Austan Goolsbee is not a credit snob

The Center for Responsible Lending estimated that in 2005, a
majority of home loans to African-Americans and 40 percent of home
loans to Hispanics were subprime loans. The existence and spread of
subprime lending helps explain the drastic growth of homeownership for
these same groups. Since 1995, for example, the number of
African-American households has risen by about 20 percent, but the
number of African-American homeowners has risen almost twice that rate,
by about 35 percent. For Hispanics, the number of households is up
about 45 percent and the number of homeowning households is up by
almost 70 percent.

And do not forget that the vast majority of
even subprime borrowers have been making their payments. Indeed, fewer
than 15 percent of borrowers in this most risky group have even been
delinquent on a payment, much less defaulted.

Here is more.

Comments

Maybe Nouriel Roubini will read it.

". . . helps explain the drastic growth of homeownership. . . ."

That's an odd word-choice.

Should use a new measure? It is interesting to see what fraction are "sub-prime," but what fraction are "stated income?"

Is "stated income" a better indicator of "bankruptcy pimps" at work?

odograph: The WSJ story to which you're referring was unusual in that it led to a cash settlement to the borrower from the bank, a clear admission that there was misdeed performed by themortgage broker involved. So what that indicates is that it isn't a typical case and can't be used to support a more general argument like yours.

"When contemplating ways to prevent excessive mortgages for the 13 percent of subprime borrowers whose loans go sour, regulators must be careful that they do not wreck the ability of the other 87 percent to obtain mortgages."

Because regulators have traditionally been much better than the market at determining these fine and shifting distinctions, right? I mean we have just a TON of data showing that we are better off handing off our decision making to government, don't we....

How about this...the sub-prime lenders knew their risks when they lent the money and the people who borrowed the money took a chance that they were willing to take of their own free will. Maybe these borrowers figured it was worth the chance? Maybe they could afford it before but not now. Reality deviating from predictions is not a sign that these low-income people are dumb clods, as congress is implying. But, as usual, the "elites" of congress are trying to swoop in to make dictate to the poor black and hispanics because they are just too black, too poor and too hispanic to make their own decisions. Congress behaves as if there is overwhelming evidence that being poor, black or hispanic equates to an IQ of about 64. Right.......

You understand, Methinks, that the loan system relies very much on government guarantees? If things go bad, the government (that's you) will pay the losses. But you think, they should not "regulate" how bad the risk should be?

Maybe you aren't as old and crooked as me, and don't remember 1985:

"For example, in March 1985, it came to public knowledge that the large Cincinnati, Ohio-based Home State Savings Bank was about to collapse. Ohio Gov. Richard F. Celeste declared a bank holiday in the state as Home State depositors lined up in a "run" on the bank's branches in order to withdraw their deposits. Celeste ordered the closure of all the state's S&Ls. Only those that were able to qualify for membership in the FDIC were allowed to reopen. Claims by Ohio S&L depositors drained the state's deposit insurance funds. A similar event also took place in Maryland.

The U.S. government agency Federal Savings and Loan Insurance Corporation, which at the time insured S&L accounts in the same way the Federal Deposit Insurance Corporation insures commercial bank accounts, then had to repay all the depositors whose money was lost."

http://en.wikipedia.org/wiki/Savings_and_loan_crisis

It's my understanding that zip code is used as part of credit scoring. Zip code correlates not only with wealth, but with race. I'd be very curious to know what happens to the credit scores without that information, and what fraction of African American homebuyers would be sub-prime in that world.

odograph,

The government will not pay the losses of subprime loans unless Fannie/Freddie go under, which is possible, but unlikely. While they might buy some for their own portfolio (not sure), it is a fraction of the fixed, prime mortgages they buy. The predominant owners of subprime are hedge funds, investment banks, and mortgage companies that didn't sell it off. There is virtually no risk (if any) to tax payers, unless you think the banking system is going to collapse.

The S&L crisis is a poor analogy. The S&L's were taking so much risk because a 1982 Federal Law (can't remember the name) was passed that allowed and encouraged them to. The law was passed because S&L liabilities are short-term and their assets were 30 year mortgages. Many knowledgeable people consider the S&L crisis to be government induced, in fact that is what I was taught in school. Your premise is misguided. I don't disagree that regulation is needed, but with the disintermediation of the last couple of decades, the risks are spread out.

Martin: I wasn't talking about what prudent people should do, or giving advice. I was talking about
how things already are. *Even with* the most reckless lenders, you literally cannot walk in one day and
get the mortgage payment before leaving. You still have 24 hours at the very least to look it over. My
point was that it requires more than a one-time haste-driven lapse of judgment.

AAACK! CB responded to Odograph before I could. And...I'm sorry to say that I am old enough to remember the S&L crisis and happy to say that I'm not crooked.

CB is correct and saved me the trouble of writing the response.

However, I fail to see the logic of regulation. What exactly would regulation do in a free market where everyone decides which transactions they want to get into? Protect Hedge funds from themselves? Protect poor, blacks and hispanics from themselves? Disclosures about risk are already a law and nobody is accusing subprime lenders of not complying with that law. So, please, would somebody undertake the task of explaining to me how it is less costly to have regulation in this area (and please don't omit the cost of enforcing the regulation with more taxpayer dollars than it is to not have it? I fail to see a benefit.

I accept the assurances that bank failures are not likely, but I do note that I never raised that as my concern. It was more a question of subsidies from the US Federal general funds. Do banks pay what would be effectively market rates for their FDIC insurance? And if not, how does this influence the credit market?

Also, why would the headline be:

Bernanke: Fannie, Freddie need tighter regulations

http://www.azstarnet.com/business/172262

This fits in nicely with a recent study on the site that said regions of the country that have higher home ownership rates also have higher unemployment. Poor people perhaps shouldn't be anchoring themselves permanently into one place, as the demand for their skills is less and more varied. They must go to the jobs, the jobs will not come to them.

odograph,

Your original post seemed to imply that taxpayers could be on the hook if the subprime market gets bad. I hope I've allayed your concerns.

Fannie and Freddie are not specificallly guaranteed by the gov't. There is what is called an implicit guarantee, the market believes the gov't won't allow them to fail if they get into trouble. The Fed has been on a mission to rid the market of that notion, but it hasn't worked. Both of those companies spend a fortune on lobbying Congress, not to mention all the projects that they have in each congressional district (such as low-income housing projects, which are great for politians). Off the top of my head, I can't think of more politically connected companies. They have successfully fought off more regulation from none other than Greenspan, and now Bernanke, for years.

I'm not sure about the influence of FDIC insurance has on credit markets, I'm sure the Fed's website has a paper or few on the subject. 100k is a relatively insignificant amount of money these days, at least relative to the size of financial markets.

"100k is a relatively insignificant amount of money these days, at least relative to the size of financial markets."

It seems that the limit's primary function in this day and age is to ensure that large depositors split their accounts in that increment. That must increase stability to some degree.

Berger et. all,

I also remember the S&L crisis (my bank acount was frozen for 3 weeks).

There were (at least) two steps leading to the implosion: the insurance level was raised, then S&L officers began making risky loans.

To my knowledge, none (or close enough to none) of these officers went to jail. (Check out Neil Bush's history)

Absent any effective enforcement of the fudiciary duties of the Officers, regulation by the government seems the only way to have a stable economy.

Person,

Cool, but just to clarify, the ratings are determined not by the timing of cash flows, but which tranche absorbs the losses, with the first to absorb losses getting the lowest rating, and so on.

I hope I'm not overusing metaphor's, industry jargon becomes part of vernacular after a while. :)

Rich,

My apologies if you thought anything I've written here has made you think I believe in 'perfect government'. Government being dependent upon the whim and hand of Man, such a concept is impossible.

And if anyone thinks I believe in no government they are greatly mistaken.

My concern is for those who seem to have been airbrushed out of this argument completely - those who might not have the smarts to become economics professors; those who might earn less than the average wage; but the same those who hhave been determined to keep themselves out of the welfare state's clutches and actually save to put down a deposit on a house who, if they haven't gone fixed rate, might now find themselves facing higher mortgage payments through no fault of their own.

It's OK for Cowen and Tabarrok to pontificate about 'credit snobs' and declaim like Demosthenses that 'all shall have credit'; do these great ideologues actually give a rat's backside for the respectable upper working class and lower middle class? Are those folks just, like, pawns to be moved across the chess board? Don't they matter|?

They're the ones who bought the dream - is it morally acceptable to say to such people, 'Sorry y'all, we've just reinterpreted the works of Friedrich von Hayek so, like, just go to hell' when the house of cards they did nothing to encourage comes crashing down around them?

No, I don't think so.

Steve_Sailer: I think Malcom_X would have also wanted the banks to make those same home loans ... but I get your point ;-)

Person,

My comment was tongue in cheek, and I wouldn't have been offended anyway, as that's how I talk.

We are not saying the same thing. You do understand conceptually how the lower tranches absorb losses, so I'm not going to go back and forth with you because the specifics of how they work aren't relevant to this thread.

cb, please specify how what you said differs from what I said.

You said:

"the ratings are determined not by the timing of cash flows, but which tranche absorbs the losses, with the first to absorb losses getting the lowest rating, and so on."

I originally said:

"I thought the way tranches worked was that you're not buying the revenue stream from a specific set of
mortgages, but rather, you're buying priority to the n-th dollars in a revenue stream from a pool of mort-
gages."

That's the same thing!

We are both saying that where the debt payments do not satisfy all obligations, first the highest-rated must
be paid, then the second-highest get paid, then the third, etc.

You don't understand that my use of "n-th dollar" refers to dollars within a coupon payment, not the order of
dollars that come in across the life of the bond.

You also seem to have a hard time when people phrase things in a way that are not financial-industry-approved.

As I read over the comments, I'm reminded why I refuse to buy! the financial difference between renting and buying is ZERO (assuming a relatively efficient market). You only "win" by buying if you value the implied option to move freely at zero and/or you can't rent the kind of shelter you can buy. Or ownership has some personal value to you and you value that more than the "move quickly" option. Real Estate is a high price risk, illiquid asset with huge exit and entry fees.

Stanford brought up an interesting study indicating that poorer people probably should not buy a house. This makes sense because the purchase of a house creates a fixed cost and the buyer takes on huge price risk in an illiquid asset. The poorer you are, the less able you are to tolerate the risk.

However, does this mean that it's a bad idea for EVERY poor person? Of course not. everyone's circumstances are different. I don't believe that we have the right to take away the rights of poor people to make their own housing decisions just because they're poor. It seems to me like a severe infringement of civil liberties without much benefit.

Which brings me to Martin's post. Martin seems to be defending government intervention in poor people's decisions to protect them from themselves. But consider this: the poor hate the paternalistic, dictatorial nature of welfare. They fight to stay off of it so that they can keep government from patronizing them. Which is more fair? Letting them suffer the consequences of their own decisions (good or bad) or infringing on their rights solely because they're poor? Why should government intervene if a private institution is willing to lend to them at a given interest rate and the borrower accepts that rate?

You say that you don't believe that government is perfect. OK. But to protect a tiny minority of poor people who aren't very good decision makers while also not stepping on everybody else's freedom would take a Utopian government. It's fantasy.

The fight between the administration (representing a handful of very large banks) and Fannie and Freddie (represented by Democrats on the hill) is almost entirely over who will accrue the cash flows generated by the guarantee of prime mortgages (which are exceedingly valuable, because conforming loans almost never default by design and the position is currently a duopoly). Nothing more and nothing less. In this case the discussions of systemic risk is mostly a club used to emphasize points made by one side or the other.

Like the S&L crisis, brought on by tax law changes that slashed property values (originally inflated by tax benefits), the current subprime mess traces its roots to the capital gains exemption that torched off the virtuous circle that led far too many folks to make decisions in an environment where collateral value increased by double digits annually.

Methinks,

"Letting them suffer the consequences of their own decisions (good or bad) or infringing on their rights solely because they're poor?"

In an ideal world, obviously the first option, every time.

However, your hypothesis demands that 'the poor' (not an expression I think I've used) have a 'right' to buy a house. Whoever 'the poor' are, they have no such thing - nobody does.

What I do not like are my own preferred demographic of 'the respectable upper working class and lower middle class' doing their hardest to be responsible, to stay independent of the state and then to have the goalposts moved furher and further away from them either because of macro policy failures or lenders' greed; a practice which tenured professors, people in the most secure form of employment out there, utterly isolated, insulated and immune from the vicissitudes of the labour market's ebbs and flows, then seek to justify by describing opposition to it as 'credit snobbery'.

"...to protect a tiny minority of poor people who aren't very good decision makers while also not stepping on everybody else's freedom would take a Utopian government. It's fantasy."

Perhaps - but when such a critical element of social mobility as home ownership is weakened by the presence on the market of the sort of mortgage products that dopeheads might dream up in their garage, it has its attractions.

Martin,

“However, your hypothesis demands that 'the poor' (not an expression I think I've used) have a 'right' to buy a house. Whoever 'the poor' are, they have no such thing - nobody does. “

Of course they do. Everyone has the right to buy whatever they can afford and can buy legally. If one doesn’t have the right to spend one’s own money as one sees fit, who has the right to spend that money?

My larger point was that a.) These people WANTED to buy a house, b.) someone was willing to lend them the money and both parties agreed to the transaction. Where’s the problem?

Also, people don’t suffer the consequences (good or bad) of their own actions in a perfect world. This is, in fact, the state of the natural world. If you eat too much, who gets fat? Me? No. You. It’s only when we install a welfare state that we increase the neighborhood effect of individual’s actions.

As long as both parties agreed to the transaction and tax payers aren’t recruited to bear the cost their mutual decision, I don’t see how we have the right to curb their actions.

I don’t agree that home ownership is at all a critical element of social mobility. A lot of people who work with me on Wall Street choose not to buy because there is no financial gain at all. All of these people moved from the bottom quintile to the top quintile (of income) without owning any real estate. This idea, long held by the average American, that plowing all your money into a single, illiquid asset is the road to riches is ignorant.

Also, I don’t think you have a clear understanding of the risks. The “dopeheads† who “dreamed up† these mortgage products took a risk with private money and bore the risk of default. You seem to imply that bankruptcy confers a benefit for these “dopeheads† when the borrowers default.

Odograph,

People don’t tend to spend based on current income. They tend to spend based on what they perceive to be permanent income – the level of income they expect to receive over some longer period of time. That’s why you don’t see much curtailment of spending in lower income brackets (they expect their income to rise) and you don’t see much extra spending in higher income brackets (they don’t spend what they perceive to be a temporary windfall).

We all make decisions based on expectations. Stock prices, for example do not only reflect the book value of the assets (capital) and the current year income. They reflect also investor expectations of income that those assets will earn in the future. Human capital can be regarded in the same way. When making decisions which have long-ranging impact, people will tend to asses not only today’s income but income they receive now and will receive in the future. That’s really what the statement you quoted was talking about.

Think of the difficulties and inefficiencies involved in readjusting your long-term decisions based on short-term fluctuations.

BTW, it struck me after I wrote my earlier piece that "buy a house, and pay it down to full ownership by retirement" is becoming a rather quaint idea.

Methinks,

"Everyone has the right to buy whatever they can afford and can buy legally."

If you don't like the answers you get, use language more carefully.

"My larger point was that a.) These people WANTED to buy a house, b.) someone was willing to lend them the money and both parties agreed to the transaction. Where’s the problem?"

We all want lots of things. Some people might even lend us money to buy them.

But that does not automatically render stoner loans sacred.

Or even prudent.

"It’s only when we install a welfare state that we increase the neighborhood effect of individual’s actions."

I prefer to think of it as socialising the risk of others' imprudence.

But whatever.

"I don’t agree that home ownership is at all a critical element of social mobility. A lot of people who work with me on Wall Street choose not to buy because there is no financial gain at all. All of these people moved from the bottom quintile to the top quintile (of income) without owning any real estate."

Dude, you can hardly be described as 'respectable upper working class or lower middle class'. Has the idea that your presumably above median level income level might have something to do with the fact that you're one of a very small group of very sophisticated economic actors occurred to you?

Or that plasterers and grease monkeys don't work on Wall St. for a reason?

"This idea, long held by the average American, that plowing all your money into a single, illiquid asset is the road to riches is ignorant."

One man's home is another 'single, illiquid asset'.

Neat.

Ever wanted to put down roots without considering its impact on your net worth?

Should children be referred to as 'biological cost centres'?

You know something, you're a totalitarian at heart. You believe everyone should think the same way you do.

'The “dopeheads† who “dreamed up† these mortgage products took a risk with private money and bore the risk of default. You seem to imply that bankruptcy confers a benefit for these “dopeheads† when the borrowers default.'

Absolutely nothing I have written could support that conclusion. I would suggest you read my last post again.

Odograph,

"But that doesn't really explain decline in US savings rates, and growth in consumer debt, does it?"

Well...yes and no. There's a lot of debate about how accurate the savings rate is based on the way it’s calculated. It's an involved debate and I’m not competent to explore it fully. But I'll give you all I can reasonably do.

Given that economists generally think that consumers prefer consumption today consumption tomorrow, why do people save at all? One reason is precautionary savings - to withstand temporary shocks like being laid off. Another is lifetime income smoothing - saving for retirement during peak earning years. Some goods require a big payment up front but are consumed over time - like cars and real estate.

If we didn't have highly developed and efficient credit markets, we would have to weather every shock from our savings and we would have to pay every up front cost of goods we consume over time out of savings. But we do have developed and efficient credit markets, so we know that even if we don't save enough to weather a shock or buy a car or a house with savings alone, we can always borrow to cover the cost. Generally, the more favourable the credit terms available, the less incentive we have to save – and credit spreads have been quite low recently, until only a few weeks ago.

There’s a debate over whether the household savings rate calculations understate household savings. As I understand it, the savings rate calculation reflects only the amount not spent from current income. It doesn’t take into account capital appreciation on that which households have already saved/invested. It’s not unreasonable to argue that if that which households have already saved has appreciated significantly, the propensity and the need to save more declines. However, a counter argument is that for most households the primary asset of most households is the family home and that presents an obvious problem.

Methinks,

I have no argue with that as a summary. It tallies with what I've read elsewhere (and is a good piece of writing). I did a quick search though, and found a 2000 study which showed median home equity flat as home sales increased (including to those buyers newly enabled by sub-prime loans). There naturally going to be a dilution effect as ownership increases, and the fraction of first-time buyers increases. There also the risk that some of that dilution might have come from folks moving up-market but down in equity. I think some folks here in SoCal abandoned equity as fast as they could, to stay on the real estate escalator.

The 2000 survey:

http://www.americasaves.org/downloads/www.americasaves.org/PressReleases/11.16.00.pdf

Ah well, you all can probably see at this point that I am extremely debt and risk averse. That doesn't make me right, and I don't think everyone should be extreme as me ... just looking for a little ... moderation.

Do as I do, not as I say.

Well, that's what it looks like to me...

Matt,

Oy! Almost as soon as I posted, I wished I hadn’t invoked the PIH. There are empirical failures – particularly in highly regulated financial markets where liquidity constraints are a problem. Taxation (particularly on wealth) is another form of distortion. Households’ inability to borrow and lend at the same rate is another. That’s a whole interesting discussion and there are people far more qualified than I to discuss the PIH.

Perhaps I should have called it people’s natural “duration matching† tendency instead of lugging the PIH into it. My point was very basic, though - usually people don’t make long term decisions based on short term circumstances alone. unless I'm very much mistaken, this point is not in dispute. I don't believe that the cost of regulation (which we never seem to think about) will exceed the benefit. I believe that it’s ridiculous to assume that government can assess the risks and expectations for individual households. The borrower and the lender assess all the relevant factors for the individual arrangement before they enter into a contract and since each is working their own best interest (and to a large extent, their interests are mutual – it doesn’t behoove the lender to drive the borrower into bankruptcy and bankruptcy isn’t a favourable outcome for the borrower either) the outcome is more favourable and less costly than government regulation.

I don't understand why you think minority sub-prime borrowers constitutes a market failure. Indeed, I would argue the opposite - that minorities (who are often low-income for a variety of reasons) have a more fair access to credit now than in the past. This seems to me to represent a more equal opportunity - a positive aspect of a free market - rather than a market failure.

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