20% DOWN IS A GOOD REGULATION
There are times when regulation just makes sense. Now, in general, I despise regulation (where I tend to make an exception is with regards to the financial industry). Being an entrepreneur, I loathe the endless stack of paperwork that I need to fill out just to run a business in this country and the various hoops I need to jump through just to get things done. I know I am not alone in this regard as the hoops are many across most industries these days. I understand that there are reasons for these rules and regulations, but it’s difficult to argue that the USA is not excessively litigious in general.
That said, there are broad rules that just make sense. A good analogy here is speed limits. If you don’t have speed limits then certain people take excessive risks that endanger the many. By reducing the average speed of drivers and actively enforcing this rule, we actually generate a higher risk/adjusted return on life. We get to places a bit slower, but more of us get to live. The economy is analogous. If there are rules and regulations that can be implemented that help to avoid massive volatility in the business cycle (thus reducing our risk adjusted returns on life) then we should be proactive in implementing those measures.
I think down payments on homes applies. TheStreet.com is reporting that the 20% down law is under consideration:
“Hopeful homebuyers may soon need to shell out more money upfront before being approved for a mortgage.
The public comment period concludes Monday for potential mortgage-related provisions spawned by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Among the potential outcomes is that homebuyers could be required to front a higher down payment – as much as 20% — before they can legally qualify for a mortgage loan.
…
In past decades, a 20% or more down payment was standard. The lower the down payment, according to conventional wisdom and ongoing research, the greater the risk of default.
As housing prices soared and mortgage lenders dove head-first into what would be the subprime crisis, that common practice fell by the wayside. You may pay more in interest, closing costs or PMI, but just 5% down is enough for many banks and lenders. FHA loans, insured by the government, typically require only a 3.5% down payment.”
I can’t be certain that a 20% down law would have eliminated the housing bubble, but I think it’s safe to say that a lot of speculative and/or high risk buyers would have been priced out of the market if this were the law of the land. Preemptive laws such as this one help to protect us all by smoothing the business cycle and helping to avoid these sorts of financial crises. It just makes sense – when you’re taking out debt that is several times your annual income you should be required to put down substantial collateral. There’s good regulation and bad regulation. In my opinion, this is good regulation that helps to increase the risk adjusted returns on all of our lives.
Feel free to relocate to Greece
And what about regulating food safety and medicines?
Disagree with you here Cullen. By instituting a 20% down rule, you are also eliminating a lot of the productive speculative ventures which allow for investors to profit on, for example, fixer uppers and immediate sales. I add value by purchasing properties with low down payment % and using my or my investors equity investment to make improvements and increase the value of the property.
Ultimately I judge the value of the property not just on what I think I can flip it for but also what it’s potential monthly cash flows are if I miss. (I did miss once).
Many of the speculative and high risk buyers didn’t have the monthly cash flows to cover the payments in the 1st place and paid more than the property was worth in expectation of selling it for more without adding value.
You’re also killing the 1st time home buyers market (if there’s anything left of it now) by telling people when they are ready to buy or not.
I think the FHA’s 3% down payment program is outstanding when used properly.
Ultimately, there’s no substitute for solid, “makes sense” underwriting.
So you want to invest 3% (33 leverage) with huge potential upside, but refuse to meet your obligations if things go south (will default if no upside).
The value you add is the labor you put in. The rest of what you do is purely speculative and it should not be subsidized by everyone else. I understand it is beneficial to you, but there is no value for all besides improving the housing stock with your labor.
Your other argument is that vultures(flippers) are good, because otherwise diseases spread(eroded home values due to empty falling apart homes). The proper solution is to enforce the current owner to maintain or sell. Unlike in nature, flippers are not necessary for the survival of all.
“The proper solution is to enforce the current owner to maintain or sell.” And if you require 20% to sell, who are they going to sell it to?
And who says I am going to default if I miss? I sold at a loss and took my pain. There was no default.
All I’m saying is there are times where 33% leverage is appropriate. I’m an entrepreneur. I see an opportunity for profit & I take it. No one subsidizes me outside of the subsidies everyone gets.
You can make a villain of flippers all you want. We provide a floor for everyone else to stand on.
The owner is going to sell to whoever is willing and able to buy. Price discovery. The percent money down does not matter.
I have no problem with flippers or flipping. It is a necessary activity that usually adds value. My problem is when you expect to be financed by the government (in fact all tax payers)to do it.
33 leverage is not 33% leverage. It is 33 X. This is a subsidy which means that it raises the housing prices.
Fair enough. While you’re in there with Mr. Boehner and his lobbyists, please get rid of the SBA to boot.
Dave- did you really just say….”productive speculative ventures?”
Dr. Michael Burry and Howard Marks have asked me to let you know you are to stay after class today..and everyday until 12/21/2012 and write the following.
I will not say productive speculative venture together.
I will not say productive speculative venture together.
Please do not talk to the Enron executives, Countrywide credit team, or Dick Fuld. They will be there also.
What else could a business be?
For Dave eyes only!
http://mjperry.blogspot.com/2011/07/how-government-policies-promoted.html
What if we are oscillating between too much regulation and too little.
Lets see: 1929(too little)….1969(too much)….2008(too little)
What’s that, roughly a 40 year cycle?
Maybe you saw my post on the article about implicit acceptance of MMT:
Hopefully these are the seeds of Real Change. It is amazing if you go back to the late 70s early 80s you can see from the quote below how the seeds of the recent chaos were planted then.
As Jeff writes in the introduction, the first part of “Age of Greed” “is mostly a story of business pioneers who fought government regulation or, through innovation, escaped government oversight,” building on fear from punishing inflation in the seventies and a new post-Watergate distrust of government, “all the while diminishing the power of government and reinforcing the changing national attitudes.”
from the book below:
http://www.truth-out.org/when-super-rich-cry-class-warfare/1311945868
But doesn’t MMT support regulation? Sure and so are we starting back towards a climax of too much regulation again?(40 yrs from now) Doesn’t that feel just about right for the next wave of inflation?
20% seems arbitrary. Why not 15% or 30%? I know it has been the standard in UW for many years, but I am not aware of the origin of that percentage.
I do beleve there should be skin in the game. And if the underwritten risk fails, the entity who took the risk with that exposure should be responsible for the loss.
I sadly agree considering large financial institutions are not allowed to fail. That way they would be held responsible along with the borrow for making a poor decision suffering large losses and possibly failure.
Again considering this is not the reality we live in (from my perception), 20% should be put in place. With that said, as stated here before, we are in a balance sheet recession where I doubt many potential home buyers have 20% to put down at these home prices.
Either home prices decline or the market will have difficulty clearing until after private sector balance sheets are repaired. Considering housing values play a pivotal role on household balance sheets, a decline in prices would exacerbate the problem. This surely would put downward pressure on the economy, again leading to further balance sheet deterioration. However, if home prices do not decline to the point where new buyers can enter with 20% down, the large inventory will continue to lead to weak housing starts. This would undoubtedly strain the economy as constructions lags.
I have a lot of sympathy for the German system when it comes to Real Estate and Real Estate loans.
They’ve managed to get their housing to decline in real terms over the years without the swings that the US and UK systems suffer from.
House prices respond to the supply of credit to buy them. The only people that win in aggregate in that system are the finance houses.
A lower supply of credit for house will directly correspond to lower house prices and if the German system is anything to go by it will not suppress house building.
Yves had a good piece on it a couple of months ago. http://www.nakedcapitalism.com/2011/06/how-germany-achieved-stable-and-affordable-housing.html
Good point. Often misrepresented in the media.
Removing subsidies (mortgage deduction, low down payment, low interest rates etc) will NOT make housing less affordable. Instead prices will come down to the proper level.
Yes. I wish the subsidies including the mortgage interest deduction would disappear. There’s no value in having 80-90% of people’s networth being tied to a single overleveraged asset.
Germany is bubbling a bit as well at least in the larger Metropolitan areas, you can’t just take the whole country as an example because you have areas where the population is shrinking (some cities lost more than 30% since reunification) and others where there is a severe shortage of affordable housing for middle class people. For example, if I were to move within my hometown Hamburg I’d have to pay double the rent I pay now for a smaller appartment. If I could afford to buy I’d have to pay over 30 times annual rent. Clearly there are issues on the supply side.
The system is pretty bank friendly: You have large down payments and default will mean bankruptcy. If the bank forecloses on the house and the purchase amount isn’t enough you owe the remainder of the principal. It’s high risk to buy here and strategic default is not an option. This helps to keep the demand side at least for loans in check. It doesn’t help rents.
There is also a difference in mentality. People here don’t see the home they own as part of their net worth and rejoice at increasing home values. They only look at what they’ll eventually save on rent once the mortgage is paid off. Germans also don’t move as often and freely as Americans do, many tend to stay in their home towns for as long as possible. This also creates a housing market that’s less liquid.
I don’t know if the low home ownership rate is desirable for a society at large.
There is a lot of incentive for those who own land and rental space to keep supply low so they can increase rents on their already paid off property.
I certainly don’t look forward to forking over half my net salary to a landlord for the rest of my life.
The down payment is part of the underwriting process. It serves to provide an incentive for homebuyers to stay current on their loans as well as reduce risk to the lender. In addition, it doesn’t discriminate against self-employed individuals, contractors, aliens, or by race or creed. You also can’t fudge it.
It is actually good for those “first time home buyers” as it will encourage deleveraging in real estate, causing prices to drop, and thus making homes cheaper. This will naturally make saving for the down payment easier.
You wouldn’t let someone drive a new $30k car on 5% down. I think it’s nuts we give people keys to homes at 3.5% down when taxpayers are on the hook.
Great post! I sure hope the law is approved. I would also like to see mortgages made full recourse loans like more prudent countries like Canada.
FHA has had 3% down for a very long time (it’s now 3.5%). I bought my first house with 3% down. Saved up for a year, lived at my sister’s with cheap rent.
It would be foolish to institute a 20% down rule for FHA.
Probably need to keep that at it current low down payment.
VA loans allow for zero down.
Fannie and Freddie, well, they are going to get revamped, that’s for sure.
A 20% down rule probably appeals mostly to those who already own a home.
Or those who can actually afford to put down 20%…..
lending standards are already 20% for those who already with a primary residence and are looking to invest in real estate
What the hell is wrong with savings discipline and postponing a major purchuse until you can actually afford it? Save more than you make, rent, keep your cost down and become a homeowner when you have proven to yourself and an underwriter at that you will actually meet your financial obligations. If you can’t come up with a substantial down payment you SHOULD NOT BE BUYING A HOUSE.
When I entered adulthood in the 70s twenty percent down was the minimum required by banks. two great things came from this. one is housing stability (prices and ownership) and two, my generation learned how to save and live below their income.
I was required to have 20% for a house I bought in 2001 in SC, but my mother sold her house to a minority person about 4 yrs earlier in a different southern state who was able to get a loan for 125% of the house appraisal with practically nothing down. Yet a minority friend of mine told me he received a class action settlement check of about $160 because of a statistical discrimination in loans (interest I believe) between minorities and non minorities. It seems to vary on a state by state basis.
What about the banks taking 20% of each loan and keeping it on their balance sheet? Then it would be self reinforcing of a free market, whether the person has 5% down, 10% or 20% down. Only banks that wished to blow themselves up (assuming they are not TBTF) would create stress in the system
Of course that is a dream scenario – we live in a country where 75% of originations now come via Wells, BAC, and JPM. I am speaking of a country that does not encourage ogilopoly.
It’s the wrong time to be considering a flat 20% dp. the right time would have been 4 or 5 years ago when prices are high, not today when prices are low and there is so much excess supply… unless the govt decided on burning them all down.
I bought my first home in 1983. Had to have 20% down and if I recall correctly, the interest rate was something like 11.5%. This was in Iowa.
20% down does NOT make sense. What would make sense is to abolish credit creation or at least all government privilege for it. That way, non-inflated housing prices and honest interest rates would allow people to save a few years for housing instead of being debt-slaves for 30 years and paying several times the principle to the government backed usury and counterfeiting cartel.
It is absurd to think we can borrow from the future via so-called “credit”. What we do instead is steal purchasing power in the present from all money holders including and especially the poor since they are usually non “credit worthy” themselves.
Did they ever pass any regulation on Derivatives?? That’s what will bring us all down.
“Being an entrepreneur, I loathe the endless stack of paperwork that I need to fill out just to run a business in this country and the various hoops I need to jump through just to get things done. I know I am not alone in this regard as the hoops are many across most industries these days.” TPC
God bless you TPC for bringing the real economy to the front of the class. Do I hear a conservative in there? Class, repeat after me: nobody wants to hire anybody in the USA because the employer-employee relationship has been suffocated by excessive regulation and taxation.
Banking is a sovereign function because banks create money in the USA and money is a sovereign function; banking must be regulated. Bring back Glass Steagall and leverage caps, and anti-bucket shop laws, and anti-usury laws, and lock Wall Street back in its New Deal cage, and then it really won’t matter whether home borrowers are legally allowed to lever at 33 to 1, or 10 to 1, or 5 to 1, because no sane lender will finance excessive and nonrecourse consumer leverage even if it remains legal to do so.
Heavily regulate utility banks, get Wall Street off welfare and break up and/or heavily tax any TBTF that rises from the mud to threaten the real economy. Deregulate to the extent possible the real economy, permanently reduce employment and corporate taxes and unshackle production and entrepreneurship. Increase taxes on private equity flips and other Wall Street churning and impose punitive taxes on investment banking to recoup the grossly excessive profits made available to Wall Street by cheap liquidity and the TBTF one way bets, but get real economy production and the private sector back into the first place in the USA. Demote the Federal Reserve from the de facto fourth branch of government and put it in its proper place as a servant of the people, or get rid of it entirely.
Educate people that living in an industrial democracy means that private sector production and jobs take precedence over governmental largesse and bureaucratic nonsense. Welcome free trade, but if our free trade policies are not reciprocated, impose tariffs to equalize the playing field for our domestic industries.
Memo to America: it’s time to wake up from the dream of the FIRE economy, unlimited leverage, the exaltation of the bureaucracy and entitlements for all.
Great post!
Ditto! That’s the agenda Congress should be working on. Not absurd political theater…
“Class, repeat after me: nobody wants to hire anybody in the USA because the employer-employee relationship has been suffocated by excessive regulation and taxation.”
Absolutely. It’s much better to hire in China where wages are low and you’re free to dump pollutants directly into the rivers.
As I remember, the housing market did just fine before the S&L deregulation of the early ’80′s. Twenty percent down was standard and the bankers worked on a 3-6-3 paradigm. Borrow at 3%, lend at 6% and be on the golf course by 3 pm.
I also agree with JWG’s excellent post. Although, I am biased towards low regulation, the banks are acting more like public utilities than private enterprise. In addition, they are part of the monetary system. For these reasons, I believe the risks they are allowed to take need to be regulated.
how bout just eliminating bailouts? and government welfare?
All for that….
I am surprised to read this. Banks have all our capital. People are broke. When the gov reigns in spending the banks will be choked into submission. Then we will be back at square one. Just give it 3 more years.
Here’s a thought; raise the down payment requirement as prices rise and lower it as prices fall.
In other words the u.s. Should be thinking less money down with house prices so weak!
Memo to MMT’ers
Much of the housing stock in the USA will be demolished due to Peak Oil
BB,
Aren’t we supposed to be more sophisticated? We got past the down payment restriction decades ago. Now, we should want to return to an antiquated policy. Can someone please refer me to that moment in time when we went back to an old way that was long forgotten and economic gain was the result.
Since anyone who borrows more than they can support threatens the stability of the remainder of the system, it’s prudent to stop this activity at the gate.
A 20% rule does not do this as effectively as penalizing lenders severely for loaning to individuals (or companies) who cannot afford to service and retire the debt.
I say this because we are now experiencing the result of individuals just borrowing beyond their means because they could. Period.
The banking system is broken to the point where lenders are still encouraged by fat salaries and profit incentives to loan to increasingly high risk individuals. I believe that this is the source of the problem.
I also believe that more often then not, within this system, risk management is a misnomer for gambling and ‘taking a position’ is nothing more than a bet.
So remove the incentives, regulate lending into a non-profit venture and roll back the wages for the whole industry to the point where criminals do not look upon it as the ‘best legal game in town’.
I might also suggest that if you could do away with most of the multi-layered ‘risk management’ activity currently in place you might find that it would free up enormous capital to produce something of real utility.
Excellent comments, Mr Roche! Indeed, 20% would remove risky buyers from the market place, but this could be done without regulations…
The 20% down could be a threshold and with lower downs requiring higher mortgage rates…
Any down payment less than 10% would require a conventional loan, to be held by the leading institution…
The maximum amortization of 20 years…
20% down is unnecessary. There are plenty of responsible people who want homes and can fulfill their obligations with 10% down or less, and those loans were just fine before the easy credit era made lenders go crazy.
Banks need to rollup their sleeves and figure out how to control their risk without killing housing demand. They also need to be regulated carefully so they aren’t incentivized to disregard risk.
The last comment from Hans describes exactly how this has been done in the past. It’s called PMI..i.e. a penalty for being not so rich. And it used to work fine.
Is this complicated? I don’t think so. Don’t throw the baby out with the bath water.
Deregulation was the prime culprit in our recent financial and real estate debacle. Starting with Glass/Segall, then debt to capitalization ratio of 20 to 40/1, relinquishing of the “uptick” rule for shorting the market, ridiculous creative financing, and all the mortgage securitization and derivatives. If all of the above were regulated even minimally, it would be smooth sailing and prosperity would not just be a pipe dream my friends.
We’ll see more renters because not many people will be able to put twenty percent. Home ownership will be out of reach for many Americans.