, that doesn’t mean your kids or assorted loved ones can easily follow in your footsteps—at least, not without help.

One way that “help” can occur for home buyers who don’t qualify for a mortgage? Getting someone else—like you, dear reader—to co-sign. In a nutshell, that means that if they can’t pay their monthly dues, the lender will expect you to cough up the cash instead.

 It’s a noble idea, helping someone buy a home. But also, of course, a scary one. It’s no surprise that many co-signers are parents doing what parents do: putting their own financial well-being aside to help their children move into a home.

But let’s be clear here: The risks are huge. Some of them are obvious, but there are plenty more that you may not have even considered. So if you’re considering co-signing, it’s best you know exactly what you’re getting into, and how to protect your finances in case things don’t go well. Here are the main caveats and considerations to keep in mind.

Identify if your borrowers (and you) are good candidates

We’re not saying co-signing is a terrible idea across the board. There are plenty of legit reasons why those near and dear to you may have trouble getting the loan on their own—say, because they’re self-employed, which makes banks leery. But if your kid can’t get a loan because he just can’t seem to pay his AmEx card on time, well, that’s a different story. Judge your own risk accordingly.

Co-signers should also consider whether they’re good candidates to be taking on more financial commitments. Generally, you should consider co-signing only if you meet a few requirements. For example, “You own your home free and clear and don’t require much credit or have a need for it,” says Mary Anne Daly, senior mortgage adviser with San Francisco–based Sindeo.

Consider the pitfalls

If your borrower has a less-than-stellar history of paying back creditors or holding down a job, proceed with caution. Extreme caution.

“Unfortunately, I’ve seen parents dig further into their savings to pay the mortgage when their child can’t make the payment,” says Ryan Halset, a Realtor® with Seattle-based Boardwalk Real Estate. And if you can’t pay, it will tarnish your credit history and future odds of borrowing money.

“Your chance of getting a loan yourself in the future could be in jeopardy,” says Janine Acquafredda, an associate broker with Brooklyn-based House N Key Realty. “Not to mention the risk of ruining relationships if things go sour.” But maybe that last part’s a given.

Think like a lender

Hard as it might be, try to keep your personal relationship with the home buyer from coloring your decision. Even if it’s your child or a longtime pal, it shouldn’t (entirely) trump the warning signs.

“Before you commit, think like a lender and look at the borrower’s income, work history, and existing debt to determine if the borrower is worthy and not a potential liability to your good credit,” says Frank Tarala, owner of Sterling Heights, MI–based Principal Brokers Network.

Saying no may be tough, but it could save you tons of heartache down the road. David Reiss, professor of law and academic program director for the Center for Urban Business Entrepreneurship, recounts a situation where parents stepped in as co-signers just before the financial crisis hit. The home’s value plunged by more than half. The borrower then left the area—and his home—in search of a new gig and couldn’t make both the mortgage payments and the rent on his new apartment.

“The parents, retirees living on a modest pension in their own home, found themselves dealing with the default of their son’s mortgage with no financial resources available as a buffer,” Reiss says. “This situation has devolved into a nightmare of defaults and attempted short sales with no end in sight.”

HOA Crybabies

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by Brandon Baunach

Realtor.com quoted me in Neighbor Files Noise Complaint With HOA for Crying Baby. It opens,

People file noise complaints against neighbors for all kinds of reasons, from dogs that won’t stop barking to partiers who won’t stop blasting Britney Spears. (Britney? Really?) Yet recently intrabuilding warfare—and a resulting official noise complaint—was lodged against a far more dubious target: a baby. A crying baby, to be exact.

The conflict escalated when condo owners Jessica and Karl Ronnevik in Greensboro, CT, learned just how much impact their 1-year-old son’s bawling was having on their next-door neighbor, via the following passive-aggressive (emphasis on aggressive) note.

“Please consider buying a parenting book or consult with a child care expert,” the missive read, according to local news channel Fox 8. “Your baby should not be crying that loudly and for that long. Try more calming techniques, music, turn on a vacuum, rocking chair, go for a walk … anything!”

File that under “helpful, not.” A parenting book! Some really out-of-the-box thinking there, neighbor! If only more parents knew about those, there would surely be no crying babies, ever. The note goes on to say, “If you don’t make changes immediately, you risk being fined by [the homeowners’] association.”

And apparently, the HOA isn’t keen on crying babies, either: A previous noise complaint by this neighbor, in December, spurred the HOA to send the Ronneviks a warning to shut their kid up—or pay a penalty.

The frazzled parents told Fox they’re doing their best to keep their son, Peter, quiet, but come on—kids cry. They contend that their son squalls no more than any other 1-year-old. The couple is also expecting a second child soon. So they caved and decided to move.

“I don’t feel comfortable living here, knowing that our neighbor is so intolerant,” Jessica Ronnevik told Fox. “It makes me feel like we have been bullied in our own home.”

So Fox asked this neighbor for further comment (he’d left his name on the note but preferred to not be identified in the press).

“I stand by the note and its contents,” his statement read. “Any excessively loud noise that interferes with the rights of neighbors is subject to possible fines, as indicated in section 4 of the HOA Rules & Regulations.”

Which got us wondering: Is this ruffled neighbor right? The experts we spoke to say no.

“The Fair Housing Act generally prohibits discrimination on the basis of familial status by housing providers,” says David Reiss, research director at the Center for Urban Business Entrepreneurship at Brooklyn Law School. This is also true for common interest communities such as those under the mandates of HOAs. “So, if a CIC discriminated against a family with children by unreasonably requiring that infants only cry softly or not at all, it could run afoul of the FHA.”

In other words, the Ronneviks could have had a decent case to stay put and let Peter cry to his heart’s content.

“Households that believe they have been discriminated against can file a complaint with state and federal regulators or consult with an attorney,” Reiss continues. “The CIC could face lawsuits which could lead to judgments where they pay damages.”