Zero-Down-Payment Loans & the Housing Crisis

Despite all the hoopla over subprime loans and unscrupulous lenders exploiting low-income homebuyers, a new analysis by University of Texas economist Stan Liebowitz finds that subprime was not all that important in the housing crisis. Most mortgage foreclosures involved prime loans, not subprimes or loans with introductory “teaser” interest rates that soon reset upward.

Instead, the majority of foreclosures involve prime borrowers who bought houses, often with little or no down payments, thinking they would appreciate. When housing prices declined instead to the point where they were “under water” — i.e., the loans were greater than the value of the homes — many people simply walked away and let the banks foreclose.

In a housing market unfettered by government regulation, home prices rise and fall with local incomes. Unless a major industry shuts down (think oil in Houston in the 1980s, Boeing in Seattle in the 1970s, the auto industry in Michigan today), home price declines tend to be small. To guard against people leaving homes, lenders traditionally require 10 to 20 percent down payments. This insures that the equity people have in their homes will almost always be greater than the remaining mortgage.

Land-use regulation, however, makes housing prices more volatile. Because homebuilders cannot quickly respond to changes in demand, a small increase in demand leads to large jumps in prices. Cities may take years to approve permits for new construction, so by the time builders get permission to build, the economy has changed and prices fall. This can lead to an apparent surplus of housing and huge declines in prices. In Merced, California, for example, prices have fallen by more than 60 percent from their 2006 peaks.

Banks should have been aware of the risk that more volatile prices would put more people under water and increased the down payment requirements. Instead, they were accused of discriminating against low-income families (when in fact the real discrimination was the fault of the land-use planners) and pressured to reduce loan requirements. Under pressure from Congress, Fannie Mae and Freddie Mac began buying loans with as little as 3 percent down payments in 1998, and later with 0 percent down payments.

Although difficult to prove, the Antiplanner contends that Congressional pressure to reduce loan requirements was motivated more by a desire to make housing affordable for the middle class than for low-income families. When land-use regulation pushes the cost of a $300,000 home to $1 million, a 10 percent down payment becomes a formidable obstacle. Reducing the down-payment requirement to 3 percent eliminates this obstacle.

The loan itself was made more “affordable” by increasing the share of income that can be dedicated to homeownership (mortgage, property taxes, and insurance). A decade ago, banks would only lend to people if this share was less than 30 percent. By 2006, the threshold had increased to 54 percent. All of these changes were made so that middle-class families could afford homes in regulated states such as California and Florida; if all states had remained as unregulated as Texas, such changes would not have been necessary.

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39 thoughts on “Zero-Down-Payment Loans & the Housing Crisis

  1. Dan

    Moronic evidenceless assertions notwithstanding, it certainly is true banks got happy with the lending, as we can see that all of a sudden many more people suddenly “qualified” to own a home. That is: they were lending to unqualified buyers to pump up their numbers. That’s a good chunk of what happened.

    DS

  2. bennett

    Just have to chime in about Texas. I live 2 doors down from a house owned by a bank on the north side of my house. 3 doors down on the south side it’s the same. Across the street, same thing. I also live in unincorporated Austin. That’s right, in the county, no zoning per se. Now this may not be substantial evidence to refute the AP’s assertion that land use regs are to blame, but they’re certainly not to blame in my neighborhood, in Texas, where foreclosures are ramped.

  3. Mike

    Expansionary monetary policy drove the circumstances in advance of the housing bubble. Indeed, it drove the dotcom bubble too. We have jumped from bubble to bubble ever since (oil, etc) until finally there was nowhere left to go in late 2008, and the hangover hit.

    It’s just going to continue to be wild swings until something is done to restore the objective value of currency, and the correction then will be “L-shaped”… and that’s political suicide for whoever is in power, so I wouldn’t count on it even though it’s really the only viable long-term solution and it will get worse the longer we wait to do it.

  4. t g

    Please visit the Federal Housing Finance Board’s site scroll down to Table 16 and look at the data. In your superstar cities, the down payment rates went UP. In your declining cities, these rates went down.

    For any set income, if you increase the down payment, and hold income stable, then the maximum biddable price can increase, because the down payment is in addition to the mortgage (which has a maximum at typically 1/3 income).

  5. t g

    Regarding the Mortgage data from FHFB:

    Look at the Loan to Price ratio. 100-(Loan to Price) is the down payment rate.

    Two items of note: Not only are the rates higher in the superstar cities, but the rates were increasing. While in the declining cities, they were decreasing.

    If one looks at capital gains (difficult to do) and adds those to income analysis, the superstar cities no longer seem so overpriced (and they certainly aren’t overmortgaged).

    Don’t confuse price with mortgage!

  6. blacquejacqueshellac

    Nearly all fiscal legislation designed to ‘help’ people or ‘regulate’ business or development results in a positive feedback loop which inexorably moves to wild oscillations. Heinlein pointed this out 40 or 50 years ago. No politician, bureaucrat or leftie has the faintest idea of the difference between positive and negative feedback. Nor cares.

    Neither do they care about the oscillations, because their pay, perks and pensions are actually enhanced by the problems they cause. An indexed pension in a time of economic trouble is a delightful thing.

  7. Dan

    Nearly all fiscal legislation designed to ‘help’ people or ‘regulate’ business or development results in a positive feedback loop which inexorably moves to wild oscillations.

    Deregulation of the Financial Sector largely contributing to the housing bubble and refuting this incorrect assertion on the ground notwithstanding,

    Another issue in this country that drove this bubble – besides the risk the FIRE sector took – is that not only did homeownership rate go up (perhaps a function of wages), but savings went waaaaaaaay down due to the primacy of consumer spending as being an important driver of our “economy”. There was simply no cushion to prevent foreclosures – no resilience, IOW.

    DS

  8. msetty

    The Matt Tiabbi story in Rolling Stone about Goldman Sachs has a much more plausible explanation for the housing and dotcom bubbles than The Antiplanner’s post.

  9. Mike

    t g: Well asked. It turns out the price of a house in 2005 was the same as the price of a comparable house in 1905 — IN GOLD. The price of oil between 2001 and 2008 tripled in dollars and doubled in Euros, but was unchanged in gold. Gold is not the sole store of objective value, but it is one store of objective value. Silver is another. Durable goods, though difficult to administer because of limited fungibility, are another.

    Ultimately, the USA had it right with Bimetallism. Silver and gold have specific industrial, scientific, and other physical uses, and their scarcity as fugitive resources are limited only by a person’s cost and wherewithal to extract them. Anchoring the dollar to one or both of those stores of objective value would be a proper solution to the fiat currency (monetary expansionism) problem we’re having today. It would be a difficult, violent upheaval of adjustment, but once adjusted, smooth sailing. There is precedent: throughout the 19th century, as America prospered and expanded, the dollar was objective gold-based currency.

    Dan brought up the popular current canard that deregulation of the financial sector “largely contributed” to the housing bubble. This is not correct. The financial sector is, and has continued to be, among the most heavily regulated markets in existence. Economist Dr. George Reisman establishes that expansionary monetary policy, not “deregulation,” caused the financial meltdown: his analysis is linked here.

    The value of a house, meanwhile, is not objective — it is subjective based on the amount a buyer with money in hand is willing to pay, same as any other transaction. A seller of a house is also free to accept any remuneration in exchange, as long as seller and buyer agree. Of course, in the aggregate, buyers and sellers default to an exchange of money due to fungibility and efficency. Currency replaced barter due to fungibility and efficiency, not objective value (the objective value was implicit), and perhaps that is why the critical element of objective value in currency was discarded by the U.S. Government in the 20th century. They didn’t realize they were excavating the primary load-bearing beam.

  10. t g

    Mike,

    I agree with you about a house having no objective (I will substitute innate) value. I think one of the issues of debate here (and on housing prices generally) is one of defining value. For it is only in defining the value of a house that one can determine if and how the price is fluctuating. If the changes in value correlate strongly with those of price, then the free-market is acting as intended. If they do not correspond, then perhaps the market is functioning irrationally, perhaps inefficiently, or perhaps the value model is incorrect.

    There is one side of this debate that establishes the value of the house as the cost of construction and one side which establishes the value as a regression of the buyer’s amenity preferences. Those seem to be the most common, but by no means exhaustive, approaches to valuing a house.

    If there can be no deterministic, verifiable value of a house…how can one claim a house is overpriced? Claiming how it is overpriced is a whole other ballgame.

  11. Dan

    Dan brought up the popular current canard that deregulation of the financial sector “largely contributed” to the housing bubble. This is not correct. The financial sector is, and has continued to be, among the most heavily regulated markets in existence. Economist Dr. George Reisman establishes that expansionary monetary policy, not “deregulation,” caused the financial meltdown: his analysis is linked here.

    Assured and confident certitude not reflected in reality and the Taibbi article (thanks Michael) refuting the certitude notwithstanding, many of the key regulations were relaxed or repealed. And the merging of once-separated entities was allowed (brokers selling insurance, e.g.).

    I was a key Analyst for a large west coast FSB and I used to have to report quarterly, semi- and annually on our compliance for our mortgage portfolio. Many of us saw it coming.

    DS

  12. t g

    On regulation, I recently had a libertarian epiphany.

    If a musical band were to auction off the opportunity to promote its tour in various cities, with the winning bidder receiving a share of that show’s ticket sales, this would amount to selling a security. It is an elegant free-market solution in which an out-of-town band could commodify the interest of a local groupie, incentivizing that groupie to bring more people to a show.

    As I thought through the opportunities for fraud, I realized why it should be regulated if such a system ever came to be. I also realized that there may be no existing law to cover such a proposal. Therein is the dilemma.

    A regulator can not possibly stay ahead of the curve. This recent fall of investment banks has not stifled the possibility of more unheard of securities. If anything, laying off the thousands of people who worked there has created the necessity for them to create new jobs from nothing. Like creative new derivatives.

  13. Mike

    t g: You realize that isn’t far from what happens with band touring, right? I’m not sure how today’s revenue structure has changed for bands, what with the much closer advertiser tie-in and sponsorships, but back in the 1990s when I was still peripherally involved in the music industry, a band would send out notice to promoters in various markets that they were touring, post a per-night flat fee, and it was up to the promoter to decide whether they could turn a profit on tickets, concessions, etc over the cost of venue and the band’s fee. For example, at the time The Cranberries were charging $85k per night, the Galactic Cowboys (a smaller act) were charging $15k per night, and +Live+ (who were huge right then) brought in $400k per night. It was up to the promoter to rent a hockey arena, pay staff, pay security, pay +Live+’s $400k, and still turn a profit on the show. It was up to +Live+ to pay their road crew, management, band members, net of apparel sales, and costs out of the $400k per night. Depending on how much the record label wanted to contribute to promotion, the flat fee might have been just costs and payroll and no profit for the band, but there was no arbitrary rule that it couldn’t be profitable.

    I suspect that the bigger bands got a piece of the gate instead of (or in addition to) the flat fee, which is in line with your securitization theory. I would suggest that the extent of regulation necessary under your theory would be toward anti-fraud enforcement. If that’s the real danger, then rather than punishing the entire batch of apples for the few bad ones, instead put more resources into bad-apple identification and extirpation. In the financial sector analogue, I’d gladly put more resources toward punishing the cons than enact regulations that impose a burden on everyone, including those who are doing business honestly.

    Dan, if you think you can argue anything to refute Dr. Reisman’s thesis, have at it. I would have thought you would be happy, considering that Dr. Reisman’s analysis of what drove the housing bubble very likely supersedes and moots O’Toole’s. I can tell you didn’t read Dr. Reisman’s analysis yet because he presents sourced facts that contradict what you wrote in your previous post.

  14. MJ

    Those seem to be the most common, but by no means exhaustive, approaches to valuing a house.

    If there can be no deterministic, verifiable value of a house…how can one claim a house is overpriced?

    You left out repeat sales indices, such as the Case-Shiller index. Looking at trends in constant-quality properties gives you a sense of where prices are going. Bob Shiller was looking at these data while the bubble was forming and was surprised by what he saw. That is why he predicted falling prices.

    There were, of course, other signs. Extremely high price-to-income ratios were one. Another was the appearance exotic mortgage products (zero-down, negative amortization, ARMs). I remember hearing about this on the news about four years ago from some housing analyst at a financial firm. Very prophetic.

    I don’t know what is implied by an “objective price”. An asset, like housing, is worth whatever people are willing to pay for it. U.S. debt might be junk, but as long as China and Saudi Arabia are willing to buy it, it has value.

    And what is a “superstar” city?

  15. Dan

    Dan, if you think you can argue anything to refute Dr. Reisman’s thesis, have at it. I would have thought you would be happy, considering that Dr. Reisman’s analysis of what drove the housing bubble very likely supersedes and moots O’Toole’s.

    Why would I want to refute it?

    It is in line and in the same direction with what I said above, without my standard ‘fake money’ line thrown in (using ‘pump up their numbers’ instead this time).

    Thanks for thinking of me, though.

    I don’t know what is implied by an “objective price”. An asset, like housing, is worth whatever people are willing to pay for it.

    Exactly.

    DS

  16. ws

    ROT:“Land-use regulation, however, makes housing prices more volatile. Because homebuilders cannot quickly respond to changes in demand, a small increase in demand leads to large jumps in prices.”

    ws:I don’t have a huge problem with this assertion (supply and demand), but never have I seen any statistical evidence of actually housing availability / numbers of cities that you or Cox speak of. Sure, I can agree that San Francisco/NY has major supply issues related to its demand needs, but so many cities that experience high housing prices do in fact have good supply of housing, which would not have much to do with a particular cities rise in housing price.

    The Imperial Valley does not seem to have any shortage of supply of housing, but they experienced a major catastrophe with the housing market.

    I can drive around the Portland metro area and see houses still for sale, or subdivisions that are abandoned for the time being. There’s plenty of building that is occurring and will occur. Supply is ample.

  17. t g

    MJ,

    Sorry, the superstar cities are defined by Gyourko as those metro areas whose median home price exceeds the national median.

    These are the same which are defined as heavily regulated by the Wharton Residential Land Use Regulatory Index.

    I thus use the term as shorthand for those cities which, by some accounts, are purportedly overvalued due to regulation (that is, due to hardly any, if any at all, other cause. Their concept, not mine).

    As far as Shiller’s repeat home sales, I would argue this does not get us close to Value. My point is that if nothing has innate value, then how can you claim it is overvalued.

    If a house does have innate value, what is it? Is it the ammenities, is it the price of construction, is it what the consumer is willing to pay?

    Those who make the argument that regulation is driving the price up (note, they never claim it is driving the value up), believe that the value of a home is its cost to construct. (For many homes in the superstar cities, this is akin to comparing the price of a cherry 1960 Aston Martin to the cost of manufacturing a 2008 Aston Martin.)

    Determining the fundamental value is, at this point, a heavily debated point, and a subjective one that cannot be decided without reliance on rhetoric and politics. What is the objective criteria which allows us to establish the value of a home? Does a home with no buyer have no value?

  18. t g

    On another note, so long as ws is introducing the actual quantity of housing stock: the popular median multiples (Median Income/Median Price) does not account (in any way) for how much stock there actually is. An extreme example for clarity: if there are twice as many homes as population, the median multiples are meaningless.

  19. lgrattan

    A friend of son, with the help of Barnny Frank and Chris Dodd and a coereced lender, purchased a new home for nothing down. Nine months later re-financed and took out $50,000. in cash. He got to the table and rolled the dice once. I assume he gave back the home but hope he kept the $50,000.

  20. Dan

    Stadelman, D 2009. Which Factors Capitalize into House Prices? A Bayesian Averaging Approach

    Abstract
    This paper investigates the robustness of 31 community specifiÂ…c explanatory variables for house prices in the Swiss metropolitan area of Zurich using Bayesian Model Averaging. The main variables which capitalize with a high posterior prob- ability are location speciÂ…c real estate characteristics, municipal taxes and ex- penditures for culture, health and social services. Demographic as well as other socioeconomic controls seem to be of minor importance. The analysis suggests a minimal list of variables that may be included in any estimation for capitalization of community speciÂ…c characteristics in the context of a metropolitan area in a highly developed country.

    Key words: Capitalization, House Price Hedonic, Taxes, Model Uncertainity,
    Bayesian Model Averaging.

    Our main results suggest that housing prices are primarily influenced by location specifiÂ…c factors such as the distance to the center, south-west exposition, the distance to local shopping centers, air pollution levels and access to fast public transport. Furthermore, Â…scale variables and especially taxes play an important role as also stressed by a large literature on capitalization including more recently Palmon and Smith (1998).

    Expenditures for culture, health and social well-being clearly seem to determine house prices whereas expenditures for administration, public security and traffic have compar- atively low posterior inclusion probabilities. Regarding the influence of schools, we …find that in the Swiss context mainly the average distance to the next school matters to some extent. Class sizes, having and own grammar school in the community and living in a community with a separate school community seems to be of less essential. This result is difierent form studies analyzing capitalization in the United States (see Brasington 1999 or Reback 2005 as an example). Moreover, and in line with the capitalization liter- ature, we …find important effects of communal median incomes on property values. Most demographic and other socioeconomic characteristics seem of minor importance. Only the density, the fraction of elderly and the fraction of commuters seem to systematically in‡uence house prices when the whole possible model space is considered. Comparisons with an OLS estimation including all variables in our dataset shows that the coeffcients of the model with the highest posterior probability of the BMA algorithm are signi…ficantly difierent from the OLS coe¢cients. The most important variables identi…ed in
    our baseline estimations also remain of high importance when performing an iterated BMA procedure with a maximum limit of controls for each speciÂ…fication.

    This analysis reveals scope for extending the research on capitalization further. Here
    we have established a set of main variables that may be considered in other capitalization
    studies in a similar context. [pp 23-23] (references omitted, emphases added)

    Like I’ve been saying.

    DS

  21. t g

    Back to the post:

    Here is O’Toole’s non sequitur: no down payment is the biggest source of foreclosures. Therefore no down payment is the biggest source of price increases.

    O’Toole, you can’t just move from one paragraph to another and have that stand as deductive logic. Nothing in the article suggests that low down payments were part of expanding prices.

    If a buyer can’t afford a down payment, his maximum biddable price on a home is limited to 1/3 his income. If a buyer can’t afford a down payment, then his income is likely low too. Which means, the no-down payment buyers are only affecting the market up to some price-point, which is likely a low one dictated by their financial state.

  22. t g

    Antiplanner,

    I apologize. You did not write that no-down payments were the source of price increases. I presumed the leap.

    On another note, you write that the Debt to Income ratio was increased to 54% by 2006, from the industry standard of 30%. I have never seen this. I assume this is the DTI for a subprime ARM after the rates reset? Everything I’ve read has said that even the subprime ARMs had to make it appear that the 30% DTI was not exceeded (hence, all the fraudulent paperwork).

  23. Dan

    Prices were increased by supply restrictions, not demand.

    No they weren’t.

    Well, maybe in one or two areas, as I’ve shown here numerous times.

    DS

  24. t g

    Prices were increased by supply restrictions.

    Hayekian free markets are necessary because no single person is capable of understanding the markets…unless that person is a libertarian who disagrees with what the market is doing – and then its absolute knowledge.

  25. prk166

    “housing prices are primarily influenced by location specific factors such as the distance to the center, south-west exposition, the distance to local shopping centers, air pollution levels and access to fast public transport.”

    Doesn’t sound like the US at all, DS.

  26. Dan

    Au contraire.

    It does indeed. It sounds exactly like many cities in the US (save the SW exposure – replace with distance to open space, perhaps).

    DS

  27. prk166

    Which ones? For example, until the Stapleton redevelopment metro Denver’s most expensive zip code was Franktown @25 miles from downtown and little public transit nor was close to major shopping. Even with Stapleton now grabbing that title, it’s nearly in the same boat, still relatively far from downtown (6-8 miles) and while with more public transit, still not well server let alone having fast public transport. It’s better for close shopping. And Stapleton’s an exception to the rule. Most US cities don’t have that sort of land available for infill projects that “close” to downtown. Look at MPLS. SE MPLS, the 55406 zip code, which borders downtown, the lovely Mississippi, has plenty of public transit including the only LRT line in the Twin Cities, has seen large single digit housing price decreases on top of housing prices that were already well below the metro’s median price. Meanwhile some of the most expensive if not the most expensive housing is 12-18 miles west of downtown Minneapolis with so-so shopping and transit that is close, both in terms of places like Eden Prairie’s Bear Path gated community where some of it’s most famous and wealthiest citizens live or in places like Wayzata around Lake Minnetonka. The same would appear to hodl true for San Diego’s most expensive zip code which, IIRC, is still also the most expensive in California. Ammenities may determine price but the primary influence, at least in the states, doesn’t appear to be influenced very much at all by things like having shopping close nor fast public transit. Now I haven’t studied this but from at least what little I know,, there seems to be at best some glaring exceptions to this. But that would mean somehow these places are all different than the majority of metros in the US.

  28. Dan

    The literature is clear. Rents are driven by amenities and proximity. Here is a decent primer on basic urban economics. Here is a scholarly paper on the basics (which also gets at why small-minority ideologues are incorrect).

    DS

  29. prk166

    Are you talking about housing prices or rents? The original euro paper you cited seemed to be about housing prices.

    Either way, amenities do have an affect on prices. The question is which amenities have more of an affect than others. And how much do those amenities have an affect versus other factors.

  30. Dan

    Rents. Ricardian rent.

    The question is which amenities have more of an affect than others. And how much do those amenities have an affect versus other factors.

    Yes. There is a whole discipline looking at it.

    DS

  31. the highwayman

    JimKarlock said: Another example in the long list of how the planning “profession” has hurt people.

    I wonder when people will realize this and drive them all out of town.

    THWM: Come on, you ran for office you jack ass!

  32. t g

    Antiplanner,

    Can you cite a source for your 54% DTI claim? The highest front end DTI (which is what your article is implying) I’ve found is 41%. I’ve been seeing this 55% tossed around on the blogs, qualified as a back end DTI by some, but haven’t seen evidence of it anywhere else.

    Echo chamber.

    Echo chamber.

    Echo chamber.

  33. t g

    Antiplanner,

    It seems that the loans which had the high DTIs were non-conforming loans. That is, loans which couldn’t meet Fannie and Freddie standards. Your post though claims it was Congressional pressure to make housing affordable which drove the increase in the DTI. You continue to claim that a lack of regulation would have corrected for this.

    But the reality seems just the opposite. If the high DTIs came from the free market are you still willing to claim that was the source of the crisis?

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