Commentary

This paper was presented at the conference "Policies to Promote Affordable Housing," cosponsored by the Federal Reserve Bank of New York and New York University's Furman Center for Real Estate and Urban Policy, February 7, 2002. It was part of Session 4: Housing Subsidies and Finance, and is a commentary on "Comparing the costs of federal housing assistance programs" by Denise DiPasquale, Dennis Fricke and Daniel Garcia-Diaz.Housing - Finance ; Rent ; Housing policy ; Housing - Prices ; Construction industry ; Housing subsidies

The Ongoing Financial Upheaval: Understanding the Sources and Way Out

The present period of financial instability is also likely to become known as the end of an era; an era of economic calm and policy consensus on ways to maintain market stability. After World War II, the federal government operated on the Keynesian principles that the right mix of spending, regulation, and interest rates could tame economic cycles and eliminate surges of unemployment. In this period, now known as the Great Moderation, we assumed that we knew how to prevent economic crises, such as the recurrence of the Great Depression. However, it is clear that those principles were erroneous as the economy has entered a lesser, but still severe downturn; the Great Recession. This paper looks at the sources of the ongoing economic crisis and points to the unique role in its origins of real estate asset bubbles and mispriced credit, not only in the origin of this crisis, but of many financial crises. An analysis of the data points to the role of mispriced mortgage backed securities (MBS) in the spread of aggressive mortgage products and the unwarranted price speculation that resulted in massive foreclosures. In turn, the paper addresses the source of mispriced risk in MBS as incomplete markets in real estate and non-tradability of MBS and related securities, which ultimately led to the collapse of financial system, threatening global economic health. The paper also suggests corrective measures that can and should be taken to assist the short and long term recovery.

Immigration and the neighborhood

What impact does immigration have on neighborhood dynamics? Within metropolitan areas, the authors find that housing values have grown relatively more slowly in neighborhoods of immigrant settlement. They propose three nonexclusive explanations: changes in housing quality, reverse causality, or the hypothesis that natives find immigrant neighbors relatively less attractive (native flight). To instrument for the actual number of new immigrants, the authors deploy a geographic diffusion model that predicts the number of new immigrants in a neighborhood using lagged densities of the foreign-born in surrounding neighborhoods. Subject to the validity of their instruments, the evidence is consistent with a causal interpretation of an impact from growing immigration density to native flight and relatively slower housing price appreciation. Further evidence indicates that these results may be driven more by the demand for residential segregation based on race and education than by foreignness per se.Immigrants

Real Estate Booms and Banking Busts: An International Perspective

Real estate cycles and banking cycles may occur independently but they are correlated in a remarkable number of instances ranging over a wide variety of institutional arrangements, in both advanced industrial nations and emerging economies. During the recent Asian financial crisis, the most seriously affected countries first experienced a collapse in property prices and a weakening of the banking systems before experiencing their exchange rate crises. Countries where banks play a more dominant role in real estate markets and hold a greater percentage of assets are the most severely affected during such a crisis. In this paper, the authors develop an explanation of how real estate cycles and banking crises are related and why they occur. The authors first discuss how real estate prices are determined and why they are so vulnerable to deviations from long-run equilibrium prices, paying special attention to the role of the banking system in determining prices. Increases in the price of real estate may increase the economic value of bank capital to the extent that banks own real estate. This then increases the value of loans collateralized by real estate and may lead to a decline in the perceived risk of real estate lending. For these reasons, an increase in real estate prices may increase the supply of credit to the real estate industry which is then likely to lead to further increases in real estate prices. The opposite is also true. A decline in the price of real estate will decrease bank capital by reducing the value of the bank's own real estate assets as well as reduce the value of loans collateralized by real estate. This may lead to defaults, thus further reducing capital. A decline in the price of real estate is also likely to increase the perceived risk in real estate lending. All of these factors reduce the supply of credit to the real estate industry. Supervisors and regulators may also react to the resulting weakening of bank capital positions by increasing capital requirements and instituting stricter rules for classifying and provisioning against real estate assets, leading to even further decline in prices and supply of credit to the real estate industry. In order to explain how real estate cycles begin, the authors turn to a model of land prices developed by Mark Carey that details the role of optimists in the process. They then bring in the role of non-financial variables as well as of banks and then turn to the part played by "disaster myopia" -- the tendency over time to underestimate the probability of low-frequency shocks -- in determining cycles. Other factors that contribute to cycles are inadequate data and weak analysis by bank managers as well as "perverse incentives" -- one result of "disaster myopia" that occurs when lenders believe that they can accept higher loan-to-value rations, weaker commitments or guarantees and looser loan covenants without increasing their risk of loss. Using this framework of the interactions between the real estate market and bank behavior, the authors interpret recent examples of real estate booms linked to banking crises in Sweden, the United States, Japan and Thailand. They then discuss measures that can be taken to limit the amplitude of real estate cycles and ways to insulate the banking system from real estate cycles. They believe that the heart of the problem is the structure of the real estate market and that cycles can be avoided by taking measures that counter: The bias towards optimism; Excessive leverage; Disaster myopia; Inadequate data and weak analysis; Perverse incentives. The authors detail their recommendations for avoiding these problems in the future. These include the development of an options market for commercial real estate, greater reliance on equity financing, changes in supervisory policy that allow the identification of vulnerable banks before they become weak banks, better publication of information relevant to the valuation of commercial real estate projects, and refraining from providing full protection to all bank creditors, especially sophisticated creditors such as corporations, banks, and institutional investors.

The Market Structure of Securitisation and the US Housing Bubble

Housing finance and, specifically, the subprime private label securitisation market in the US, was at the epicentre of the global financial crisis. Excessive debt expansion in the run-up to the crisis resulted in credit risk, under-identified and mispriced ex ante, and in systemic risk. This paper considers the role of financial innovation in debt markets and the changing market structure of securitisation in the evolution of the US housing price bubble. New financing vehicles contributed to growing risk, but the more salient factor was the change in the structure of securitisation, which led to unsustainable levels of debt

The Housing and Credit Bubbles in the United States and Europe: A Comparison

A house price boom occurred simultaneously in the United States and in a number of European countries from 2003 to 2007, accompanied in each case by an expansion in housing finance. This article considers the role of financial innovation along with incomplete markets in these cycles

The housing finance revolution

Housing ; Housing - Prices ; Mortgages

Next Steps in the Housing Finance Reform Saga

Momentum seemed to be escalating in early 2014 for the passage of a comprehensive reform package of the housing finance system in the U.S., but that was not to be, as neither political party fully supported its passage, derailing the progress made over the previous few years. While consensus around the primary features of reform has grown, new research that questions these assumptions needs to be addressed and the inertia keeping the country mired in the current, uncertain system needs to be overcome. In this brief, we will discuss the progress made thus far en route to reform, analyze the disparate elements of the leading proposals, and incorporate new findings that will shape the additional research that must be done before policymakers can agree on the best path forward.https://repository.upenn.edu/pennwhartonppi/1025/thumbnail.jp

Immigration and the neighborhood

What impact does immigration have on neighborhood dynamics? Within metropolitan areas, we find that housing values have grown relatively more slowly in neighborhoods of immigrant settlement. We propose three nonexclusive explanations: changes in housing quality, reverse causality, or the hypothesis that natives find immigrant neighbors relatively less attractive (native flight). To instrument for the actual number of new immigrants, we deploy a geographic diffusion model that predicts the number of new immigrants in a neighborhood using lagged densities of the foreign-born in surrounding neighborhoods. Subject to the validity of our instruments, the evidence is consistent with a causal interpretation of an impact from growing immigration density to native flight and relatively slower housing price appreciation. Further evidence indicates that these results may be driven more by the demand for residential segregation based on race and education than by foreignness per se