Inclusionary Housing: Fact and Fiction

photo by Bart Everson

The Center for Housing Policy has issued a policy brief, Separating Fact from Fiction to Design Effective Inclusionary Housing Programs. I am not sure fact was fully separated from fiction when I finished reading it.  It opens,

Inclusionary housing programs generally refer to city and county planning ordinances that require or incentivize developers to build below-market-rate homes (affordable homes) as part of the process of developing market-rate housing developments. More than 500 local jurisdictions in the United States have implemented inclusionary housing policies, and inclusionary requirements have been adopted in a wide variety of places—big cities, suburban communities and small towns.

Despite the proliferation of inclusionary housing programs, the approach continues to draw criticism. There have been legal challenges around inclusionary housing requirements in California, Illinois, Idaho, Colorado and Wisconsin, among others. In addition to legal questions, critics have claimed inclusionary housing policies are not effective at producing affordable housing and have negative impacts on local housing markets.

While there have been numerous studies on inclusionary housing, they unfortunately do not provide conclusive evidence about the overall effectiveness of inclusionary housing programs. These studies vary substantially in terms of their research approaches and quality. In addition, it is difficult to generalize the findings from the existing research because researchers have examined policies in only a handful of places and at particular points in time when economic and housing market conditions might have been quite different. Given these limitations, however, the most highly regarded empirical evidence suggests that inclusionary housing programs can produce affordable housing and do not lead to significant declines in overall housing production or to increases in market-rate prices. However, the effectiveness of an inclusionary housing program depends critically on local economic and housing market characteristics, as well as specific elements of the program’s design and implementation. (1, endnotes omitted and emphasis in the original)

The brief concludes that, in general, ” mandatory programs in strong housing markets that have predictable rules, well-designed cost offsets, and flexible compliance alternatives tend to be the most effective types of inclusionary housing programs.” (11, emphasis removed)

I have to say that this research brief does not give me a great deal of confidence that mandatory inclusionary zoning programs are going to be all that effective.  Indeed, the conclusion suggests that many ducks need to line up before we can count on them to make a real dent in affordable housing production. While this by no means should imply that they should be curtailed, we should continue to evaluate them carefully to see if they live up to their promise.

The Prime Crisis

Ben Franklin, Founder of the University of Pennsylvania

Fernando Ferreira and Joseph Gyourko, both at Penn’s Wharton School, have posted A New Look at the U.S. Foreclosure Crisis: Panel Data Evidence of Prime and Subprime Borrowers from 1997 to 2012 to SSRN. Unfortunately it is behind a National Bureau of Economic Research paywall. The paper makes the case for “a reinterpretation of the U.S. foreclosure crisis as more of a prime, rather than a subprime, borrower issue.” (1) The authors conclude,

The housing bust and its consequences are among the defining economic events of the past quarter century. Constructing and analyzing new and very large micro data spanning the cycle and all sectors of the mortgage market leads us to reinterpret the ensuing foreclosure crisis as something much more than a subprime sector issue. Many more homes were lost by prime mortgage borrowers, and their loss rates not only increased relatively early in the crisis, but stayed high through 2012. This new characterization of the crisis motivates a very different empirical strategy from previous research on this topic. Rather than focus solely on the subprime sector and subprime traits, we turn to the traditional home mortgage default literature that explains outcomes in terms of common factors such as negative equity and borrower illiquidity.

The key empirical finding is that negative equity conditions can explain virtually all of the difference in foreclosure and short sale outcomes of Prime borrowers compared to all Cash owners. This is true on average, over time (including the spike in their foreclosure rate beginning in 2009), and across metropolitan areas. Given the predominance of this group in terms of foreclosures and short sales, this is tantamount to explaining the crisis itself. We can explain much, but not all, of the variation in Subprime borrower outcomes in terms of negative equity or borrower illiquidity conditions, so something potentially ‘special’ about the subprime sector still is unaccounted for. That said, it also could be that a less noisy measure of borrower illiquidity would be able to account for this residual variation. That remains for future research.

None of the other ‘usual suspects’ raised by previous research or public commentators change this conclusion. Housing quality traits, household demographics (race or gender), buyer income, and speculator status do not have a material influence on outcomes across borrower types. Certain loan-related attributes such as initial LTV, whether a refinancing occurred or a second mortgage was taken on, and loan cohort origination quarter do have some independent influence, but they are much weaker than that of current LTV. (27)

I will have to leave it to other empiricists to evaluate whether this sure-to-be-controversial study is methodologically sound, but I sure did find their policy conclusion to be interesting:

We are not able to provide a definitive recommendation one way or another, but we can rule out one noteworthy reason offered for not aiding homeowners—namely, that the crisis was mostly about irresponsible subprime sector actors (both lenders and borrowers) who were undeserving of transfers. Of course, this is not to say that there was no such behavior. The evidence from other research and serious journalists is that there was. However, it is clear from the passage of time (and the accumulation and analysis of new data that provides) that the problem was much more widespread and systemic.  (28)

Hopefully, this is a lesson that we can take with us into the next (inevitable) housing crisis so we lay the foundation for policy solutions based on facts and not rely on moral judgments about borrowers that are built on shaky ground.

The Community Reinvestment Act: Guilty of What?

Ray Brescia recently posted the final version of The Community Reinvestment Act: Guilty, but not as Charged to SSRN. The article wades into a seemingly technical debate that has extraordinary political and ideological implications: did misguided liberal policies push financial institutions to engage in the risky lending practices that led to the financial crisis. I never gave this argument much credit because the supposed chain of causation seemed too attenuated to me. Nonetheless, the debate has had legs among some policy analysts. The article generally agrees with my own — admittedly impressionistic — views of the matter. It also argues that the CRA needs to be modernized to reflect how mortgage credit is extended in the 21st century. The abstract reads,

Since its passage in 1977, the Community Reinvestment Act (CRA) has charged federal bank regulators with “encourag[ing]” certain financial institutions “to help meet the credit needs of the local communities in which they are chartered consistent with safe and sound” banking practices. Even before the CRA became law – and ever since – it has become a flashpoint. Depending on your perspective, this simple and somewhat soft directive has led some to charge that it imposes unfair burdens on financial institutions and helped to fuel the subprime mortgage crisis of 2007 and the financial crisis that followed. According to this argument, the CRA forced banks to make risky loans to less-than creditworthy borrowers. Others defend the CRA, arguing that it had little to do with the riskiest subprime lending at the heart of the crisis.

Research into the relationship between the mortgage crisis and the CRA generally vindicates those in the camp that believe the CRA had little to do with the risky lending that fueled these crises. At the same time, recent research by the National Bureau of Economic Research attempts to show that the CRA led to riskier lending, particularly in the period 2004-2006, when the mortgage market was overheated.

This paper reviews this and other existing research on the subject of the impact of the CRA on subprime lending to assess the role the CRA played in the mortgage crisis of 2007 and the financial crisis that followed. This paper also takes the analysis a step further, and asks what role the CRA played in failing to prevent these crises, particularly their impact on low- and moderate-income communities: i.e., the very communities the law was designed to protect. Based on a review of the best existing evidence, the initial verdict of not guilty – that the CRA did not cause the financial crisis, as some argue – still holds up on appeal. At the same time, as more fully described in this piece, an appreciation for the weaknesses inherent in the law’s structure, when combined with an understanding of the manner in which it was enforced by regulators, lead one to a different conclusion; although the CRA did not cause the crisis, it failed to prevent the very harms it was designed to prevent from befalling the very communities it is supposed to protect.

The defects in the CRA that emerge from this review, in total, suggest not that the CRA was too strong, but, rather, too weak. They also point to important reforms that should be put in place to strengthen and fine-tune the CRA to ensure that it can meet its important goal: ensuring that financial institutions meet the needs of low- and moderate-income communities, communities for which access to capital and banking services on fair terms is a necessary condition for economic development, let alone economic survival. Such reforms could include expanding the scope of the CRA to cover more financial institutions, creating a private right of action that would grant private and public litigants an opportunity to enforce the law through the courts, and having regulators enforce the CRA in such a way that will put more pressure on banks to modify more underwater mortgages.

I doubt that this article will be the final word on this topic, both because the existing empirical work seems inconclusive and also because the topic is one that has important ideological implications for the right and the left (‘government caused the financial crisis’ versus ‘corporate greed run amok caused the crisis’). Nonetheless, this article provides a thorough critique of one of the leading empirical studies of the topic.

Realistic Strategies for Consumer Education

The Consumer Financial Protection Bureau has issued its latest Strategic Plan, Budget, and Performance Plan and Report. I was critical of last year’s strategic plan as it related to financial education. I felt that the CFPB was too optimistic about the efficacy of financial education, given the current state of research on this topic.

I was impressed, however, by the CFPB’s approach in this year’s strategic plan:

The CFPB believes that financial education’s primary goal is to help consumers to take the steps necessary to make choices that will improve their financial well-being and help them reach their own life goals. However, prior to the start of the CFPB’s work, very little empirical research had been conducted in the financial education field regarding what variables measure financial health in terms of real-world outcomes for consumers. By defining these variables through data-driven research, the Bureau will be able to define what knowledge and skills are associated with financial health. This research will inform the Bureau’s ongoing efforts to identify, highlight, and spread effective approaches to financial education. (64)

I am pleased that the CFPB appears to be more skeptical about the efficacy of consumer education in this strategic plan and that is reflected in its performance measure:

FY 2013: Identify variables that are likely to be key drivers of financial health

FY 2014: Develop and test metrics (questions) that accurately measure these variables

FY2015: Develop and implement framework for integration into Consumer Education and Engagement Activities; Complete testing financial health metrics

FY2016: Use metrics to establish a baseline of U.S. consumer financial well-being and begin testing hypotheses of identified success factors in consumer financial decision-making (64-65)

This performance measure does not make assumptions about the efficacy of financial education. By treating the topic like a blank slate, it is more likely that the Bureau will be able to avoid dead ends and blind alleys as it attempts to help people to navigate the world of consumer finance.

This is not to say that the Bureau will necessarily be successful.  But it does appear that the Bureau is not falling for some of the wishful thinking that some of those in the financial education field have succumbed to.

Good Data for the FHFA

The Federal Housing Finance Agency released a White Paper on the FHFA Mortgage Analytics Platform.  By way of background, the White Paper states that

The Federal Housing Finance Agency (FHFA) maintains a proprietary Mortgage Analytics Platform to support the Agency’s strategic plan. The objective of this white paper is to provide interested stakeholders with a detailed description of the platform, as it is one of the tools the FHFA uses in policy analysis. The distribution of this white paper is part of a larger effort to increase transparency on mortgage performance and the analytical tools used for policy analysis and evaluation within the FHFA.

The motivation to build the FHFA Mortgage Analytics Platform derived from the Agency’s need for an independent empirical view on multiple policy initiatives. Academic empirical studies may suffer from a lack of high quality data, while empirical work from inside the industry typically represents a specific view. The FHFA maintains several vendor platforms from which an independent view is possible, yet these platforms tend to be inflexible and opaque. The unique role of the FHFA as regulator and conservator necessitated platform flexibility and transparency to carry out its responsibilities.

The FHFA Mortgage Analytics Platform is maintained on a continuous basis; as such, the material herein represents the platform as of the publication date of this document. As resources permit, this document will be up dated to reflect enhancements to the platform. (2)

This platform is a very welcome development for exactly the reasons that the White Paper sets forth.  Academics have a very hard time accessing good data on the mortgage markets (its usually expensive, untimely, limited).  Industry interpretations of data typically have agendas.

A sampling of the Platform’s elements include:

  • Performing Unpaid Principal Balance
  • Scheduled Paid Principal Balance
  • Unscheduled Paid Principal
  • Dollars of New 90 Day Delinquencies
  • Non-Performing Balances
  • Property Value of Non-Performing Loans (30-31)

Let us hope that the Platform offers a transparent and flexible tool to track this very dynamic market.

Frannie Effects on Mortgage Terms

The Federal Reserve’s Alex Kaufman has posted The Influence of Fannie and Freddie on Mortgage Loan Terms to SSRN.  It is behind a paywall on SSRN, but an earlier draft is available elsewhere on the web. The abstract reads,

This article uses a novel instrumental variables approach to quantify the effect that government‐sponsored enterprise (GSE) purchase eligibility had on equilibrium mortgage loan terms in the period from 2003 to 2007. The technique is designed to eliminate sources of bias that may have affected previous studies. GSE eligibility appears to have lowered interest rates by about ten basis points, encouraged fixed‐rate loans over ARMs and discouraged low documentation and brokered loans. There is no measurable effect on loan performance or on the prevalence of certain types of “exotic” mortgages. The overall picture suggests that GSE purchases had only a modest impact on loan terms during this period.

This is pretty dry reading, but it is actually an important project: “[g]iven the GSEs’ vast scale, the liability they represent to taxpayers, and the decisions that must soon be made about their future, it is crucial to understand how exactly they affect the mortgage markets in which they operate.” (2, earlier draft) The current conventional wisdom is that the two companies will return in something that looks like their pre-conservatorship form.

Given that that is the case, studies such as these are useful for providing some facts about the actual impact that these two companies actually have on the mortgage market.  In terms of their impact on loan terms, it appears that the two companies have a modest or even “mixed” effect, at least for the subset of mortgages studied. (22, earlier draft) And there “is no measurable effect on loan performance” at all. (22, earlier draft)

I have argued previously that returning Fannie and Freddie to their pre-conservatorship ways is a bad call. I still think that is the case. And I think studies such as these offer support for that view, in the face of the conventional wisdom.


Regression Aggression: Statistics and Disparate Impact

The Third Circuit affirmed, in Rodriguez et al. v. National City Bank et al., No. 11-8079 (Aug. 12, 2013), the denial of final approval “of the parties’ proposed settlement and certification of the settlement class” in a mortgage loan discrimination case brought by minority borrowers who claimed a disparate impact resulting from how the defendants charged borrowers. (4)

The part of the opinion that I found most interesting (but not compelling) was where it discussed the statistical work that the plaintiffs had done to support their case.  The Court states that

Even if Plaintiffs had succeeded in controlling for every  objective  credit-related variable – something no court could have reviewed because the analyses are not of record – the regression analyses  do not even purport to control for individual, subjective considerations.  A loan officer may have set an individual borrower’s interest rate and fees based on any number of non-discriminatory reasons, such as whether the mortgage loans were intended to benefit other family members who were not borrowers, whether borrowers misrepresented their income or assets, whether borrowers were seeking or had previously been given  favorable loan-to value terms not warranted by their credit status, whether the loans were part of a beneficial debt consolidation, or even concerns the loan officer  may have  had  at the time  for the financial institution irrespective of the borrower. While those possibilities do not necessarily rebut the argument that the Discretionary Pricing Policy opened the door to biases that individual loan officers could have harbored,  they  do undermine the assertion that there was a common and unlawful mode by which the officers exercised their discretion. (26-27)

I have not read the plaintiffs’ study, but the Court’s logic seems suspect to me. I can’t imagine how a statistician would “control for individual, subjective considerations,” particularly as that appears to be an infinite set of variables. Indeed, the Court gives little meaningful guidance as to what a comprehensive regression analysis would look like. What “individual, subjective considerations” would they include?  Where would that data exist to be studied?

The court does note some serious problems with the plaintiffs’ case, including the fact that they did not introduce their data or regression analyses into the record.  But those failings are not sufficient to explain the Court’s reasoning in the selection quoted above.

This case might be ripe for reconsideration or an en banc review, even if just to clarify what the Court wants from plaintiffs in future disparate impact cases.