PolicyCast: Addressing Housing’s Shortcomings

Kirk Willison, Arch MI’s Vice President for Government and Industry Relations: One of the conundrums coming out of the Coronavirus Pandemic is how the nation’s housing economy is soaring while much of the economy tanked. The last time the economy notably stumbled, it was housing’s crash that led to the Great Recession of 2008 and 2009. It’s a totally different story this time around. To better understand the paradox, I turned to Professor Richard Green, Director of the USC Lusk Center for Real Estate in Los Angeles and a professor at USC’s Marshall School of Business. Richard’s experience in real estate economics includes both the practical and the theoretical.

In between stints in academia, he served as a principal economist at Freddie Mac and an advisor to the U.S. Department of Housing and Urban Development. Of particular interest to Richard is the disappearance of affordable housing, and that includes the resulting impact on the economic fortunes of people of color, the households most likely to suffer due to a housing shortage.

Like any renowned professor, Richard is a prolific writer and researcher. At his core he works to improve housing outcomes by focusing on policy aims. He says to have true value, research must be distilled, so it is useful to policymakers. To be able to nudge things along in the right direction, he contends, makes a professor’s life worth living. Well, Dr. Richard Green, it’s a pleasure to have you joining the Arch Mortgage Insurance PolicyCast, and take it as a sign of my immense respect for you that this UCLA graduate has turned to an expert at our archrival, the University of Southern California, to tap into your considerable insights on housing policy and housing economics. So, thanks for being here.

Richard K. Green, Ph.D., director of the University of Southern California Lusk Center for Real Estate: Well, Kirk, it’s great to be with you. And just so you know, I live with a UCLA faculty member, so I love UCLA, too. Not quite as much as USC, but I love UCLA.

Willison: Richard, why don’t you start off by telling us a little bit about the Lusk Center for Real Estate at USC.

Green: We are a real estate research center that supports the research of, I would say, about 20 faculty members around the campus on anything related to real estate. That ranges from urban economics to issues of design, issues of equity in real estate, to mortgage pricing to default modeling, which is something your audience would probably be interested in. It’s a pretty wide gamut.

Willison: Well, Richard, the Coronavirus Pandemic has taken a terrible toll on the health of millions of people and their employment. But in the largely unforeseen result, the nation’s housing markets have prospered. And one of the reasons I was really eager to have you on this program is that you’ve studied this paradox. So, let’s talk about that as well as a couple other things, like who is being left behind in the current housing boom and what should be done about it. Finally, I’ll ask whether housing policymakers should be focused more on increasing the supply of homes or increasing access to credit.

Lastly, I’d really like to hear your thoughts on some real world solutions to solving a problem that’s particularly bad in California, and that’s homelessness. So, you know, not too long ago, housing was the catalyst for one of the biggest economic collapses in the country’s history — what we now call the Great Recession. So how did it happen that while much of the economy plummeted during this pandemic, housing flourished?

Green: I think the big thing that happened is after housing plummeted in 2007, it never really recovered. So, if we look at how housing has evolved over the period of the recovery between, I’ll say 2009 and 2020, housing lost relative to GDP about 20% of its share and it never caught back up. And this is in contrast to what we saw between the end of World War II and 2007, which is housing and GDP more or less tracked one another. And by that, I mean new investment, which has two forms — new units or new houses and also home improvements. So we now went through a period of about 12 years where we just didn’t build very much housing relative to the size of the economy. I think what put housing in a relatively strong position as we went through the pandemic is we just didn’t have enough of it.

There are various estimates of how many units short we are. Laurie Goodman at the Urban Institute has a number of about 4 million that actually seems about right to me. So, you had this just shortage of supply — and this is particularly acute in a place like California — but, actually, this was true nationwide. It’s not as bad as California, but nationwide, we never saw the recovery in new construction that we might have normally seen in a period of economic recovery.

So you had that and on the other hand, you had this phenomenon of interest rates falling, mortgage rates falling to I’m pretty sure their lowest level in the post-World War II period, maybe their lowest level ever in American history. For those who retained their jobs, the impact of COVID on their economic well-being was pretty small. What you had is the share of the population who were pretty well off found themselves just as well off, if not better off, with (low) mortgage rates that had never been seen before.

As a consequence of that, you had tremendous demand chasing a very limited amount of houses. You had this influx of demand without supply either on the new construction side or the listing side, and with that, you get this amazing pop in prices. I wish I could tell you I was smart enough to have seen this coming 14 months ago, but I didn’t at all. But, it was this sort of mixture of events that led to this remarkable rise in home prices.

Willison: Is there any end in sight to the rising home prices?

Green: We have reached a point now where if you look at people’s total carrying cost of a house — house prices have gone up enough that they’ve offset the benefit of those lower mortgage rates. And mortgage rates have ticked up a little bit as well, although they’re still very low. When you look at what is that mortgage payment when you add the property taxes and the maintenance costs, you’re now about back where you were at the end of 2019. As I’m sure you know, we saw a real slowdown in house price growth in 2019. And I think it’s because we do sort of hit an affordability limit in the housing market even for those who have pretty good jobs. That suggests to me that we shouldn’t see any more big increases in house prices.

Willison: Many more homeowners chose not to move, but they chose to refinance, and it was a kind of another product of a situation where the affluent or the people who were successful enough to be able to keep their jobs during the pandemic really got a leg up over those who didn’t, who weren’t homeowners. Those who really were lower-income had to go to work or lost their job, perhaps. So, a lot of people have been left out of that refinance boom. And I know that you’ve studied the issue. You’ve written a bit on it. Do you want to talk a little bit about what your proposed solution is?

Green: Yes. First of all, let’s talk a little bit of history. One of the frustrating things about America is the inequity in the housing market. And to some extent, it’s income, but I’m going to put it more on race. There was a piece in The Guardian this week that I think was very illustrative. There was a family in Los Angeles, which we think of as very liberal and open-minded, who owned a property in Manhattan Beach, which is perhaps the most affluent place in Los Angeles County. There are other competitors for that, but it’s way up there.

They opened a resort — and this was in the 1920s — for African Americans, and it was this lovely place on the beach. They ran a lovely resort, and it was a place where Black people could feel comfortable enjoying the beach and the ocean in California, which is quite wonderful. And the neighbors in Manhattan Beach didn’t like this very much, and the KKK harassed the owners and the patrons of this place. Ultimately, the city used eminent domain to strip this African American family of their property on the beach and paid them a fraction of the property value at the time. Now, there’s a little bit of good news. The California legislature is working to do the right thing by, basically, enabling  the descendants of that family will get that property back — and it’s currently worth about $75 million.

So, I’m very much hoping that happens. But, the point is this is a story that was repeated over and over again. Some  African-Americans have had property. It’s not just that it’s been harder for them to acquire property than other groups, which has always been true because of things like how FHA was run. But, they’ve actually had property stripped from them over and over again.

Willison: Home wealth or family wealth, a great deal of that is connected with home ownership. And the fact that whites have 10 times more family wealth than Blacks is connected to that.

Green: Yes. So now, let’s fast forward, and I’m not going to quite get us to the pandemic, but let’s get us to the mid-aughts. When subprime lending was happening and predatory lending was happening, there was an opportunity. This was a good time to get a mortgage. Rates were quite low compared to the previous, say, 25 years. And you had Black people being steered into subprime loans when they qualified for Fannie or Freddie loans. So they were asked or they were incentivized into worse credit for them, lower-quality credit for them than they could have gotten. And there are people who say, “Well, shouldn’t people take some responsibility for their decisions?” So, they made bad decisions, but , mortgages are things that very few people understand.

My favorite story about that is I was sitting at a conference at the Harvard Business School. This is about 2007 or 2008, and it was filled with Harvard professors and Yale professors. I don’t know why I was invited, but I was, and a person stood up and said, “Okay, how many of you people in this audience have a variable-rate mortgage?” About half the people raised their hand. And then she said, “Okay, if you could tell me whether it’s tied to LIBOR or one-year Treasuries, keep your hand raised. Otherwise, lower it. And, if you could tell me what the margin is, keep your hand raised. If you can you tell me what the maximum interest rate you could pay on your mortgages, keep your hand raised?” At that point, there was only one person left with his hand raised in the audience, and the person sitting next to me said, “I know that guy and he would never admit in public he doesn’t know something.”

Anyway, long story short, (too many African-Americans) got steered into these really crappy mortgages. The crisis comes along and  they’ve lost their houses. So you saw this tremendous decline in homeownership among African-Americans as a result of subprime lending. We’ve had this constant stripping of equity and inadequate access to opportunities …  This has been because of a set of policy decisions. It’s not because somehow out in the ether, this is what the market has done.

So, what could we do now? Well, Kirk, as you were referring to, I did a paper with good friends of mine about having a HARP (Home Affordability Refinance Program) 3, which, basically, says the following: If you have a loan from Fannie or Freddie and it has an above-market interest rate, you just get it refinanced, period.. Without any underwriting.

What that does is it reduce the underwriting costs of doing a mortgage, right? Those upfront costs are real costs that intervene in the refinance process. I understand if you’re really underwriting a loan, it takes resources to do it, but in this case, it seems silly to do underwriting because the loan already exists. What we know is if you cut the interest rate on that loan, its default rate is going to be lower and not higher.

Willison: Well, and we have some history with this, right?

Green: Yeah. Because we did this with HARP. We had HARP 1 and 2. HARP 1 was too cumbersome, which is why it didn’t work particularly well. HARP 2 basically did (work) and you didn’t need an appraisal to get a refinance on a loan.

Also, if you’re upside down, you still get a refinance on your loan. Because if you’re upside down, you’re upside down whether you’re at 6% or 4%. At 4%, we now know the most important modification you can do on a loan that’s troubled is to cut the monthly payment on it. So, one of the benefits of going through something like the Global Financial Crisis is we learned some things.

At the end of the day you say, “Well, isn’t that bad for the investors?” Yes, but for the investors, prepayment was always a possibility. If that’s the rate’s fault, people are going to  refinance and, perhaps, they shouldn’t benefit from people being stuck because of an underwriting standard that doesn’t make any sense. In fact,  those HARP loans with lower interest rates did much better. I mean, we really basically came close to solving the default problem by doing that. Now, everybody has equity in their house … I mean, it’s astonishing how few people are upside down. We couldn’t have imagined this 10 years ago, right Kirk?

Willison: Now interest rates have begun to creep up a little bit. Is there still a market for this?

Green: Most of the people who could refinance did, but those who couldn’t, were probably at about 4.5% and we’re in the 3% range. So, 100 basis points on a $250,000 mortgage, which is about average, that’s $2,500 in yearly savings. That’s real money for a typical family.

Willison: So, Arch Mortgage Insurance is actually an advocate of a streamlined approach as well. We went out and we talked to some of the GSE officials, and they said “Here’s the problem that we face. We have already sold all that credit risk into the private investors through credit risk transfer transactions, and, therefore, it doesn’t behoove us to go through this whole process again and then sell these loans again.” What’s your response to that?

Green: So, my response to that is first, that basically extinguishes that credit risk transfer obligation, right? Those folks are basically going to be repaid and then that’s done. So, in a sense, that’s good because it should mean that their pricing on the CRTs, which is something I’ve had issues with, should get better, right? You go through the worst time and you don’t lose money by buying the credit risk transfer. Wow, maybe this is a pretty good thing to invest in. Maybe I don’t need the kind of heavy price that I’m getting right now in order to do it. So that’s the first thing. The second thing is, let us remember that Fannie and Freddie are still wards of the government. Part of their job is to make the country better, and this would make the country better.

Willison: Richard, on another policy area, we’re seeing some signs that policymakers are recognizing the benefits of carefully targeting subsidies for homeownership so that (owners) build up equity faster rather than driving home prices higher. There’s a couple of new proposals in Washington calling for targeting subsidies to first-generation homebuyers, either for down payments or in the case of one bill that’s being proposed by Senator Warner of Virginia, buying down interest rates on a 20-year fixed-rate mortgage so that the monthly payments are largely equivalent to a monthly payment on a 30-year fixed-rate mortgage. What are your thoughts about that approach?

Green: I like both ideas and let me give a shout out to somebody I disagree with a lot, who is Ed Pinto at the American Enterprise Institute, but he has a really neat idea.

Willison: He’s my next guest, by the way, on PolicyCast.

Green: Well, it will amuse him that I complimented him. He came up with an affordable mortgage idea, which  basically would be a 15-year mortgage, but again the interest rate would be bought down for the first X years of the mortgage, and it would be a zero down (payment) product. His reasoning for it is good. He says a 30-year mortgage with 3% down is still way more vulnerable for the first, say, five years than a 15-year mortgage with nothing down. Because you get so much amortization, you have people building up equity much faster. This idea of doing something to shorten up the life of mortgages makes lots of sense to me. And again, an interest rate buydown to make the payment equivalent makes sense to me.

It would look like a VA mortgage program for first-generation homeowners. As you know, Kirk, the VA program, I know they’re a competitor of yours, but they require zero down. And the VA loans performed better than any others did through the Global Financial Crisis. Now they are carefully underwritten and they use something that I think makes a lot of sense and don’t know why it hasn’t been used in a while, which is instead of using ratios, they look at residuals of income after you’ve made all your obligations. So, they’re basically asking, do you have cushion left over. That seems a much more sensible underwriting program to me.

Willison: So while some in Congress are moving in the direction of trying to target and expand homeownership opportunities, the FHFA and the Treasury Department recently amended the so-called preferred stock purchase agreement and now will actually cap the amount of so-called high risk loans that the GSEs are allowed to purchase, both on a purchase money basis and a refinance basis. And I want to know, what might these impacts be for the low-income minority borrowers?

Green: I think terminology is really important here as they’re referring to borrowers when they should be thinking about the product. What is a fixed-rate mortgage? It’s a low-risk product. How do we know this? If we, again, go back to the Global Financial Crisis and we look at what was the biggest predictor of default, it wasn’t the borrower, it was the product. So. by definition, what Fannie and Freddie do is a low-risk product. Consumers understand what they’re getting. What Fannie and Freddie do is issue a really safe consumer product. And consumers are really good about knowing what they can afford and what they can’t. If that payment is constant, it’s not going to ever surprise them.

I think this characterization of Fannie and Freddie doing any high-risk loans is incorrect. And where they are now is basically they’re in the 760-plus FICO business because with their loan-level price adjustments …Okay, maybe it’s more like more like 720, but that’s a really, really creditworthy borrower. Everybody else is going to FHA because the MI premium for FHA is lower than those loan-level price adjustments are. So, as it is, I think they’re failing their duty to serve and to put any more impediments in the way of that just makes no sense to me.

Willison: Earlier you talked a little bit about the housing shortage and the need for more homes. But in an earlier conversation, you said it’s really not a national issue so much as it is a regional one. And I wondered if you could kind of a chat about that and then with some of the older stock, what kind of programs might be needed to incentivize rehabilitation of older homes?

Green: My answer is Section 8 would largely solve our problem between the Rockies and the Appalachians. If you look at those places, the issue is not that housing is that expensive, it’s that incomes in many places are low. So, you know, you look at the farm towns in Iowa, Nebraska Kansas and Oklahoma and so on, people just don’t have income. But if you look at the rents or you look at price of houses, you wouldn’t say to yourself, “That’s really expensive.” Building new housing is not going to solve that problem.

On the rental side, Section 8 would help people out a lot, but also I think helping people rehab their old houses so they can live in a dignified way does make a lot of sense. And that’s a lot less expensive. You’re talking about maybe $40,000 to $50,000 to rehabilitate an old unit as opposed to spending, you know, even in a relatively expensive place, building a new unit is probably at $150,000 to $200,000. Preserving what you have and having subsidy target that as opposed to building brand new things seems more sensible to me.

Now on the coasts, of course, the problem is that housing is just really expensive. And there is a sort of worst of all worlds in Miami, where incomes are really low and housing is …  not as expensive as it is in Washington or Los Angeles or Seattle, but it’s still pretty expensive. In those places, we have this mechanism called Section 42 where we build new affordable product, but at astonishingly high price per unit. In the Bay Area, I don’t think I’m exaggerating when I say there are units that have cost a million dollars to build for affordable housing.

What seems more sensible to me is to basically have new housing done by the market because it’s just expensive, and the market — because it doesn’t have to face as many rules as a government-sponsored program — tends to deliver units more cheaply, although it’s still expensive in some of these major markets. Subsidies could be used to acquire existing property with covenants put on it to prevent rents from rising above a certain level and put in money to rehab this property I think you would find that would be a much less expensive way to deliver units to low-income people than the way we’re doing right now.

We have a program called Project Home Key where cities are buying hotel rooms that are not being used right now because of the pandemic. They’re acquiring these rooms for $200,000 to $300,000 instead of building beds for $500,000 or $700,000. And a student of mine did an inventory in Los Angeles County, and she estimated that you could probably acquire about 22,000 units of not-quite-dead-but-nearly-dead hotel room space around LA County. They’re scattered all over the county, so they’re near jobs … We’re not talking about putting people in a place where there’s no access to anything. In fact, by their very nature, these places are going to be on transit lines and near job centers. There are about 60,000 homeless in LA County right now.

So, this certainly doesn’t solve it, but it makes a dent and you overcome the zoning issues, right? You’re not siting a new “homeless shelter,” but instead you are just converting it from one use to another. The building’s already there. I think recasting the stuff that already exists as a way to better house lower-income people might be a more cost effective and easier thing to do.

Willison: Richard, this has been a fun interview. You’ve done your university proud. I appreciate you taking the time today to chat with us.

Green: Well, Kirk, thank you for having me. You sound like you’ve had a great set of people on. Good work!