Tuesday, April 21, 2009
Why Did Texas Skirt the Housing Crash?
Von Pepe sends me this interesting analysis of the relatively moderate boom/bust in Texas house prices.
The analyst thinks the answer is that Texas law prohibits prepayment penalties. In other words, homeowners in Texas were allowed to pay down their mortgages ahead of schedule, without being penalized by the lender. He concludes:
An interesting theory; I would like to see some more evidence though before signing off on it. (And the guy promises to do more research in future posts.) For example, if he could show that all or most states that banned prepayment penalties experienced low default rates, and in particular if he showed that the worst states all allowed the penalties, then that would be something.
In any event, I wrote an article defending prepayment penalties back when primary presidential candidate Hillary Clinton proposed abolishing them. An excerpt:
The analyst thinks the answer is that Texas law prohibits prepayment penalties. In other words, homeowners in Texas were allowed to pay down their mortgages ahead of schedule, without being penalized by the lender. He concludes:
I also want to get away from the duality of thinking of the subprime crisis as evil banks looting homeowners or evil lenders tricking banks. With the genius of prepayment penalties, banks didn’t have to make money by lending loans to credible homeowners - they could form a de facto company with unqualified borrowers to bet on house prices rising. The prepayment penalty was the bank’s equity in this endeavor. Or another way to say it is that the banks found a way to hire a person to sit in a house they wanted to gamble on; this was a subprime loan with a prepayment penalty. More to follow.
An interesting theory; I would like to see some more evidence though before signing off on it. (And the guy promises to do more research in future posts.) For example, if he could show that all or most states that banned prepayment penalties experienced low default rates, and in particular if he showed that the worst states all allowed the penalties, then that would be something.
In any event, I wrote an article defending prepayment penalties back when primary presidential candidate Hillary Clinton proposed abolishing them. An excerpt:
[I]t actually hurts borrowers (and lenders) when possible, voluntary contracts are declared inadmissible. Despite the presidential candidates’ desires to mother all of us, most people aren’t nearly as incompetent as the politicians would have us believe, especially when it comes to huge decisions such as financing a home purchase. The reason some borrowers are willing to sign contracts that include prepayment penalties is that the interest rate is correspondingly lower. If you think a prepayment penalty is absurd, you don’t need Hillary Clinton to rescue you. You can simply choose to take out a mortgage without a prepayment penalty (and pay a slightly higher interest rate because of your decision). Pretty simple, eh?
What most people don’t realize is that helping the borrower by giving him the option of prepaying the mortgage necessarily hurts the lender. When the bank lends you $200,000 to buy a house, it needs to compare the pros and cons of that loan with other possible investments. For example, it could have bought $200,000 worth of government bonds instead. Now from the bank’s point of view, one of the benefits of the mortgage loan is that it pays a higher rate of return than the government bond. But one of the drawbacks is that, if interest rates drop, the homeowner can refinance, whereas Uncle Sam can’t call in his bonds...
In other words, when the bank is planning its cash flows into the future, it is far more confident in fixed payments...as opposed to payment streams that might suddenly stop (such as a homeowner who refinances). In the financial community this is called prepayment risk. And guess what? If bankers are going to take on riskier investments, they require correspondingly higher expected returns. That’s part of the reason that mortgage rates are higher than U.S. bond rates...Including prepayment penalties in mortgage contracts mitigates this risk, and so allows the lender to charge a lower interest rate than he would accept without such a built-in compensation.
Comments:
A friend in the mortgage business told me about another reform: HVCC (Home Valuation Code of Conduct). It's specific to Fannie/Freddie loans, but that's a big part of the market. It sounds like it's full of possible backfires - has anyone seen a good analysis of it?
# posted by 
: April 21, 2009 at 7:39 PM
: April 21, 2009 at 7:39 PM
Bob,
This is an area where I consider myself an expert.
Texas is considerably more friendly to development than areas in the West, Northeast, and Florida. Krugman correctly noted this when he wrote about "zoned zone".
The artificially restricted supply in many regions is what allowed home prices to surge. In Texas, and many "fly-over" states a housing bubble is almost impossible. If home prices even marginally increase over costs, builders build more homes in a mostly unrestricted environment. When building is artificially constrained prices soar as land prices drive up costs.
Geographically there are few real restrictions either. Go out to north Dallas or west Houston and you'll see the endless flat expanses which developers have at their disposal.
If you look at Atlanta, Charlotte, and to a lesser extend Chicago you will see a similar avoidance of the housing boom/bust.
The Case-Shiller data for Dallas shows that home prices simply did not rise more than around 3-4% a year over the last 15-20 years. Mind you, Houston and Dallas were 2 of the 4 fastest growing metros in the U.S., so demand can not be explanation for high prices.
Search on Wendell Cox and you'll see a pretty extensive comparison of restrictions vs. home prices. It's pretty convincing.
If you look at RealtyTrac data, you'll see something even more amazing. Foreclosures in Texas have consistently trended DOWNWARD over the last 3 years. They are now about 30% below what they were in 2006.
Home prices in Texas relative to incomes never rose much and perhaps even declined. Few people need an exotic loan to buy a brand new $100K house. Few are going to speculate when prices are only rising 3-4% a year.
This is an area where I consider myself an expert.
Texas is considerably more friendly to development than areas in the West, Northeast, and Florida. Krugman correctly noted this when he wrote about "zoned zone".
The artificially restricted supply in many regions is what allowed home prices to surge. In Texas, and many "fly-over" states a housing bubble is almost impossible. If home prices even marginally increase over costs, builders build more homes in a mostly unrestricted environment. When building is artificially constrained prices soar as land prices drive up costs.
Geographically there are few real restrictions either. Go out to north Dallas or west Houston and you'll see the endless flat expanses which developers have at their disposal.
If you look at Atlanta, Charlotte, and to a lesser extend Chicago you will see a similar avoidance of the housing boom/bust.
The Case-Shiller data for Dallas shows that home prices simply did not rise more than around 3-4% a year over the last 15-20 years. Mind you, Houston and Dallas were 2 of the 4 fastest growing metros in the U.S., so demand can not be explanation for high prices.
Search on Wendell Cox and you'll see a pretty extensive comparison of restrictions vs. home prices. It's pretty convincing.
If you look at RealtyTrac data, you'll see something even more amazing. Foreclosures in Texas have consistently trended DOWNWARD over the last 3 years. They are now about 30% below what they were in 2006.
Home prices in Texas relative to incomes never rose much and perhaps even declined. Few people need an exotic loan to buy a brand new $100K house. Few are going to speculate when prices are only rising 3-4% a year.
The Blackadder Says:
Banning Pre-Payment Penalties tends to raise interest rates and discourage lending. Normally that's bad. But of course if the government is doing something else to artificially lower interest rates and expand credit, then presumably the effect of something like a PPP ban could be positive, right?
Banning Pre-Payment Penalties tends to raise interest rates and discourage lending. Normally that's bad. But of course if the government is doing something else to artificially lower interest rates and expand credit, then presumably the effect of something like a PPP ban could be positive, right?
# posted by : April 22, 2009 at 7:40 PM
: April 22, 2009 at 7:40 PM
1. I’ve been to Texas 7 times in the last two years and drove pretty much from one end to the other. Despite its massive population, the state is amazingly empty and houses are real cheap. I’m sure that is a good explanation of why there was little speculation during the boom.
2. The Fed caused the artificial housing boom and people who bought in on it based upon a false expectation of ever rising prices are now in tough shape. As such, if someone was precluded from buying an overpriced house due to the impact some odd regulation, that person may very well be better off now for having not purchased than if they had purchased, but due solely to good luck. However, liberals and interventionists will constantly be pointing to this or that onerous regulation which precluded home buying as the universal solution to housing booms. That is no argument for regulation. As Bob Murphy once said, they might have precluded the boom by decapitating all real estate agents.
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2. The Fed caused the artificial housing boom and people who bought in on it based upon a false expectation of ever rising prices are now in tough shape. As such, if someone was precluded from buying an overpriced house due to the impact some odd regulation, that person may very well be better off now for having not purchased than if they had purchased, but due solely to good luck. However, liberals and interventionists will constantly be pointing to this or that onerous regulation which precluded home buying as the universal solution to housing booms. That is no argument for regulation. As Bob Murphy once said, they might have precluded the boom by decapitating all real estate agents.
# posted by : April 22, 2009 at 9:20 PM
: April 22, 2009 at 9:20 PM Subscribe to Post Comments [Atom]
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