January 24, 2018
The Miraculous Continuous Workout Mortgage
Professor Robert Shiller
Nobel Prize winner Robert Shiller et al. have posted Continuous Workout Mortgages: Efficient Pricing and Systemic Implications to SSRN. The paper opens,
The ad hoc measures taken to resolve the subprime crisis involved expending financial resources to bail out banks without addressing the wave of foreclosures. These short-term amendments negate parts of mortgage contracts and question the disciplining mechanism of finance. Moreover, the increase in volatility of house prices in recent years exacerbated the crisis. In contrast to ad hoc approaches, we propose a mortgage contract, the Continuous Workout Mortgage (CWM), which is robust to downturns. We demonstrate how CWMs can be offered to homeowners as an ex ante solution to non-anticipated real estate price declines.
The Continuous Workout Mortgage (CWM, Shiller (2008b)) is a two-in-one product: a fixed rate home loan coupled with negative equity insurance. More importantly its payments are linked to home prices and adjusted downward when necessary to prevent negative equity. CWMs eliminate the expensive workout of defaulting on a plain vanilla mortgage. This subsequently reduces the risk exposure of financial institutions and thus the government to bailouts. CWMs share the price risk of a home with the lender and thus provide automatic adjustments for changes in home prices. This feature eliminates the rational incentive to exercise the costly option to default which is embedded in the loan contract. Despite sharing the underlying risk, the lender continues to receive an uninterrupted stream of monthly payments. Moreover, this can occur without multiple and costly negotiations. (1, references omitted)
If it is not obvious, this is a radical idea. It was not even contemplated before the financial crisis. That being said, it is pretty brilliant financial innovation, one that should not just be discussed by academics. The paper provides a lot more detail about the proposal for those who are interested. And if you want to avoid taxpayer bailouts of the housing market in the future, you should be interested.
January 24, 2018 | Permalink | No Comments
January 23, 2018
Aggressive Retirement Investing in Real Estate Lending
InsuranceNewsNet.com quoted me in Investors ‘Flocking In’ to Real Estate Lending. It reads, in part,
The stock market is off to a roaring start in 2018, but there’s no shortage of investment gurus who warn that continued equities growth is far from guaranteed.
The dreaded market correction could be coming sooner, rather than later, some say.
That gives some money managers pause about what asset tools to steer in and out of a client’s retirement portfolio. But there’s an emerging school of thought that one specific alternative investment could be good protection against a stock market correction.
“We’re seeing financial experts weigh in with their 2018 investing recommendations, citing everything from mutual funds to value stocks,” said Bobby Montagne, chief executive officer at Walnut Street Finance, a private lender.
But one prime retirement savings vehicle often gets overlooked — real estate lending, Montagne said.
Real estate lending means investing in a private loan fund managed by a private lender. Walnut Street is one such lender in the $56 billion home-flipping market.
“Your money helps finance individuals who purchase distressed properties, renovate them, and then quickly resell at a profit,” Montagne explained. “Investments are first-lien position and secured by real assets.”
With real estate lending, investors can put small percentages of their 401(k)s or IRAs in a larger pool of funds, which lenders then match with budding entrepreneurs working on home flipping projects, he said.
“It allows investors to diversify their portfolios without having to collect rent or renovate homes, as they would in hands-on real estate investing,” Montagne added.
* * *
An Aggressive Investment
Some investment experts deem any investment associated with real estate flipping as a higher-risk play.
“Investing a percentage of a retirees funds in real estate flipping would be considered an aggressive investment,” said Sid Miramontes, founder and CEO of Irvine, Calif.-based Miramontes Capital, which has more than $250 million in assets under management.
Even though the investor would not directly manage the real estate project, he or she has to understand the risks involved in funding the project, material costs, project completion time, the current interest rate environment, where the properties are located geographically and the state of the economy, he said.
“I have had pre-retirees invest in these projects with significant returns, as well as clients that did not have experience and results were very poor,” he added. “The investor needs to realize the risks involved.”
A 1 percent to 5 percent allocation is appropriate, only if the investor met the aggressive investment criteria and understood the real estate market, Miramontes said.
Investment advisors and their clients should also be careful about grouping all real estate lending into one basket.
“You could invest in a mortgage REIT, which would be a more traditional vehicle to get exposure to real estate lending,” said David Reiss, professor of law at Brooklyn Law School in Brooklyn, N.Y. “If you’re doing something less traditional, research the fund’s track record, volatility, management, performance and expenses.
“You should be very careful about buying into a fund that does not check out on those fronts.”
January 23, 2018 | Permalink | No Comments
January 22, 2018
The Case for More Federal Housing Assistance
Corianne Payton Scally et al. of the Urban Institute have posted a Research Report, The Case for More, Not Less: Shortfalls in Federal Housing Assistance and Gaps in Evidence for Proposed Policy Changes. The Executive Summary opens,
Federal housing assistance programs aim to ensure that those who receive assistance have decent, safe, and affordable housing. Unlike some other key safety net programs, however, housing assistance is not an entitlement, which means it does not provide benefits to all who are deemed eligible. Currently, available assistance falls significantly short of the current and growing need for it: only one in five renter households who qualify for housing assistance actually receive any.
Recent proposals, including the recently enacted Tax Cuts and Jobs Act, the administration’s proposed fiscal year 2018 budget, and Speaker of the House Paul Ryan’s A Better Way plan, threaten deep cuts and significant changes to housing assistance. These funding and policy changes will decrease the funds for the preservation and creation of affordable housing, reduce the amount of assistance available, and may undermine the stability of those currently on assistance.
This report provides an overview of the current landscape of housing assistance, its central role in the safety net, and the evidence on contemporary policy proposals. We highlight several critical gaps in our knowledge that suggest we need a serious review of our affordable housing policy with a focus on developing a stronger evidence base before attempting large-scale changes to federal housing assistance programs. (v, citation omitted)
The title of the report is very hopeful in the current political environment, but the report does close with some fundamental questions that members of both parties should struggle with:
- How should we determine need for housing assistance?
- What subgroups should be prioritized for housing assistance and for what reasons?
- How should “affordable” be defined—30 percent of income, or more? Less?
- What is the public cost of transitioning more households to work versus continuing to provide housing assistance?
- What are the best practices for coordinating and delivering services for adults? For children and youth?
It would be great to hear definitive Republican and Democratic answers to these questions.
January 22, 2018 | Permalink | No Comments
January 19, 2018
Understanding Homeownership
The Housing Finance Policy Center at the Urban Institute released its House Finance at a Glance Chartbook for December. It states that financial education “can help reduce barriers to homeownership.” As I argue below, I do not think that financial education is the right thing to emphasize when trying to get people to enter the housing market.
The Introduction makes the case for financial education:
While mortgage debt has been stable to marginally increasing, other types of debt, particularly auto and student loan debt have increased far more rapidly. Our calculations, based on The Federal Reserve Bank of New York’s Quarterly Report on Household Debt and Credit, show that over the past 5 years (Q3 2012 to Q3 2017), mortgage debt outstanding has grown at an annualized rate of 1.3 percent, while non-mortgage debt (which includes credit card debt, student loan debt, auto debt, and other debt) has grown by 6.8 percent annualized rate. Student loan debt has grown by 7.3 percent per year while auto debt has been growing by 9.6 percent per year. In Q3 2012, the number of accounts for mortgage loans and auto loans are very close (84 million vs 82 million). By Q3 2017, the number of accounts for mortgages had fallen to 80 million consistent with declining homeownership rate, while the number of accounts for auto loans had increased to 110 million.
Another metric where auto loans have diverged from mortgages is delinquency rates. Over the past 5 years, mortgage delinquencies have plummeted (pages 22 and 29) while the percent of auto loans that is more than 90 days late is roughly flat despite an improving economy. However, the percent of auto loans transitioning into serious delinquency has risen from 1.52 percent in Q3 2012 to 2.36 percent in Q3 2017. While these numbers remain small, the growth bears monitoring.
When we looked at the distribution of credit scores for new auto origination and new mortgage origination, we found no major change in either loan category; while mortgage credit scores are skewed higher, the distribution of mortgage credit scores (page 17) and the distribution of auto credit scores have been roughly consistent over the period. Our calculations based off NY Fed data shows the percent of auto loan origination balances with FICOs under 660 was 35.9% in Q3, 2012, it is now 31.7%; similarly the percent of auto origination with balances under 620 has contracted from 22.7 percent to 19.6 percent. There have been absolutely more auto loans with low FICOs originated, but this is because of the increased overall volume.
So what might explain the differences in trends in the delinquency rate and loan growth between these two asset classes? A good part of the story (in addition to tight mortgage credit) is that many potential low- and moderate-income borrowers do not believe they can get a mortgage. As a result, many don’t even bother to apply. We showed in our recently released report on Barriers to Accessing Homeownership that survey after survey shows that borrowers think they need far bigger down payments than they actually do. And there are many down payment assistance programs available. Moreover, it is still less expensive at the national level to own than to rent. This suggests that many LMI borrowers who are shying away from applying for a mortgage could benefit from financial education; with a better grasp of down payment facts and assistance opportunities, many of these families could be motivated to apply for mortgages and have the opportunity to build wealth. (5)
I am not sure if financial education is the whole answer here. Employment instability as well as generalized financial insecurity may be playing a bigger role in home purchases than in car purchases. The longer time horizon as well as the more serious consequences of a default with homeownership may be keeping people from stepping into the housing market. This is particularly true if renters have visions in their heads of family members or friends suffering during the long and lingering foreclosure crisis.
January 19, 2018 | Permalink | No Comments
January 18, 2018
The FHFA’s Take on Housing Finance Reform
FHFA Director Watt
Federal Housing Finance Agency Director Watt sent Federal Housing Finance Agency Perspectives on Housing Finance Reform to Senate Banking Chair Michael Crapo (R-ID) and Senator Sherrod Brown of Ohio, the top Democrat on that committee. There are no real surprises in it, but it does set forth a series of housing finance objectives that the FHFA supports:
• Preserve the 30-year fixed-rate, prepayable mortgage;
• End taxpayer bailouts for failing firms;
• Maintain liquidity in the housing finance market;
• Attract significant amounts of private capital to the center of the housing finance system through both robust equity capital requirements and credit risk transfer (CRT) participation;
• Provide for a single government-guaranteed mortgage-backed security that will improve the liquidity of the to-be-announced (TBA) market and promote a fair and competitive funding market for Secondary Market Entities (SMEs);
• Ensure access to affordable mortgages for creditworthy borrowers, sustainable rental options for families across income levels, and a focus on serving rural and other underserved markets;
• Provide a level playing field for institutions of all sizes to access the secondary market;
• Include tools for the regulator to anticipate and mitigate downturns in the housing market, including setting appropriate capital and liquidity requirements for SMEs, having prompt, corrective action authority for SMEs that are weak or troubled, and having authority to adjust CRT requirements as needed; and
• Provide a stable transition path that protects the housing finance market and the broader economy from potential disruptions and ensures that the new housing finance system operates as intended. (1)
The FHFA’s take on housing finance reform seems to be somewhat different from what various members of Congress are reportedly promoting. It is not clear though that the views of the FHFA are all that relevant to the Congressional leaders who are shaping the next housing finance reform bill. Nor do I expect that Director Watt’s views are particularly valued by the Trump Administration, given that he is a former Democratic member of Congress. That being said, Director Watt has always made it clear that it is Congress and not the FHFA that should be charting the path forward for housing finance reform.
While his views on the matter differ from those of some members of Congress, all of the relevant stakeholders seem to agree on the broad contours of what the 21st century’s housing finance infrastructure should look like. There should be an explicit guarantee to support the housing market during liquidity crises. And the main elements of the current market, such as the thirty year fixed-rate mortgage, should be maintained. Here’s hoping that a bipartisan push can get this done this year.
January 18, 2018 | Permalink | No Comments
January 17, 2018
How to Rent out A Condo
Realtor.com quoted me in How to Rent out a Condo: Watch out! It’s Not the Same as a Home. It opens,
How to rent out a condo: This may seem like a simple question, but if you own a condominium, you probably know it’s actually rather complicated.
For those who are foggy on what a condo is, let’s start with the definition: It’s a home, typically part of a larger building, that comes with shared common areas such as yards and garages that are maintained by hired help, rather than by individual owners. This makes condo ownership a breeze, by comparison with the labor involved in maintaining your own house, and you pay for that convenience in condo fees.
This more communal living arrangement, however, also means that you can’t just rent out your place whenever the whim strikes. In the past, condominiums were pretty flexible about allowing unit owners to rent out their homes. In recent years, though, condo associations have become a little more restrictive, according to David Reiss, professor of law and academic program director at Brooklyn Law School. Here we break down everything you need to know about how to rent out a condo.
Step 1: Read your condo association’s governing documents
Every condominium is different, but they all have one important feature in common: Owners are subject to a set of rules established by the condo association and upheld by the Board of Directors. Some do not allow for renting as an option. Review your condo association’s bylaws, and/or rules and regulations, to understand the existing policies regarding renting out units.
Step 2: Know your condo association’s restrictions
If renting is allowed, there may be limitations on the length of the lease term—including minimum and maximum times—and on whether pets are allowed. Also look into whether or not renting has been an issue in the past, which could give you a crystal ball into your future. “Review board meeting minutes to see if any new policies are being discussed that might impact your plans,” says Reiss.
Another potential renting deal-breaker to be aware of is that some condominium associations allow only a certain percentage of total units to be rented out at any one time. Check to see if the current ratio of rented to non-rented condos will accommodate your unit. Keep in mind that some associations only allow renting after an owner has lived there for a minimum period, usually two years.
January 17, 2018 | Permalink | No Comments
January 25, 2018
Credit Risk Transfer and Financial Crises
By David Reiss
Susan Wachter posted Credit Risk Transfer, Informed Markets, and Securitization to SSRN. It opens,
Across countries and over time, credit expansions have led to episodes of real estate booms and busts. Ten years ago, the Global Financial Crisis (GFC), the most recent of these, began with the Panic of 2007. The pricing of MBS had given no indication of rising credit risk. Nor had market indicators such as early payment default or delinquency – higher house prices censored the growing underlying credit risk. Myopic lenders, who believed that house prices would continue to increase, underpriced credit risk.
In the aftermath of the crisis, under the Dodd Frank Act, Congress put into place a new financial regulatory architecture with increased capital requirements and stress tests to limit the banking sector’s role in the amplification of real estate price bubbles. There remains, however, a major piece of unfinished business: the reform of the US housing finance system whose failure was central to the GFC. Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs), put into conservatorship under the Housing and Economic Recovery Act (HERA) of 2008, await a mandate for a new securitization structure. The future state of the housing finance system in the US is still not resolved.
Currently, US taxpayers back almost all securitized mortgages through the GSEs and Ginnie Mae. While pre-crisis, private label securitization (PLS) had provided a significant share of funding for mortgages, since 2007, PLS has withdrawn from the market.
The appropriate pricing of mortgage backed securities can discourage lending if risk rises, and, potentially, can limit housing bubbles that are enabled by excess credit. Securitization markets, including the over the counter market for residential mortgage backed securities (RMBS) and the ABX securitization index, failed to do this in the housing bubble years 2003-2007.
GSEs have recently developed Credit Risk Transfers (CRTs) to trade and price credit risk. The objective is to bring private market discipline to bear on risk taking in securitized lending. For the CRT market to accomplish this, it must avoid the failures of financial assets to price risk. Are prerequisites for this in place? (2, references omitted)
Wachter partially answers this question in her conclusion:
CRT markets, if appropriately structured, can signal a heightened likelihood of systemic risk. Capital markets failed to do this in the run-up to the financial crisis, due to misaligned incentives and shrouded information. With sufficiently informed and appropriately structured markets, CRTs can provide market based discovery of the pricing of risk, and, with appropriate regulatory and guarantor response, can advance the stability of mortgage finance markets. (10)
Credit risk transfer has not yet been tested by a serious financial crisis. Wachter is right to bring a spotlight on it now, before events in the mortgage market overtake us.
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January 25, 2018 | Permalink | No Comments