The Subprime Meltdown and the Ownership Society
WashingtonPost.com, April 7, 2007
A huge percentage of the easy-money mortgages issued to low- and moderate-income families in the past few years are going bad. This has led to bankruptcies for the big lenders in this market and millions of dollars in losses. The chain of defaults has also raised concerns about the mortgage and housing market more generally, and a growing number of economists view a recession induced by a housing crash as a distinct possibility.
The full effects of the collapse of the subprime market remain to be seen, but it is not too early to talk about the policies that got us here. In particular, the government policy of promoting homeownership should be examined.
Proselytizers of homeownership can be found in both political parties. Democrats have long argued for lending policies that allow easier mortgage credit to low-income families to help remove an important obstacle to achieving financial security. Republicans tend to frame their support for homeownership as part of their drive to create an "ownership society" in which everyone owns a piece of the country and can share in its prosperity.
The result has been a range of policies that promote homeownership while generally neglecting renters.
While homeownership is often desirable as a means for accumulating wealth and obtaining secure housing, it will not always be a good mechanism for either. People often find it necessary to move for reasons that are not easily controlled. For example, sickness, death or unexpected family break-ups may require changes in living arrangements. Similarly, in the dynamic U.S. economy, where job security is a relic of the past, workers frequently have to move to maintain or advance their careers.
Since large transaction costs (typically close to 10 percent of the sale price) are associated with buying and selling a home, it generally does not make sense for someone to buy a home unless he or she can stay in it for a substantial period. A University of Washington study found in 2004 that among low- and moderate-income home buyers in the 1980s and '90s, the median family owned its home for less than four years (higher turnover rates in recent years have almost certainly shortened this period). This means that the transaction costs associated with buying and selling a house, such as Realtor fees, financing fees and other closing costs, must be averaged over just four years.
If, say, those fees came to 10 percent on a $200,000 house, or $20,000, then the transaction costs would have added $5,000 per year to the housing cost for a typical moderate-income home buyer. Since the median annual rent in Washington is only around $9,000, the transaction costs associated with buying and selling a home are significant. A family that lived in a home for only four years almost certainly would have been better off renting.
The situation is even worse if the home purchase price was driven up in a speculative bubble, as was the case with many homes in recent years. Not only will some home buyers incur large transaction costs, but in today's market they are also likely to be forced to sell their houses for less than they paid. This is precisely why so many moderate-income home buyers are defaulting on their mortgages. They have been stuck with mortgages that they cannot afford, on homes that are worth less than their purchase price. In this situation, many people wind up losing whatever savings they put into their house.
While there are losers in this story, there are also winners. The transaction costs borne by home buyers are income for those in the real estate industry.
Upwards of 2 million subprime borrowers are expected to default in the next few years, with as many as 20 percent of subprime borrowers being hit over this period. If the average purchase price for these borrowers' homes was $200,000, these home buyers would have generated close to $40 billion in real estate and mortgage fees. That considerable sum is likely to persuade many to hear the gospel of the ownership society.
A serious housing policy should recognize that renting can be a better option for many Americans, especially for tens of millions of families with low and moderate incomes. The country cannot allow its housing policy to be determined by ideology or the interest groups that benefit from this ideology.
Dean Baker is co-director of the Washington-based Center for Economic and Policy Research.