Tag Archives: regulation

The Economics of Housing Supply

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chart by Smallman12q

Housing economists Edward L. Glaeser and Joseph Gyourko have posted The Economic Implications of Housing Supply to SSRN (behind a paywall but you can find a slightly older version of the paper here). The abstract reads,

In this essay, we review the basic economics of housing supply and the functioning of US housing markets to better understand the distribution of home prices, household wealth and the spatial distribution of people across markets. We employ a cost-based approach to gauge whether a housing market is delivering appropriately priced units. Specifically, we investigate whether market prices (roughly) equal the costs of producing the housing unit. If so, the market is well-functioning in the sense that it efficiently delivers housing units at their production cost. Of course, poorer households still may have very high housing cost burdens that society may wish to address via transfers. But if housing prices are above this cost in a given area, then the housing market is not functioning well – and housing is too expensive for all households in the market, not just for poorer ones. The gap between price and production cost can be understood as a regulatory tax, which might be efficiently incorporating the negative externalities of new production, but typical estimates find that the implicit tax is far higher than most reasonable estimates of those externalities.

The paper’s conclusions, while a bit technical for a lay audience, are worth highlighting:

When housing supply is highly regulated in a certain area, housing prices are higher and population growth is smaller relative to the level of demand. While most of America has experienced little growth in housing wealth over the past 30 years, the older, richer buyers in America’s most regulated areas have experienced significant increases in housing equity. The regulation of America’s most productive places seems to have led labor to locate in places where wages and prices are lower, reducing America’s overall economic output in the process.

Advocates of land use restrictions emphasize the negative externalities of building. Certainly, new construction can lead to more crowded schools and roads, and it is costly to create new infrastructure to lower congestion. Hence, the optimal tax on new building is positive, not zero. However, there is as yet no consensus about the overall welfare implications of heightened land use controls. Any model-based assessment inevitably relies on various assumptions about the different aspects of regulation and how they are valued in agents’ utility functions.

Empirical investigations of the local costs and benefits of restricting building generally conclude that the negative externalities are not nearly large enough to justify the costs of regulation. Adding the costs from substitute building in other markets generally strengthens this conclusion, as Glaeser and Kahn (2010) show that America restricts building more in places that have lower carbon emissions per household. If California’s restrictions induce more building in Texas and Arizona, then their net environmental could be negative in aggregate. If restrictions on building limit an efficient geographical reallocation of labor, then estimates based on local externalities would miss this effect, too.

If the welfare and output gains from reducing regulation of housing construction are large, then why don’t we see more policy interventions to permit more building in markets such as San Francisco? The great challenge facing attempts to loosen local housing restrictions is that existing homeowners do not want more affordable homes: they want the value of their asset to cost more, not less. They also may not like the idea that new housing will bring in more people, including those from different socio-economic groups.

There have been some attempts at the state level to soften severe local land use restrictions, but they have not been successful. Massachusetts is particularly instructive because it has used both top-down regulatory reform and incentives to encourage local building. Massachusetts Chapter 40B provides builders with a tool to bypass local rules. If developers are building enough formally-defined affordable units in unaffordable areas, they can bypass local zoning rules. Yet localities still are able to find tools to limit local construction, and the cost of providing price-controlled affordable units lowers the incentive for developers to build. It is difficult to assess the overall impact of 40B, especially since both builder and community often face incentives to avoid building “affordable” units. Standard game theoretic arguments suggest that 40B should never itself be used, but rather work primarily by changing the fallback option of the developer. Massachusetts has also tried to create stronger incentives for local building with Chapters 40R and 40S. These parts of their law allow for transfers to the localities themselves, so builders are not capturing all the benefits. Even so, the Boston market and other high cost areas in the state have not seen meaningful surges in new housing development.

This suggests that more fiscal resources will be needed to convince local residents to bear the costs arising from new development. On purely efficiency grounds, one could argue that the federal government provide sufficient resources, but the political economy of the median taxpayer in the nation effectively transferring resources to much wealthier residents of metropolitan areas like San Francisco seems challenging to say the least. However daunting the task, the potential benefits look to be large enough that economists and policymakers should keep trying to devise a workable policy intervention. (19-20)

Treasury’s Overreach on Securitization Reform

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Treasury Secretary Mnuchin Being Sworn in by Vice President Pence

The Department of the Treasury released its report, A Financial System That Creates Economic Opportunities Capital Markets. I will leave it to others to dissect the broader implications of this important document and will just highlight what it has to say about the future of securitization:

Problems related to certain types of securitized products, primarily those backed by subprime mortgage loans, contributed to the financial crisis that precipitated the Great Recession. As a result, the securitization market has acquired a popular reputation as an inherently high-risk asset class and has been regulated as such through numerous post-crisis statutory and rulemaking changes. Such treatment of this market is counterproductive, as securitization, when undertaken in an appropriate manner, can be a vital financial tool to facilitate growth in our domestic economy. Securitization has the potential to help financial intermediaries better manage risk, enhance access to credit, and lower funding costs for both American businesses and consumers. Rather than restrict securitization through regulations, policymakers and regulators should view this component of our capital markets as a byproduct of, and safeguard to, America’s global financial leadership. (91-92, citations omitted)

This analysis of securitization veers toward the incoherent. It acknowledges that relatively unregulated subprime MBS contributed to the Great Recession but it argues that stripping away the regulations that were implemented in response to the financial crisis will safeguard our global financial leadership. How’s that? A full deregulatory push would return us to the pre-crisis environment where mortgage market players will act in their short-term interests, while exposing counter-parties and consumers to greater risks.

Notwithstanding that overreach, the report has some specific recommendations that could make securitization more attractive. These include aligning U.S. regulations with the Basel recommendations that govern the global securitization market; fine-tuning risk retention requirements; and rationalizing the multi-agency rulemaking process.

But it is disturbing when a government report contains a passage like the following, without evaluating whether it is true or not:  “issuers have stated that the increased cost and compliance burdens, lack of standardized definitions, and sometimes ambiguous regulatory guidance has had a negative impact on the issuance of new public securitizations.” (104) The report segues from these complaints right to a set of recommendations to reduce the disclosure requirements for securitizers. It is incumbent on Treasury to evaluate whether those complaints are valid are not, before making recommendations based upon them.

Securitization is here to stay and can meaningfully lower borrowing costs. But the financial crisis has demonstrated that it must be regulated to protect the financial system and the public. There is certainly room to revise the regulations that govern the securitization sector, but a wholesale push to deregulate would be foolish given the events of the 2000s.

The Financial Meltdown and Consumer Protection

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photo by HTO

Larry Kirsch and Gregory D. Squires have published Meltdown: The Financial Crisis, Consumer Protection, and the Road Forward. According to the promotional material,

Meltdown reveals how the Consumer Financial Protection Bureau was able to curb important unsafe and unfair practices that led to the recent financial crisis. In interviews with key government, industry, and advocacy groups along with deep archival research, Kirsch and Squires show where the CFPB was able to overcome many abusive practices, where it was less able to do so, and why.

Open for business in 2011, the CFPB was Congress’s response to the financial catastrophe that shattered millions of middle-class and lower-income households and threatened the stability of the global economy. But only a few years later, with U.S. economic conditions on a path to recovery, there are already disturbing signs of the (re)emergence of the high-risk, high-reward credit practices that the CFPB was designed to curb. This book profiles how the Bureau has attempted to stop abusive and discriminatory lending practices in the mortgage and automobile lending sectors and documents the multilayered challenges faced by an untested new regulatory agency in its efforts to transform the broken—but lucrative—business practices of the financial services industry.

Authors Kirsch and Squires raise the question of whether the consumer protection approach to financial services reform will succeed over the long term in light of political and business efforts to scuttle it. Case studies of mortgage and automobile lending reforms highlight the key contextual and structural conditions that explain the CFPB’s ability to transform financial service industry business models and practices. Meltdown: The Financial Crisis, Consumer Protection, and the Road Forward is essential reading for a wide audience, including anyone involved in the provision of financial services, staff of financial services and consumer protection regulatory agencies, and fair lending and consumer protection advocates. Its accessible presentation of financial information will also serve students and general readers.

Features

  • Presents the first comprehensive examination of the CFPB that identifies its successes during its first five years of operation and addresses the challenges the bureau now faces
  • Exposes the alarming possibility that as the economy recovers, the Consumer Financial Protection Bureau’s efforts to protect consumers could be derailed by political and industry pressure
  • Offers provisional assessment of the effectiveness of the CFPB and consumer protection regulation
  • Gives readers unique access to insightful perspectives via on-the-record interviews with a cross-section of stakeholders, ranging from Richard Cordray (director of the CFPB) to public policy leaders, congressional staffers, advocates, scholars, and members of the press
  • Documents the historical and analytic narrative with more than 40 pages of end notes that will assist scholars, students, and practitioners

I would not describe the book as objective, given that Senator Elizabeth Warren wrote the forward and the President Obama’s point man on Dodd-Frank, Michael Barr, wrote the afterward. Indeed, it reads more like a panegyric. Nonetheless, the book has a lot to offer to scholars of the CFPB who are interested in hearing from the people who helped to stand up the Bureau.

Increasing Price Competition for Title Insurers

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The New York State Department of Financial Services issued proposed rules for title insurance last month and requested comments. I submitted the following:

I write and teach about real estate and am the Academic Director of the Center for Urban Business Entrepreneurship.  I write in my individual capacity to comment on the rules recently proposed by the New York State Department of Financial Services (the Department) relating to title insurance.

Title insurance is unique among insurance products because it provides coverage for unknown past acts.  Other insurance products provide coverage for future events.  Title insurance also requires just a single premium payment whereas other insurance products generally have premiums that are paid at regular intervals to keep the insurance in effect.

Premiums for title insurance in New York State are jointly filed with the Department by the Title Insurance Rate Service Association (TIRSA) on behalf of the dominant title insurers.  This joint filing ensures that title insurers do not compete on price. In states where such a procedure is not followed, title insurance rates are generally much lower.

Instead of competing on price, insurers compete on service.  “Service” has been interpreted widely to include all sorts of gifts — fancy meals, hard-to-get tickets, even vacations. The real customers of title companies are the industry’s repeat players — often real estate lawyers and lenders who recommend the title company — and they get these goodies.  The people paying for title insurance — owners and borrowers — ultimately pay for these “marketing” costs without getting the benefit of them.  These expenses are a component of the filings that TIRSA submits to the Department to justify the premiums charged by TIRSA’s members.  As a result of this rate-setting method, New York State policyholders pay among the highest premiums in the country.

The Department has proposed two new regulations for the title insurance industry.  The first proposed regulation (various amendments to Title 11 of the Official Compilation of Codes, Rules, and Regulations of the State of New York) is intended to get rid of these marketing costs (or kickbacks, if you prefer). This proposed regulation makes explicit that those costs cannot be passed on to the party ultimately paying for the title insurance.  The second proposed regulation (a new Part 228 of Title 11 of the Official Compilation of Codes, Rules, and Regulations of the State of New York (Insurance Regulation 208)) is intended to ensure that title insurance affiliates function independently from each other.

While these proposed regulations are a step in the right direction, they amount to half measures because the dominant title insurance companies are not competing on price and therefore will continue to seek to compete by other means, as described above or in ever increasingly creative ways.  Proposed Part 228, for instance, will do very little to keep title insurance premiums low as it does not matter whether affiliated companies act independently, so long as all the insurers are allowed to file their joint rate schedule.  No insurer will vary from that schedule whether or not they operate independently from their affiliates.

Instead of adopting these half-measures and calling it a day, the Department should undertake a more thorough review of title insurance regulation with the goal of increasing price competition.  Other jurisdictions have been able to balance price competition with competing public policy concerns.  New York State can do so as well.

Title insurance premiums are way higher than the amounts that title insurers pay out to satisfy claims.  In recent years, total premiums have been in the range of ten billion dollars a year while payouts have been measured in the single percentage points of those total premiums.  If the Department were able to find the balance between safety and soundness concerns and price competition, consumers of title insurance could see savings measured in the hundreds of millions of dollars a year.

The Department should explore the following alternative approach:

  • Prohibiting insurers from filing a joint rate schedule;
  • Requiring each insurer to file its own rate schedule;
  • Requiring that each insurer’s rate schedule be posted online;
  • Allowing insurers to discount from their filed rate schedule so that they could better compete on price;
  • Promulgating conservative safety and soundness standards to protect against insurers discounting themselves into bankruptcy to the detriment of their policyholders; and
  • Prohibiting insurers from providing any benefits or gifts to real estate lawyers or other parties who can steer policyholders toward particular insurers.

If these proposals were adopted, policyholders would see massive reductions in their premiums.

Some have argued that New York State’s title insurance regulatory regime promotes the safety and soundness of the title insurers to the benefit of title insurance policyholders.  That may be true, but the cost in unnecessarily high premiums is not worth the trade-off.

Increased competition is not always in the public interest but it certainly is in the case of New York State’s highly concentrated title insurance industry.  The Department should seek to create a regulatory regime that best balances increased price competition with adequate safety and soundness regulation.  New Yorkers will greatly benefit from such reform.

High Rents and Land Use Regulation

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photo by cincy Project

The Federal Reserve’s Devin Bunten has posted Is the Rent Too High? Aggregate Implications of Local Land-Use Regulation. It is a technical paper about an important subject. It has implications for those who are concerned about the lack of affordable housing in high-growth areas. The abstract reads,

Highly productive U.S. cities are characterized by high housing prices, low housing stock growth, and restrictive land-use regulations (e.g., San Francisco). While new residents would benefit from housing stock growth in cities with highly productive firms, existing residents justify strict local land-use regulations on the grounds of congestion and other costs of further development. This paper assesses the welfare implications of these local regulations for income, congestion, and urban sprawl within a general-equilibrium model with endogenous regulation. In the model, households choose from locations that vary exogenously by productivity and endogenously according to local externalities of congestion and sharing. Existing residents address these externalities by voting for regulations that limit local housing density. In equilibrium, these regulations bind and house prices compensate for differences across locations. Relative to the planner’s optimum, the decentralized model generates spatial misallocation whereby high-productivity locations are settled at too-low densities. The model admits a straightforward calibration based on observed population density, expenditure shares on consumption and local services, and local incomes. Welfare and output would be 1.4% and 2.1% higher, respectively, under the planner’s allocation. Abolishing zoning regulations entirely would increase GDP by 6%, but lower welfare by 5.9% because of greater congestion.

The important sentence from the abstract is that “Welfare and output would be 1.4% and 2.1% higher, respectively, under the planner’s allocation.” Those are significant effects when we are talking about  real people and real places. The introduction provides a bit more context for the study:

Neighborhoods in productive, high-rent regions have very strict controls on housing development and very limited new housing construction. Home to Silicon Valley, the San Francisco Bay Area is the most productive and most expensive metropolitan region in the country, and yet new housing construction has been very slow, especially in contrast to less-productive large cities like Houston, Texas. The evidence suggests that this slow-growth environment results from locally determined regulatory constraints. Existing residents justify these constraints by appealing to the costs of new development, including increased vehicle traffic and other types of congestion, and claim that they see few, if any, of the benefits from new development. However, the effects of local regulation extend beyond the local regulating authorities: regions with highly regulated municipalities experience less-elastic housing supply. (2, footnotes omitted)

The bottom line, as far as I am concerned, is that localities that are attempting to deal with their affordable housing problems have to directly address how they go about their zoning. If the zoning does not support housing construction, then no amount of affordable housing incentives will address the demand for housing in high growth places like NYC and San Francisco.

Secrets of The Title Insurance Industry

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The New York State Department of Financial Services has proposed two new regulations for the title insurance industry. Premiums for title insurance in New York State are set by regulators, so title insurance companies cannot compete on price. Instead, they compete on service.  “Service” has been interpreted widely to include all sorts of gifts — fancy meals, hard-to-get tickets, even vacations. The real customers of title companies are the industry’s repeat players — often lawyers and lenders who recommend the title company — and they get these goodies.  The people paying for title insurance — owners and borrowers — ultimately pay for these “marketing” costs without getting the benefit of them.

The first regulation is intended to get rid of these marketing costs (or kickbacks, if you prefer). This proposed regulation makes explicit that those costs cannot be passed on to the party ultimately paying for the title insurance. The proposed regulation reads, in part,

(a) As used in this section:

(1) Compensation means any fee, commission or thing of value.

(2) Licensee means an insurance agent, title insurance agent, insurance broker, insurance consultant, or life settlement broker.

(b) Insurance Law section 2119 authorizes a licensee to receive compensation provided that the licensee has obtained a written memorandum signed by the party to be charged, in accordance with such section.

(c) A licensee shall not charge or collect compensation without such a memorandum, nor shall any such licensee charge or receive compensation except as provided in Insurance Law section 2119.

(d) The memorandum shall include the terms and date of the agreement, and the amount of the compensation. Where compensation is permitted, to the extent practical, the licensee shall obtain the written memorandum prior to rendering the services. The licensee shall not stipulate, charge or accept any compensation if the licensee has not fully disclosed the amount or nature of the compensation or the basis for determining the amount of the compensation prior to the service being rendered. (5-6)

The second regulation is intended to ensure that title insurance affiliates function independently from each other.

While these proposed regulations are a step in the right direction, I wonder how effective they will be, given that title companies cannot compete on price. Maybe it would be better to let them do just that, as some other states do . . .

These are mighty technical proposed regulations, but they will have a big impact on consumers. Have no doubt that industry insiders will comment on these regs. Those concerned with the interests of consumers should do so as well.

The Department of Financial Services is accepting comments on these two proposed regulations through June 19th, 2017.

Hope for the Securitization Market

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The Structured Finance Industry Group has issued a white paper, Regulatory Reform: Securitization Industry Proposals to Support Growth in the Real Economy. While the paper is a useful summary of the industry’s needs, it would benefit from looking at the issue more broadly. The paper states that

One of the core policy responses to the financial crisis was the adoption of a wide variety of new regulations applicable to the securitization industry, largely in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). While many post-crisis analysts believe that the crisis laid bare the need for meaningful regulatory reform, SFIG members believe that any such regulation must: ƒ

  • Reduce risk in a manner such that benefits outweigh costs, including operational costs and inefficiencies; ƒ
  • Be coherent and consistent across the various sectors and across similar risk profiles; ƒ
  • Be operationally feasible from both a transactional and a loan origination basis so as not to compromise provision of credit to the real economy; ƒ
  • Be valued by key market participants; and ƒ
  • Be implemented in a targeted way (i.e. without unintended consequences).

In this paper, we will distinguish between the types of regulation we believe to be necessary and productive versus those that are, at the very least, not helpful and, in some cases, harmful. To support this approach, we believe it is helpful to evaluate financial market regulations, specifically those related to securitization, under three distinct categories, those that are:

1. Transactional in nature; i.e., directly impact the securitization market via a focus on underlying deal structures;

2. Banking rules that include securitization reform within their mandate; and

3. Banking rules that simply do not contemplate securitization and, therefore, may result in unintended consequences. (3)

The paper concludes,

The securitization industry serves as a mechanism for allowing institutional investors to deliver funding to the real economy, both to individual consumers of credit and to businesses of all sizes. This segment of credit reduces the real economy’s reliance on the banking system to deliver such funding, thereby reducing systemic risk.

It is important that both issuers of securitization bonds and investors in those bonds align at an appropriate balance in their goals to allow those issuers to maintain a business model that is not unduly penalized for using securitization as a funding tool, while at the same time, ensuring investors have confidence in the market via “skin in the game” and sufficiency of disclosure. (19)

I think the paper is totally right that we should design a regulatory environment that allows for responsible securitization. The paper is, however, silent on the interest of consumers, whose loans make up the collateral of many of the mortgage-backed and asset-backed securities that are at issue in the bond market. The system can’t be designed just to work for issuers and investors, consumers must have a voice too.