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.