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Mortgaging Household and Global Financial Stability: To What End? Debt-Financed Homeownership: Its Evolution, Impact and Future October 12, 2018 William R. Emmons and Lowell R. Ricketts These views are ours alone and not necessarily those of the Federal Reserve Bank of St. Louis or the Federal Reserve System. Mortgaging Household and Global Financial Stability: To What End? Why do policies support highly leveraged homeownership? Household-level impacts: Ex ante vulnerable groups poorly served (young; no college; African American and Hispanic). Macro-financial impacts: Bursting of leveraged housing bubbles creates long, deep, damaging recessions/crises. Leveraged homeownership makes sense for some people; but for many others, we need a different policy mix. 1 U n d e r Negative Equity => 9-10 Million Involuntary Exits from Homeownership W a t e r 2 U n d e r Socastee SC Lumberton NC Homeownership Includes Idiosyncratic Catastrophic Risk (e.g., Hurricane Florence) Pawleys Island SC Bucksport SC Photos by Victor J. Blue for the New York Times W a t e r 3 Is Housing a Good Investment? Yes, according to Jorda, Knoll, Kuvshinov, Schularick and Taylor (2017*). − In a long international sample, average housing returns were as good or better than equity returns with lower risk. Not necessarily, say Piazzesi and Schneider (2016**), because idiosyncratic housing risk is very high. − Idiosyncratic housing risk is 4X housing-index risk − Housing Sharpe ratios are exaggerated in the literature * Jorda, Oscar; Knoll, Katharina; Kuvshinov, Dmitry; Schularick, Moritz; and Taylor, Alan M. “The Rate of Return on Everything, 1870-2015,” NBER working paper, Dec. 2017. ** Piazzesi, Monika; and Scheider, Martin. “Housing and the Macroeconomy,” Handbook of Macroeconomic 2 (2016), pp. 1547-1640. 4 How Does Homeowner Policy Incorporate Risk? Do homeownership policies take risk into account at all? − “The prices of individual houses are highly volatile. Moreover, a large component of this volatility is idiosyncratic.” (Piazzesi and Schneider, 2016*, p. 1603) − “A related question is whether the government should promote homeownership in the first place, given that it involves a large undiversified investment and potential welfare costs in default.” (Piazzesi and Schneider, 2016, p. 1628) * Piazzesi, Monika; and Scheider, Martin. “Housing and the Macroeconomy,” Handbook of Macroeconomic 2 (2016), pp. 1547-1640. 5 U n d e r Lumberton NC Leveraged Housing Bubbles Hurt Growth (Jorda, Schularick and Taylor, “Leveraged Bubbles,” 2015) Five-year 29 percentage-point cumulative loss of per-capita real GDP (17 countries, 1870-2013) Bucksport SC W a t e r 6 Policies Encourage Leveraged Homeownership Why homeownership? − Wealth accumulation; strong communities; economic growth − Evidence is mixed; don’t forget role of strong vested interests Why debt? − Adverse selection, moral hazard (this actually makes sense) Why high LTVs? − Marginal buyers are poor − Tax incentives encourage infra-marginal leveraging 7 Hispanic & Black Families Haven’t Accumulated Real Value of Mean Homeowners' Equity (HOE) and All Other Wealth by Race and Ethnicity (Index values = 100 in base year) 300 Hispanic other wealth (1) Black other wealth (3) 250 200 Hispanic HOE (6) Black HOE (8) 150 100 50 1989 Source: Federal Reserve Survey of Consumer Finances 1992 1995 1998 White HOE Black HOE Hispanic HOE Other-race HOE 2001 2004 2007 2010 2013 2016 White other wealth Black other wealth Hispanic other wealth Other-race other wealth 8 Starting Date Doesn’t Matter Much Real Value of Mean Homeowners' Equity (HOE) and All Other Wealth by Race and Ethnicity (Index values = 100 in base year) 350 300 Hispanic other wealth (3) Black other wealth (5) Hispanic HOE (6) Black HOE (8) 250 200 150 100 50 1992 Source: Federal Reserve Survey of Consumer Finances 1995 1998 White HOE Black HOE Hispanic HOE Other-race HOE 2001 2004 2007 2010 2013 2016 White other wealth Black other wealth Hispanic other wealth Other-race other wealth 9 Starting Date Doesn’t Matter Much Real Value of Mean Homeowners' Equity (HOE) and All Other Wealth by Race and Ethnicity (Index values = 100 in base year) 350 300 Black other wealth (3) Hispanic other wealth (6) Hispanic HOE (7) Black HOE (8) 250 200 150 100 50 1995 Source: Federal Reserve Survey of Consumer Finances 1998 2001 White HOE Black HOE Hispanic HOE Other-race HOE 2004 2007 2010 2013 2016 White other wealth Black other wealth Hispanic other wealth Other-race other wealth 10 Starting Date Doesn’t Matter Much Real Value of Mean Homeowners' Equity (HOE) and All Other Wealth by Race and Ethnicity (Index values = 100 in base year) 250 200 Black HOE (5) Hispanic other wealth (6) Black other wealth (7) Hispanic HOE (8) 150 100 50 1998 Source: Federal Reserve Survey of Consumer Finances 2001 2004 White HOE Black HOE Hispanic HOE Other-race HOE 2007 2010 2013 2016 White other wealth Black other wealth Hispanic other wealth Other-race other wealth 11 Starting in 2001 Makes It Look Better Real Value of Mean Homeowners' Equity (HOE) and All Other Wealth by Race and Ethnicity (Index values = 100 in base year) 300 250 200 Hispanic HOE (1) Black HOE (2) Hispanic other wealth (4) Black other wealth (8) 150 100 50 2001 Source: Federal Reserve Survey of Consumer Finances 2004 White HOE Black HOE Hispanic HOE Other-race HOE 2007 2010 2013 2016 White other wealth Black other wealth Hispanic other wealth Other-race other wealth 12 But That Didn’t Last Real Value of Mean Homeowners' Equity (HOE) and All Other Wealth by Race and Ethnicity (Index values = 100 in base year) 200 150 Hispanic other wealth (3) Black other wealth (4) Hispanic HOE (7) Black HOE (8) 100 50 2004 Source: Federal Reserve Survey of Consumer Finances 2007 White HOE Black HOE Hispanic HOE Other-race HOE 2010 2013 2016 White other wealth Black other wealth Hispanic other wealth Other-race other wealth 13 ∆HOE (2007-16): Hispanic -38%, Black -20% Real Value of Mean Homeowners' Equity (HOE) and All Other Wealth by Race and Ethnicity (Index values = 100 in base year) 150 Hispanic other wealth (3) Black other wealth (5) 100 Black HOE (7) Hispanic HOE (8) 50 2007 Source: Federal Reserve Survey of Consumer Finances 2010 White HOE Black HOE Hispanic HOE Other-race HOE 2013 2016 White other wealth Black other wealth Hispanic other wealth Other-race other wealth 14 Weak Wealth-Building from Homeownership ∆HOE (1989-2016): Hispanic 57%, Black 34% ∆Other NW (1989-2016): Hispanic 107%, Black 91% ∆HOE (1989-2016): White 56%, Other 109% ∆Other NW (1989-2016): White 132%, Other 144% ∆HOE (2007-16): Hispanic -38%, Black -20% ∆Other NW (2007-16): Hispanic 10%, Black -2% ∆HOE (2007-16): White -12%, Other 3% ∆Other NW (2007-16): White 27%, Other 10% 15 Housing Crash Hit Vulnerable Families Hardest Young − For example: Family heads born in the 1970s − Ages 28-37 in 2007 (median 33); 34-43 in 2013 (median 39) No college − Vast majority of families have less than a 4-year degree Non-white − Hispanic − African American 16 Young Families’ HO Rate: Born in the 1970s Homeownership Rate (%): 1970-79 Birth-Year Cohort vs. Predicted 80 70 2007 60 2016 2004 50 2001 40 30 20 Source: Federal Reserve Survey of Consumer Finances SCF Predicted: All families 10 Actual: All 1970s families 0 24 26 28 30 32 34 36 38 Age of family head 40 42 44 17 Non-College Families’ HO Rate: Born in 1970s Homeownership Rate (%): 1970-79 Birth-Year Cohort vs. Predicted 80 70 60 2007 50 2016 2004 2001 40 30 20 Source: Federal Reserve Survey of Consumer Finances SCF Predicted: All families 10 Non-college graduate 1970s families 0 24 26 28 30 32 34 36 38 Age of family head 40 42 44 18 Black, Hispanic Families’ HO Rate: Born in 1970s Homeownership Rate (%): 1970-79 Birth-Year Cohort vs. Predicted 80 70 60 2007 50 2016 2001 40 2004 30 20 Source: Federal Reserve Survey of Consumer Finances SCF Predicted: All families Black 1970s families Hispanic 1970s families 10 0 24 26 28 30 32 34 36 38 Age of family head 40 42 44 19 Young Families’ Median NW: Born in the 1970s Median Family Net Worth (Thousands of 2016 $): Actual 1970s Cohort vs. Predicted from Entire SCF Sample 120 SCF Predicted: All families 100 Actual: All 1970s families 2016 80 60 2007 2004 40 Source: Federal Reserve Survey of Consumer Finances 2001 20 24 26 28 30 32 34 36 38 40 42 44 20 Non-College Families’ Median NW: Born in 1970s Median Family Net Worth (Thousands of 2016 $): Actual 1970s Cohort vs. Predicted from Entire SCF Sample 120 SCF Predicted: All families 100 Actual: 1970s non-college graduates 80 60 2007 40 Source: Federal Reserve Survey of Consumer Finances 2016 2004 2001 20 24 26 28 30 32 34 36 38 40 42 44 21 Black, Hispanic Families’ Median NW: Born in ‘70s Median Family Net Worth (Thousands of 2016 $): Actual 1970s Cohort vs. Predicted from Entire SCF Sample 120 SCF Predicted: All families 100 Black 1970s families Hispanic 1970s families 80 60 40 Source: Federal Reserve Survey of Consumer Finances 2007 2001 20 2016 2004 24 26 28 30 32 34 36 38 40 42 44 22 Young Families’ HD/Y Ratios: Born in the 1970s Housing Debt/Usual Income (Percent): Actual 1970s Families vs. Predicted from Entire SCF Sample 200 SCF Predicted: All families Hispanic 1970s families Black 1970s families Non-college graduates 2007 All 1970s Families 150 2004 2016 2001 100 50 Source: Federal Reserve Survey of Consumer Finances 0 24 26 28 30 32 34 36 38 40 42 44 23 Young Families’ 60+DQ Ratios: Born in the 1970s Share of Families with a Serious Delinquency (60+ Days Past Due; Percent): Actual 1970s Birth Cohort vs. Ratio Predicted from Entire Sample 25 SCF Predicted: All families All 1970s families 1970s non-college graduates 20 Hispanic 1970s families Black 1970s families 2004 15 2001 2007 2016 10 Source: Federal Reserve Survey of Consumer Finances 5 0 24 26 28 30 32 34 36 38 40 42 44 24 The “Big-Picture” View of Housing Bubbles “Demand for a new investment bubble began months ago, when the subprime mortgage bubble burst and left the business world without a suitable source of pretend income…. 25 The “Big-Picture” View of Housing Bubbles “Demand for a new investment bubble began months ago, when the subprime mortgage bubble burst and left the business world without a suitable source of pretend income…. “’Every American family deserves a false sense of security,’ said Chris Reppto, a risk analyst for Citigroup in New York. ‘Once we have a bubble to provide a fragile foundation, we can begin building pyramid scheme on top of pyramid scheme, and before we know it, the financial situation will return to normal.’“ The Onion, “Recession-Plagued Nation Demands New Bubble to Invest In,” July 14, 2008. 26 Leveraged Housing Bubbles Very Damaging Jorda, Schularick and Taylor (2015*) evidence − Annual data on equity and housing markets, bank credit growth; 17 countries, 1870-2013 − Asset bubbles + credit => Worse recessions, financial crises? Conclusions − Bursting stock-market bubbles make recessions worse − Bursting credit-fueled housing bubbles create financial crises − Policymakers ignore them at the economy’s peril * Jorda, Oscar; Schularick, Moritz; and Taylor, Alan M. “Leveraged Bubbles,” Journal of Monetary Economics 76 (2015), pp. S1-S20. 27 Low Interest Rates vs. Financial Liberalization Sommer, Sullivan and Verbrugge (2013*) − Changes in “fundamentals” (interest rates, collateral requirements (max LTV), income growth) can account for 50 percent of the price-rent ratio increase, 1995-2006. − Lower real interest rates => House-price boom − Higher LTV ratios => Homeownership boom Large remaining role for “overly optimistic expectations” about house-price growth—i.e., a bubble. * Sommer, Kamila; Sullivan, Paul; and Verbrugge, Randal. “The Equilibrium Effects of Fundamentals on House Prices and Rents,” Journal of Monetary Economics 60 (2013), pp. 854-70 28 The Onion Made A Good Point… Favilukis, Ludvigson and Van Nieuwerburgh (2017*) − Conclusions from GE model: Financial liberalization was more important than lower real interest rates (from global capital inflows) for house prices and homeownership increases. − A housing bubble (perceived as permanent) fulfilled a need for greater risk-sharing—many wealth- and liquidity-constrained families used housing debt to smooth lifetime incomes. Underlying problems: 1) Marginal homebuyers are poor, 2) Before 2007, we didn’t understand mortgage/housing risks. * Favilukis, Jack; Ludvigson, Syndey C.; and Van Nieuwerburgh, Stijn. “The Macroeconomic Effects of Housing Wealth, Housing Finance, and Limited Risk Sharing in General Equilibrium,” Journal of Political Economy 125 (2017), No. 1, pp. 140-223. 29 The Future of Leveraged Homeownership The future of homeownership—never hit 69% again? − Rebalance policies to support all tenure choices. Role of mortgage debt—worst financing except all others. − Why not eliminate tax preferences for debt? An old idea—Henry George’s land-value tax (1879). − Housing bubbles actually are land bubbles. − If we’re doomed to recurrent housing bubbles, why not raise tax revenue from them with an LVT? Might also damp them. 30