Monthly Archives: July 2015
“It’s really hard to analyze these RTO programs (without more information), but my instincts tell me they aren’t economic for most consumers. Think about it, you have ex-Goldman and Lehman folks in this business; they aren’t there because they expect their profit margins to be small!!! If home prices fall, people would be better off being renters (because they would pay lower market rents). If home prices rise,…
…my guess is they would have to rise a lot to make economic sense for the RTO consumer. Why? Because they are giving up a big piece of future appreciation AND they are paying higher than market rents. Effectively, they are paying the RTO firm for an option to buy the home, at an agreed-upon price, in the future. But how much does this option (versus just renting) cost them? It’s not clear to me. Based on this article and my long experience in housing and mortgage finance, I would bet the disclosures to consumers here aren’t really sufficient to allow them to understand the future economic trade-offs they are making compared to renting-only (and taking their chances of buying at a later time) or buying now (if they can). There is a reason that the RTO housing business has never been a big business, despite the enormous size of the housing market.”, Mike Perry, former Chairman and CEO, IndyMac Bank
Rent-to-Own Homes Make a Comeback
Investment firms bank on giving renters an option to buy
A home on the market in an Orlando suburb that meets Home Partners’ criteria. Photo: CENTURY 21 Roo Realty
By Laura Kusisto
Wall Street firms have found a new way to profit from consumers with blemished credit who can’t qualify for a mortgage: let them rent a home first with the option to buy it later.
Rent-to-own programs, once run mainly by small operators, were popular with cash-strapped consumers during the 1990s. They faded a decade later when easy lending made it possible for almost anyone to buy a home with no money down, but with lenders setting a higher bar, they are making a comeback.
For investors, it is a chance to profit off the recovering housing market. Consumers get a chance to lock in a home before they have the money together for a down payment. But the price may be higher rent in the interim and a higher purchase price the longer they wait to move from renting to owning.
One of the fastest-growing rent-to-own companies is Home Partners of America, which was co-founded three years ago by former Goldman Sachs executive William Young. Mortgage securities veteran Lewis Ranieri was an early investor in the company, and real-estate mogul Sam Zell has acted as an adviser to Mr. Young. Late last year, Home Partners received a $500 million equity investment from a group led by money manager BlackRock Inc.’s alternative investments arm.
Mr. Young, who formerly co-headed Goldman Sachs’s European mortgage department, said he saw an untapped market helping people who are being shut out of the housing market.
“What really frustrates me personally is that a lot of people I grew up with, extended family members, would have trouble getting access to mortgage credit today,” said Mr. Young. He says his company spent $100 million to buy about 320 homes in June, up from $15 million, or 66 homes, in June of last year.
Brian Stern, a managing director at BlackRock, said he sees Home Partners as a long-term, sustainable business. Mr. Ranieri said the program is both viable and needed given tightness of mortgage credit and the lack of readily available solutions. Mr. Zell declined to comment.
Here’s how Home Partners’ program works. A consumer teams up with a real-estate agent to select a home in one of Home Partners’ approved communities, which tend to be suburban locations with strong school systems and with homes priced between $100,000 and about $725,000. Home Partners buys the home and leases it to the consumer, who has the right to purchase the home from Home Partners within five years in most places. During the renting years, the consumer is expected to repair his or her credit and save for a down payment, but the longer they rent the more they will pay to acquire the house.
For example, a house shown on Home Partners website has a list price of $449,975 in Chula Vista, Calif. The family that agrees to rent that house from Home Partners has the right to purchase the home for $472,035 after one year and would have to pay $573,762 if it waited five years before purchasing, a markup of 28% from the initial list price.
The monthly rent on the property would start at $2,810 a month and escalate to $3,256 in the fifth year.
For consumers, that likely means that they are paying a premium over renting or buying a typical home. Monthly payments on a 30-year conventional mortgage on the same house would be around $1,800. The average rent for a single-family home in San Diego is $2,270 a month, according to Moody’s Analytics—although typical single-family rentals are likely smaller and in less desirable areas.
Home Partners officials say that the increases are in line with the rapid rise in home prices in markets such as California and rents are typically within 5% to 10% of comparable properties in the market. The S&P/Case-Shiller Home Price Index, covering the entire nation, rose 4.4% in the 12 months ended in May, slightly greater than a 4.3% increase in April. Home prices in San Diego climbed 4.8% year-over-year in May 2015, according to the index.
Home Partners also notes that the consumer can decide not to purchase if the home is more expensive than comparable properties in the area. If price growth slows and the consumer thinks buying a home is a bad deal, they can walk away with no penalty and Home Partners would re-rent the home. The company says that they expect about half of their renters to ultimately purchase.
Tiffany Morgan, who works in marketing in Sugarland, Texas, turned to Home Partners 2013 after a divorce destroyed her credit. When she first heard about the program, she thought it was a scam. “I thought no way…it’s some scheme that I’m going to fall into,” said Ms. Morgan, who is in her mid-30s with a 7-year-old son.
Home Partners purchased the home for around $205,000 and she rented it for about a year for $1,730 a month. That same year she improved her credit and bought the house for $215,000. She thought, “What’s the worst case? I’ll lease it for a while and then if I fall in love with it I’ll do what I need to do to make it happen.”
For consumers, the advantage is that the homes tend to be in nicer neighborhoods with better school districts than most single-family rental properties. It also guarantees that if house prices escalate faster than that, the price is guaranteed when they go to purchase the home.
Sarah Edelman, a senior policy analyst at the Center for American Progress, a Washington-based nonpartisan policy institute, said that it is early to tell if Home Partners’ rent and home price bumps will prove to be in line with the market.
“All things equal this could be a really great opportunity for consumers,” she said, referring to the cost of Home Partners program versus the rest of the market. “But all things need to be equal.”
So far, Home Partners operates only in 30 metropolitan areas in 15 states, including California, Florida and Texas. It currently doesn’t operate in the Northeast. But Home Partners is teaming up with Berkshire Hathaway Home Services and Realogy Holdings Corp., which operates several real-estate brokerage franchises including Century 21 and Coldwell Banker, which will give it national reach.
A motivating factor for home buyers to use a rent-to-own program is the combination of government policies and banks’ increased cautiousness have made mortgages much more difficult to get, even for middle-class Americans. Buyers typically must have higher credit scores than were needed even in the early 2000s, before the subprime boom. The homeownership rate for middle-income Americans has fallen to 63% from 69% in 2000, according to Zillow.
Home Partners isn’t alone in seeing a profitable niche in the rent-to-own space. New York City-based HomeLPC, started by a former Lehman Brothers banker, launched about a year ago and has expanded to three states, where it has bought two dozen homes. It plans to expand into five more states by the first quarter of 2016. Premium Point Investments, a New York-based asset manager, is in the midst of testing a rent-to-own business focused on the South and Southeast.
Whether rent-to-own will prove to be profitable remains to be seen. A number of companies that rent out single-family homes have found that few renters have become buyers, either because they haven’t been able to restore their credit or haven’t been able to save enough for a down payment. But Home Partners said its credit screening targets middle-class and affluent clients who have steady jobs and an overall financial history that makes it likely they will be able to repair their credit and save money for a down payment within a few years.
“When it comes to purchasing a home, timing really is everything. Some recent buyers have been extraordinarily lucky, with home values that have roughly doubled in as little as four years. When the real estate bubble burst, they bought at the lowest point in their local markets.”, Laura Thompson, Zillow, July 21, 2015
“I agree!!! Yet, how come Zillow, nor a buyer’s Realtor, appraiser, or mortgage lender advise prospective buyer’s on the importance of timing? I’ll tell you why. It’s because they don’t get paid anything unless you BUY!!! Might this be why Nobel Laureate Shiller constantly says that U.S. homebuyers are irrational? I am building an application to help prospective homebuyers make more rational decisions about buying a home, with a mortgage.”, Mike Perry, former Chairman and CEO, IndyMac Bank
Here’s where the nation’s luckiest home buyers live
By Lauren Thompson, Zillow
When it comes to purchasing a home, timing really is everything. Some recent buyers have been extraordinarily lucky, with home values that have roughly doubled in as little as four years. When the real estate bubble burst, they bought at the lowest point in their local markets.
Zillow analyzed cities with populations over 50,000 and found the luckiest home buyers in America — those who bought in the right place at the right time and have now seen the highest appreciation growth on their homes. The analysis tracked home purchases beginning in January 2006.
Here are where the luckiest home buyers in America live, and when they purchased their homes
“I agree with Mr. Fink, who is advising Hillary and probably is responsible for most of her negative views about the “quarterly capitalism” of public company managers and boards. But capital gains tax treatment alone is not enough. The SEC has moved in the opposite direction by empowering short-term shareholders and board elections. If you want to meaningfully address this issue, only allow long-term shareholders to vote on the most important matters.”, Mike Perry
“To some degree, she (Hillary Clinton) could have been channeling Laurence D. Fink, the chief executive of BlackRock, the $4 trillion asset manager, who has long lamented the short-term nature of individual shareholders and the perverse impact their buying and selling can have on boards. This year, he wrote a letter — recounted in this column — to corporate chieftains complaining about their focus on buying back stock and paying special dividends instead of investing in their businesses for the long term, citing the same statistic as Mrs. Clinton (or was it the other way around?): $900 billion has been shoveled back to investors instead of reinvested in research or equipment or jobs. Mr. Fink, too, proposed a new tax scheme to compel investors to hold shares long-term.Unlike Mrs. Clinton’s proposal, Mr. Fink’s involves both a carrot and a stick. He suggested applying capital gains treatment “only after three years, and then to decrease the tax rate for each year of ownership beyond that, potentially dropping to zero after 10 years.”, Andrew Ross Sorkin, “Hillary Clinton Aim Is to Thwart Quick Buck on Wall Street”, The New York Times, July 28, 2015
Hillary Clinton Aim Is to Thwart Quick Buck on Wall Street
Hillary Clinton called out “hit-and-run activists whose goal is to force an immediate payout,” in a speech last week. Credit Spencer Platt/Getty Images
While Washington and the media were worked up about Hillary Rodham Clinton’s emails last Friday, most of the nation seemingly missed — or at least largely ignored — what may have been her most important comments yet about how she plans to transform Wall Street and corporate America.
If Mrs. Clinton becomes president, her remarks may turn out to be more than campaign talking points — and could radically change the way investors and chief executives behave.
For those who were too distracted by the email controversy, here’s a brief recap of what she said:
Speaking at N.Y.U.’s Stern School of Business, Mrs. Clinton announced a radical proposal to rewrite the tax code to empower “outside investors who want to build companies” and discourage “cut-and-run shareholders.”
To end what she described as “quarterly capitalism” — meaning investors’ obsessions with quarterly earnings reports — she proposed extending the definition of the long-term holding period for the lower capital gains rate to two years from one, saying one year “may count as ‘long-term’ for my baby granddaughter, but not for the American economy.”
But the real shift is a plan to introduce a “six-year sliding scale” for capital gains taxes. Individuals in the top bracket would pay ordinary income tax on the sale of investments — 39.6 percent — in the first two years and “then the rate would decrease each year” over the next four years until it returns to the current capital gains rate of 20 percent.
To some degree, she could have been channeling Laurence D. Fink, the chief executive of BlackRock, the $4 trillion asset manager, who has long lamented the short-term nature of individual shareholders and the perverse impact their buying and selling can have on boards.
This year, he wrote a letter — recounted in this column — to corporate chieftains complaining about their focus on buying back stock and paying special dividends instead of investing in their businesses for the long term, citing the same statistic as Mrs. Clinton (or was it the other way around?): $900 billion has been shoveled back to investors instead of reinvested in research or equipment or jobs. Mr. Fink, too, proposed a new tax scheme to compel investors to hold shares long-term.
Unlike Mrs. Clinton’s proposal, Mr. Fink’s involves both a carrot and a stick. He suggested applying capital gains treatment “only after three years, and then to decrease the tax rate for each year of ownership beyond that, potentially dropping to zero after 10 years.”
Mrs. Clinton’s proposal is useful in starting a meaningful conversation about an issue that might be too wonky for most voters but could have a significant impact on business. Helping create an incentive system that makes investors — and therefore chief executives and their boards of directors — less focused on quarterly profits and their immediate stock price should be a boon to the economy. From a political perspective, it’s hard to argue with — it’s about as safe as they come.
Even one likely target of her proposal, the activist investor Carl C. Icahn, who has long mounted proxy contests, in part to push companies to buy back stock, said he was a fan. “Although I’ve said this before, you may be surprised by what I’m telling you: I agree with a lot of the things she has been saying,” Mr. Icahn told me. “She is onto something.” (Of course, for some progressive Democrats, that’s an endorsement that might raise more questions about whether she is soaking the rich enough.)
Mr. Icahn, positioning himself as a shareholder advocate who has long argued that he has been miscast as short-term-oriented, added: “In too many cases the real culprits of short-termism are the boards and the C.E.O.s that do buybacks which they know will promote their stocks in the short term and make their options more valuable.”
Critics of her plan said that, in practice, changing investor behavior was more challenging than a stump speech or even the change she suggests in the tax code.
After all, public pension plans and 401(k) plans don’t pay taxes and they represent about two-thirds of all invested assets. To her credit, Mrs. Clinton points out the shortfall of her program’s reach.
Having said that, most of the volume on any given day isn’t coming from public pension funds and 401(k)s — those are actually real, long-term invested assets — but from hedge funds and the like.
Curiously, Mrs. Clinton says the new tax structure would apply only to the nation’s wealthiest in the top tax bracket. (Why she wants to give incentives to the richest to make long-term investments and those with less wealth to be able to day-trade without any disincentive is inexplicable.)
As she continued her speech at the business school, she stepped into riskier territory, commenting on the activists and buybacks themselves.
“As president,” she said, “I would order a full review of regulations on shareholder activism, some of which haven’t been re-examined in decades, let alone modernized to reflect changing realities in our economy.”
She called some of them “hit-and-run activists whose goal is to force an immediate payout,” using language akin to that of under-attack C.E.O.s. She also hinted that she would “take a hard look at stock buybacks.” That’s code for an argument by some — Senator Elizabeth Warren included — that stock buybacks could be considered stock manipulations.
While that might resonate politically for some in the party, it is likely to be a step too far, one that even Democratic supporters like Mr. Fink would never back.
A version of this article appears in print on July 28, 2015, on page B1 of the New York edition with the headline: Clinton Aim Is to Thwart Quick Buck on Wall St.
“By its very nature, the Export-Import Bank is corporate welfare, and its beneficiaries have no interest in seeing the taxpayer money dry up. Their claims about the bank’s importance are a reflection of this fact; what they want is for the American public to bear the risk for private companies’ profit…
…These unintended consequences directly refute one of the most-repeated claims about the bank’s expiration — that jobs will be lost. Expiration could actually spur job creation at businesses that are no longer at a taxpayer-financed disadvantage…These findings point to a simple conclusion: Politicians and bureaucrats shouldn’t be in the business of picking the economy’s winners; they will inevitably end up picking losers too. Better to let the economy create jobs and exports on its own, without tipping the scales in any one company’s or industry’s favor. It remains to be seen whether Congress is willing to let that happen. The House may pass a reauthorization before the end of the week. If only lawmakers would recognize that, when the bank expired on June 30, taxpayers were let off the hook and American exporters were given a level playing field for the first time in 81 years. That’s something Congress should celebrate, not reverse.”, Andy Koenig and Marc Short, “No Export-Import Bank? No problem”, The Los Angeles Times, July 28, 2015
No Export-Import Bank? No problem.
President Obama meets with small business owners to discuss the importance of the reauthorization of the Export-Import Bank in the Roosevelt Room of the White House on July 21.
(Pool / Getty Images)
By Andy Koenig, Marc Short
July was supposed to be a particularly bad month for the U.S. economy. On June 30, the U.S. Export-Import Bank’s charter officially expired. For the previous 81 years, this little-known New Deal relic handed out hundreds of billions of dollars in taxpayer-backed financing to benefit a select few well-connected companies, which used the taxpayers’ generosity to sell their products overseas. Many of those businesses spent the last few months predicting that the bank’s expiration would be devastating for American jobs and the country’s global economic competitiveness.
After three weeks of nonstop lobbying and outside pressure, including from President Obama, the Senate voted Sunday to reauthorize the bank, and the House of Representatives is debating whether to follow suit this week. It should not.
All of the hysterical predictions are wrong. The economy looks no different now than it did on June 30. Nor should anyone expect the economy to suffer from the bank’s expiration in the coming weeks, months and years.
By its very nature, the Export-Import Bank is corporate welfare, and its beneficiaries have no interest in seeing the taxpayer money dry up. Their claims about the bank’s importance are a reflection of this fact; what they want is for the American public to bear the risk for private companies’ profit.
Even though the bank’s charter expired on June 30, the bank itself will survive for some time. According to the Congressional Research Service, it will continue “administering its assets and collecting any obligations it holds,” which could take years. Its beneficiaries have plenty of time to find alternative financing from the private market.
Despite claims that the Export-Import Bank is a friend to small business, big firms typically benefit from around 75% to 80% of the bank’s taxpayer money on an annual basis. A mere 10 companies received 64% of the bank’s financing in 2013, and roughly 30% went to just one company: Boeing. Yet Boeing has already indicated that it will be able to find alternative financing for its planes.
A 2014 analysis by Standard & Poor’s found that the bank’s closure would have little or no effect on its largest beneficiaries, including General Electric, Caterpillar and others. In short, the private sector is ready and willing to replace it.
More broadly, the bank’s expiration could actually help the economy. The less than 2% of American exporters that benefit from the bank may bemoan their loss of subsidies, but the other 98%— more than 300,000 companies — are now able to compete on a level playing field.
The Mercatus Center’s Veronique de Rugy has shown how the Export-Import Bank’s support for one company can have unintended, negative consequences for others because the recipient gets a competitive edge over its rivals. Similarly, when the bank uses taxpayer funding to help a foreign company buy an American-made product, that same company can gain an advantage over American firms.
This is particularly true for foreign airlines that buy Boeing’s planes — Boeing benefits, but domestic airlines suffer. The Air Line Pilots Assn. estimates that the bank’s support for just two foreign airlines — Emirates and Air India — has eliminated roughly 7,500 airline jobs here at home.
These unintended consequences directly refute one of the most-repeated claims about the bank’s expiration — that jobs will be lost. Expiration could actually spur job creation at businesses that are no longer at a taxpayer-financed disadvantage.
Indeed, although the bank’s champions say that it supports some 164,000 jobs that are now at risk, other federal agencies point out this should be taken with a grain of salt, or even the whole shaker. The Government Accountability Office — the federal government’s nonpartisan internal watchdog — has documented how the bank’s clumsy attempts to boost exports “largely shift production among sectors within the economy rather than raise the overall level of employment.” The GAO also found that the bank can’t distinguish “between jobs that were newly created and those that were maintained.” But perhaps its most important finding is that the bank “cannot answer the question of what would have happened without Ex-Im financing.”
These findings point to a simple conclusion: Politicians and bureaucrats shouldn’t be in the business of picking the economy’s winners; they will inevitably end up picking losers too. Better to let the economy create jobs and exports on its own, without tipping the scales in any one company’s or industry’s favor.
It remains to be seen whether Congress is willing to let that happen. The House may pass a reauthorization before the end of the week. If only lawmakers would recognize that, when the bank expired on June 30, taxpayers were let off the hook and American exporters were given a level playing field for the first time in 81 years.
That’s something Congress should celebrate, not reverse.
Andy Koenig and Marc Short are the senior policy advisor and president, respectively, at Freedom Partners Chamber of Commerce.
“As two former chief economists of the U.S. Chamber, we know whereof we speak when we point out that it’s the same old battle between the chamber’s large-members’ crony-capitalist cabal versus its small-business and entrepreneurial members and free marketeers inside the chamber. We were two of the free marketeers who fought that fight from the inside…
…during the Reagan and George H.W. Bush administrations with considerable success. But today the crony capitalists have the upper hand, both inside government and at the chamber, and business and the people are the worse for it.”, Richard W. Rahn and Lawrence Hunter, Washington D.C., The Wall Street Journal: Letters to the Editor, July 28, 2015
Ex-Im Bank: Watch Out for a Trap
If Republicans and Democrats join together to resurrect the Export-Import Bank, swing voters could conclude that the GOP is equally as wasteful as Democrats.
Your July 24 editorial “Raising Ex-Im From the Dead” makes a compelling case to let the deceased, New Deal, credit-subsidy program rest in ignominy, to which we would attach an appropriate epitaph: Gone and Forgotten—Good Riddance to Bad Economics. Beyond that, we would add only a coda to your assessment of the politics behind the conniving effort in Congress to revive the rotting corpse. As you note, the political muscle behind House Speaker John Boehner’s untoward resurrection effort is the U.S. Chamber of Commerce, which at the behest of a few of its members is pressuring Congress to revive the bank. As two former chief economists of the U.S. Chamber, we know whereof we speak when we point out that it’s the same old battle between the chamber’s large-members’ crony-capitalist cabal versus its small-business and entrepreneurial members and free marketeers inside the chamber. We were two of the free marketeers who fought that fight from the inside during the Reagan and George H.W. Bush administrations with considerable success. But today the crony capitalists have the upper hand, both inside government and at the chamber, and business and the people are the worse for it.
Richard W. Rahn
It is possible that the GOP might be walking into a political trap on this issue that will have repercussions in 2016.
One of the major issues the GOP has in its favor is reducing the horrendous debt that the Obama administration has accumulated in the past seven years. If Republicans and Democrats join together to resurrect the Export-Import Bank, swing voters could conclude that the GOP is equally as wasteful as Democrats.
Even worse, it gives Donald Trump a good reason to run as an Independent, arguing that only he is capable of cleaning up the Republican Party, as well as the Democratic Party.
What your editorial and other pieces fail to acknowledge are the 89 other countries around the globe that currently offer low-cost guarantees similar to Ex-Im. These countries will continue to offer these guarantees regardless of our decision. Eliminating the Ex-Im Bank would mean the U.S. would be at a competitive disadvantage against the rest of the globe. Perhaps Boeing could finance its sales privately, but not at the same cost of the EU’s guarantees of Airbus; therefore Boeing loses. So long as the rest of the world is offering said government guarantees, the U.S. would be naive to take such a moral high ground on its own and sacrifice so many U.S. jobs unilaterally.
River Forest, Ill.
“Extravagant expectations do lurk in parts of the market. In the 2015 Yale School of Management survey of recent home buyers that Karl Case of Wellesley College, Anne Thompson of Dodge Data and Analytics and I direct, our preliminary results confirmed the overall Pulsenomics conclusion yet found that some people have strikingly unrealistic expectations…
…In San Francisco, for example, we found that while the median expectation for annual home price increases over the next 10 years was only 5 percent, a quarter of the respondents said they thought prices would increase each year by 10 percent or more. That would mean a net 150 percent increase in a decade. These people are apparently not thinking about the supply response that so big a price increase would generate. People like this could bid prices in some places so high that eventually the local market will collapse. Yet the smart money can’t find a profitable way to correct such errors today. The bottom line is that there is no reason to assume that the real estate market is even close to efficient. You may want to buy a house if you love it and can afford it. But remember that you cannot safely rely on “comparable sales” to judge that the price is fair. The market isn’t efficient enough for that.”, Robert J. Shiller, “The Housing Market Still Isn’t Rational”, The New York Times, July 27, 2015
“Once again, the truth is revealed. It wasn’t home lenders who caused the pre-2008 crisis housing bubble, but the irrational exuberance of homebuyers. Shiller may be right about the lack of short sellers and he is certainly right that market comparable appraisals are flawed (a topic I have long-identified and discussed extensively on this blog). I guess I need to get off the dime and get my Prospective Home Buyer application completed, so that homebuyers can be more rational by answering the following question (with an objective guesstimate): “If I buy this home, with this mortgage, am I likely to have a reasonable return on my invested capital (over my investment horizon)?”, Mike Perry, former Chairman and CEO, IndyMac Bank
The Housing Market Still Isn’t Rational
By ROBERT J. SHILLER
Home prices have been climbing. They have risen 27 percent nationally since 2012, even more in places like San Francisco. But why worry? If you accept the efficient markets theory — and believe that real estate is an efficient market — then these prices are based on “new information,” even if you don’t know what that information is.
The problem with this kind of thinking is that the efficient markets theory is at best a half-truth, as a voluminous literature on market anomalies shows. What’s more, even that half-truth is grounded mainly in the stock market, which attracts professional investors who sometimes do make the market behave efficiently.
The housing market is another matter. It is far less rational than even the often irrational stock market, for a couple of important reasons. First, most investors find it difficult to understand how housing supply responds to changes in demand. Only a small minority of people think carefully about such things. Second, it is very hard for the minority of smart-money investors who do understand such matters to bet against bubble-level prices in real estate markets. In housing, the smart money has relatively little voice.
Credit Tim Cook
For the first point, in “A Nation of Gamblers: Real Estate Speculation and American History,” a presentation at the 2013 American Economic Association convention, Edward L. Glaeser of Harvard University reviewed real estate booms and busts. He showed how real estate investors have repeatedly made the mistake of neglecting the supply response to rising prices. In the Alabama cotton farmland boom of 1815 to 1819, for example, high cotton prices seemed to justify high prices for cotton land. What most investors failed to see at the time was that these cotton prices would induce new farmers around the world to begin to grow cotton. That same failure to anticipate how supply can respond to demand applies to many forms of real estate today. Developers and builders will, one way or another, exploit overpricing, increasing effective supply, in that way bringing real estate prices down.
For the second point, in 1977 Edward M. Miller pointed out in The Journal of Finance something that should have been obvious: Efficient markets require the possibility of selling short. In the stock market, for example, with short-selling, people who think the market is overpriced and headed for a fall can borrow shares and sell the borrowed shares at the current high price. If share prices do indeed fall, they can buy the shares back at a lower price and repay the loan, with a profit.
Short-selling helps prevent bubbles from forming, but such negative bets cannot easily occur in the housing market. You can’t routinely borrow a house and sell it, promising to buy back the same house later to repay the loan.
Markets without the possibility of making these negative bets will be inefficient. That’s because if it is not possible to short, the smart money can do no more than avoid holding an overpriced asset. Canny traders are forced to sit on the sidelines, and watch in futility as prices decline as they expected. Without short-sellers, there is nothing to stop a group of ignorant investors — who get some ill-conceived idea that a certain investment is just terrific — from bidding up prices to extravagant levels. In the housing market, that poses an enormous problem.
Suppose that you are convinced housing prices are too high. How can you profit from this insight? You might consider shorting the residential real estate investment trusts (REITs) that invest in residential properties and are themselves traded on stock exchanges. However, REIT prices do not have a consistent correlation with housing prices, and tend to resemble stock prices instead. For example, the housing market declined in the two years after the March 2009 bottom of the stock market. The S & P/Case-Shiller National Home Price Index fell 6 percent over this period. But, over that same time interval, the S & P 500 Residential REIT index tripled in value. Clearly, shorting this index would have been a bad move, even though a bet that housing prices would decline was spot on.
During the financial crisis, some professional investors did manage to profit by correctly forecasting home price declines. They used mortgage derivatives such as collateralized debt obligations to place their bets. John Paulson of Paulson & Company is well known for very successfully profiting from his prediction of trouble in the housing market. But mortgages are not homes, and he and others like him did not beat down the emerging housing bubble before it grew out of proportion.
In 2006, in collaboration with several colleagues and me, the Chicago Mercantile Exchange set up a futures market for single-family homes in 10 United States cities. This market is still going today, but it is not very active and it can be used to place only a small bet that home prices will fall.
There is a way for smart money to profit from an understanding of high prices. It is to build new houses and sell them before prices fall. This is a time-consuming process but it is what we are starting to see now, as housing starts and permits data show.
Still, despite rising prices, at present, exuberant investors do not dominate the domestic housing market over all. The Pulsenomics survey of household heads in January showed that national home price expectations are modest: on average increases of only 3.7 percent a year are expected for the next 10 years.
Extravagant expectations do lurk in parts of the market. In the 2015 Yale School of Management survey of recent home buyers that Karl Case of Wellesley College, Anne Thompson of Dodge Data and Analytics and I direct, our preliminary results confirmed the overall Pulsenomics conclusion yet found that some people have strikingly unrealistic expectations.
In San Francisco, for example, we found that while the median expectation for annual home price increases over the next 10 years was only 5 percent, a quarter of the respondents said they thought prices would increase each year by 10 percent or more. That would mean a net 150 percent increase in a decade. These people are apparently not thinking about the supply response that so big a price increase would generate. People like this could bid prices in some places so high that eventually the local market will collapse. Yet the smart money can’t find a profitable way to correct such errors today.
The bottom line is that there is no reason to assume that the real estate market is even close to efficient. You may want to buy a house if you love it and can afford it. But remember that you cannot safely rely on “comparable sales” to judge that the price is fair. The market isn’t efficient enough for that.
Robert J. Shiller is Sterling Professor of Economics at Yale. Follow him on Twitter at @RobertJShiller.
A version of this article appears in print on July 26, 2015, on page BU6 of the New York edition with the headline: Why Smart Money Can’t Stop a Housing Bubble
“To limit abuse by the rulers, ancient Rome wrote down the law and permitted citizens to read it. Under Dodd-Frank, regulatory authority is now so broad and so vague that this practice is no longer followed in America. The rules are now whatever regulators say they are…
…Most criticism of Dodd-Frank focuses on its massive regulatory burden, but its most costly and dangerous effects are the uncertainty and arbitrary power it has created by the destruction of the rule of law. This shackles economic growth but more important, it imperils our freedom. (For example:) Over the years the Federal Trade Commission and the courts defined what constituted “unfair and deceptive” financial practices. Dodd-Frank added the word “abusive” without defining it. The result: The CFPB can now ban services and products offered by financial institutions even though they are not unfair or deceptive by long-standing precedent.”, Phil Gramm, former Chairman of the United States Senate Banking Committee, “Dodd-Frank’s Nasty Double Whammy”, The Wall Street Journal, July 24, 2015
“Nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles known as the Rule of Law. Stripped of technicalities, this means that government in all its actions is bound by rules fixed and announced beforehand….rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one’s individual affairs on the basis of this knowledge. Though this ideal can never be perfectly achieved, since legislators as well as those to whom the administration of law is entrusted are fallible men and women, the essential point, that discretion left to the executive organs wielding coercive power should be reduced as much as possible, is clear enough. While every law restricts individual freedom to some extent by altering the means which people may use in the pursuit of their aims, under the Rule of Law the government is prevented from stultifying individual efforts by ad hoc action. Within known rules of the game the individual is free to pursue personal ends and desires, certain that the powers of government will not be used to deliberately frustrate their efforts. The distinction we have drawn before between the creation of a permanent framework of laws within which the productive activity is guided by individual decisions and the direction of economic activity by a central authority is thus really a particular case of the more general distinction between the Rule of Law and arbitrary government……..The (collectivist) planning authority cannot confine itself to providing opportunities for unknown people to make whatever use of them they like. It cannot tie itself down in advance to general and formal rules which prevent arbitrariness. It must provide for the actual needs of people as they arise and then choose deliberately between them. It must constantly decide questions which cannot be answered by formal principles only, and, in making these decisions, it must set up distinctions of merit between the needs of different people…..In the end somebody’s views must become part of the law of the land, a new distinction of rank which the coercive government imposes upon the people. The distinction we have just used between formal law or justice and substantive rules is very important ands at the same time most difficult to draw precisely in practice. Yet the general principle involved is simple enough. The difference between the two kinds of rules is the same as that between laying down a Rule of the Road, as in a Highway Code, and ordering people where to go; or better still between providing signposts and commanding people which road to take. The formal rules tell people in advance what action the state will take in certain types of situation, defined in general terms, without reference to time and place or particular people….The knowledge that in such situations the state will act in a definite way, or require people to behave in a certain manner, is provided as a means for people to use in making their own plans.”, Nobel Laureate F.A. Hayek, “The Road to Serfdom”
Dodd-Frank’s Nasty Double Whammy
The legislation has hit the banking industry hard, hurting the recovery. Worse is its effect on the rule of law.
Photo: Getty Images
By Phil Gramm
Five years after the passage of the Dodd-Frank financial law, the causes and effects of the failed economic recovery are apparent throughout the banking system. The Federal Reserve’s monetary easing has inflated bank reserves, but lending has barely increased. Today banks maintain an extraordinary $29 of reserves for every dollar they are required to hold. In the first quarter of 2015 banks actually deposited more money in the Fed ($65.1 billion) than they lent ($52.5 billion).
According to the Federal Deposit Insurance Corp., 1,341 commercial banks have disappeared since 2010. Remarkably, only two new banks have been chartered. By comparison, in the quarter century before the financial crisis, roughly 2,500 new banks were chartered. Even during the Great Depression of the 1930s, an average of 19 new banks a year were chartered.
A Mercatus Center survey found that while community banks have hired 50% more compliance officers to deal with Dodd-Frank, overall industry employment has increased only 5% and remains below precrisis levels. Industrial, consumer and mortgage finance continue to flee the banking system, as the American Bankers Association reported this week that the law’s regulatory burden has led almost half of banks to reduce offerings of financial products and services.
New financial-services technology, such as online and mobile payment systems, has continued to blossom, but almost exclusively outside the banking system. The massive resources of, and talent in, banks have been sidetracked, rather than being employed to make loans and boost the economy.
Worst of all, Dodd-Frank has empowered regulators to set rules on their own, rather than implement requirements set by Congress. This has undermined a vital condition necessary to put money and America back to work—legal and regulatory certainty.
It is true that a certain amount of regulatory flexibility is necessary in many laws. But in the Securities Exchange Act of 1934, and most subsequent banking law before Dodd-Frank, the powers Congress granted to regulators were fairly limited and generally implemented by bipartisan commissions.
Major decisions were debated and voted on in the clear light of day. Precedents and formal rules were knowable by the regulated. And regulators generally had to be responsive to Congress, which controlled agency appropriations. These checks and balances, while imperfect, did promote general consistency and predictability in federal regulatory policy.
This process has been undermined. For example, Dodd-Frank’s Consumer Financial Protection Bureau is not run by a bipartisan commission. And the CFPB’s funding is automatic, virtually eliminating any real ability for elected officials to check its policies. Consistency and predictability are being replaced by uncertainty and fear.
Over the years the Federal Trade Commission and the courts defined what constituted “unfair and deceptive” financial practices. Dodd-Frank added the word “abusive” without defining it. The result: The CFPB can now ban services and products offered by financial institutions even though they are not unfair or deceptive by long-standing precedent.
Regulators in the Dodd-Frank era impose restrictions on financial institutions never contemplated by Congress, and they push international regulations on insurance companies and money-market funds that Congress never authorized. The law’s Financial Stability Oversight Council meets in private and is made up exclusively of the sitting president’s appointed allies. Dodd-Frank does not say what makes a financial institution systemically important and thus subject to stringent regulation. The council does. Banks so designated have regulators embedded in their executive offices to monitor and advise, eerily reminiscent of the old political officers who were placed in every Soviet factory and military unit.
Dodd-Frank’s Volcker rule prohibits proprietary trading by banks. And yet, despite years of delay and hundreds of pages of new rules, no one knows what the rule requires—not even Paul Volcker.
Then there is the “living will,” a plan that banks deemed to be systemically important must submit to the Fed and the FDIC on how they would be liquidated if they fail. The Fed and the FDIC have almost total discretion in deciding whether the plan is acceptable and therefore whether to institute a variety of penalties, including the divestiture of assets.
Large banking firms must undergo stress tests to see if they could survive market turmoil. But what does the stress test test? No one knows. The Fed’s vice chairman, Stanley Fischer, said in a speech last month that giving banks a clear road map for compliance might make it “easier to game the test.” Compliance is indeed easier when you know what the law requires, but isn’t that the whole point of the rule of law?
To limit abuse by the rulers, ancient Rome wrote down the law and permitted citizens to read it. Under Dodd-Frank, regulatory authority is now so broad and so vague that this practice is no longer followed in America. The rules are now whatever regulators say they are.
Most criticism of Dodd-Frank focuses on its massive regulatory burden, but its most costly and dangerous effects are the uncertainty and arbitrary power it has created by the destruction of the rule of law. This shackles economic growth but more important, it imperils our freedom.
Mr. Gramm is a former chairman of the Senate Banking Committee and a visiting scholar at the American Enterprise Institute.
“As my progressive young students listened to me explain why government was preventing them from using their cell phones to get home from the bars on Saturday night, I could see their minds change. Before I knew it, I was talking to a bunch of 20- and 21-year-old anti-government activists.”, United States Senator Marco Rubio
(Senator Rubio describes explaining to a college class he taught how Miami had banned Uber cars.), L. Gordon Crovitz, “Why Uber Drives the Left
Why Uber Drives the Left Crazy
Why New York City Mayor Bill de Blasio’s attempt to protect a government-enforced cartel ran out of gas.
Lining up in Queens, N.Y., to register as Uber drivers, July 21. Photo: Shannon Stapleton/Reuters
By L. Gordon Crovitz
Progressive New York Mayor Bill de Blasio and Socialist Paris Mayor Anne Hidalgo found common cause on a shared threat while attending a recent climate-change conference at the Vatican. “The people of our cities don’t like the notion of those who are particularly wealthy and powerful dictating the terms to a government elected by the people,” Mr. de Blasio declared. “As a multibillion-dollar company, Uber thinks it can dictate to government.”
But before Mr. de Blasio could return from Rome, he learned that people really don’t like when politicians try to take away their favorite app for getting around the government’s taxi cartel. The mayor was forced to drop his plan to limit Uber to a 1% annual increase in cars, far below the current rate.
It’s hard to see why Mr. de Blasio thought that would be good politics. Two million New Yorkers have downloaded the Uber app onto their mobile devices—a quarter of the city’s population and more than twice the number of citizens who voted for Mr. de Blasio. But it’s easy to understand why he views Uber as an ideological threat. A tipping point is in sight where big-government politicians can no longer deprive consumers of new choice made possible by technology—whether for car rides, car sharing or home rentals. Mr. de Blasio’s experience should encourage other politicians to sign up for innovation.
Uber has become a wedge issue. The Conservative mayor of London, Boris Johnson, took the opposite approach from Mr. de Blasio. “You are dealing with a huge economic force which is consumer choice, and the taxi trade needs to recognize that,” he said recently. He told a gathering of taxi drivers in London: “I’m afraid it is a tragic fact that there are now more than a million people in this city who have the Uber app.” When cabbies objected that Uber drivers were undercutting their prices, Mr. Johnson replied: “Yes, they are. It’s called the free market.”
Presidential candidates are divided as well. Hillary Clinton implicitly criticized Uber in her campaign speech on economic policy, saying the “so-called ‘gig economy’ ” is “raising hard questions about workplace protections and what a good job will look like.”
By contrast, Florida’s Sen. Marco Rubio has a chapter in his presidential campaign book, “American Dreams,” titled “An America Safe for Uber.” He describes explaining to a college class he taught how Miami had banned Uber cars. “As my progressive young students listened to me explain why government was preventing them from using their cell phones to get home from the bars on Saturday night, I could see their minds change,” he writes. “Before I knew it, I was talking to a bunch of 20- and 21-year-old anti-government activists.”
For its part, Uber hired David Plouffe, who managed Barack Obama’s 2008 campaign, to help wage the political fight. Mr. de Blasio didn’t know what hit him. He justified the cap on Uber cars by blaming the company for traffic congestion, citing a 0.84-mile-an-hour decline in Manhattan’s average vehicle speed between 2010 and 2014. That took chutzpah, given that the mayor himself pushed through a reduction in the speed limit to 25 miles an hour from 30. It also ignored the numerous bike lanes and pedestrian roadblocks the city built during that period.
Uber made the fight personal by adding a “de Blasio” mode to its app, estimating how long the wait would be under the proposed law. Model Kate Upton tweeted in Uber’s support. Errol Louis wrote in the Daily News that “Mayor de Blasio is leaving N.Y.ers stranded—like a black man trying to hail a cab uptown.” An Uber spokesman picked up the theme: “There is nothing progressive about protecting millionaire taxi [campaign] donors who mistreat drivers and discriminate against riders.”
New York taxi medallions have plummeted in value due to competition. Their owners made the fatal miscalculation of assuming City Hall would always protect them by limiting the number of cabs. They failed to anticipate how new technology eventually disrupts every industry. Apps like Uber give consumers better protection, prices and services than regulators ever can.
Government-enforced cartels fall faster and harder to disruptive innovation than most businesses. When change comes, it is more dramatic than in industries that already have competition. The fate of taxis is a warning to other regulated industries that new technologies always give consumers more choice. And citizens can always make the choice to vote for candidates who embrace innovation over regulations that protect entrenched interests.
Crazy”, The Wall Street Journal, July 27, 2015
“MBA’s July 10th chart of the week highlights retail mortgage applications per underwriter with a ten-year trend in average monthly underwriter productivity for the retail production channel. For large lenders, generally in the top 25 nationwide, u/w productivity is 5 times lower than it was ten years ago, dropping to 33 applications per underwriter (per month) in 2014…
…from 165 applications per underwriter (per month) in 2005. Productivity for mid-sized lenders, originating an average $1.2 billion in 2014, has dropped to 37 applications per underwriter (per month) in 2014 from 135 (per month) in 2005.”, Excerpt from Mortgage Industry Newsletter, July 2015
“These days, I guess it takes ALL DAY for underwriters to make the decision (to approve or reject) on about ONE and ONE HALF home loans (three every two days), with all the post-crisis, CYA, form-over-substance, industry regulation??? Pre-crisis, underwriters used to be able to decision a home loan in a little over an hour. Underwriting a home loan isn’t rocket science!!! That’s outrageous and that increased cost is one of the many reasons that American homeowners are paying thousands of dollars in increased government regulatory/compliance costs (largely hidden/imbedded within a higher interest rate for their mortgage) for nothing. NO benefit to the borrower/homeowner. And very little real benefit to the lender or investor in the mortgage.”, Mike Perry, former Chairman and CEO, IndyMac Bank
“The U.S. Department of Education makes loans without regard to the borrower’s future ability to repay the debt. Federal Perkins and Stafford loans, for example, do not consider the student’s credit history. Aggregate loan limits are not based on the student’s likely income after graduation…
…Colleges are not permitted to categorically reduce loan limits based on the borrower’s degree level, academic major or enrollment status. For example, students who are enrolled on a half-time basis can borrow the same amount as full-time students. The U.S. Department of Education has issued guidance that restricts the colleges’ statutory authority to reduce loan amounts, thereby preventing colleges from taking steps to ensure that students graduate with an affordable amount of debt…”, Mark Kantrowitz, “Uncle Sam, Predatory Lender?”, The Wall Street Journal, July 25, 2015
Notable & Quotable: Uncle Sam, Predatory Lender?
Mark Kantrowitz, senior vice president and publisher of Edvisors.com, on the state of federal student loans.
Mark Kantrowitz, senior vice president and publisher of Edvisors.com, writing for the site on July 14:
Photo: Getty Images
Is the federal government a predatory lender?
A predatory lender makes loans with unfair or abusive terms and conditions, where the lender coerces, induces or deceives the borrower into accepting the loan. A predatory lender may also take advantage of a borrower’s lack of understanding and lack of sophistication with regard to complicated financial transactions.
The U.S. Department of Education makes loans without regard to the borrower’s future ability to repay the debt. Federal Perkins and Stafford loans, for example, do not consider the student’s credit history. Aggregate loan limits are not based on the student’s likely income after graduation. . . .
Colleges are not permitted to categorically reduce loan limits based on the borrower’s degree level, academic major or enrollment status. For example, students who are enrolled on a half-time basis can borrow the same amount as full-time students. The U.S. Department of Education has issued guidance that restricts the colleges’ statutory authority to reduce loan amounts, thereby preventing colleges from taking steps to ensure that students graduate with an affordable amount of debt. . . .
Policymakers often argue that easy access to federal loans provides low-income students with access to a postsecondary education. But loans are not really financial aid, as they don’t cut college costs. Loans must be repaid, usually with interest. Loans are not a solution if they bury borrowers in more debt than they can afford to repay.
Something is deeply wrong with the current federal student aid system when Federal Pell Grant recipients are about twice as likely to graduate with debt as non-recipients, and with thousands of dollars of additional debt. Federal student aid policy should be based on a principle of meeting the demonstrated financial need of low-income students solely with grants, not loans.