It has been nearly ten years since the housing crisis led to the worst recession since the Great Depression. Thus, it may be a good time for some reflections.
The first reflection is that government subsidies to promote home ownership are counterproductive. These subsidies did increase the home ownership rate from 64% to 69% between the mid-1990s and mid-2000s, but then it fell to 63% due to the crisis. Today, the home ownership rate is no higher than what it was during the 1960s. Government subsidies for the purchases of houses, especially non-owner occupied houses, should be curtailed. In the states hardest hit by the housing crisis, mortgages for non-owner occupied houses comprised nearly half of the market.
The second reflection is that owning a house is not optimal for everyone. The zero down, interest-only mortgages that were popular prior to the crisis simply turned people into glorified renters, but with more downside. A person holding this mortgage builds no equity and can quickly find himself underwater (owing more on the mortgage than the house is worth) if house prices fall. This makes the house impossible to sell, which makes it difficult for the person to move for a new job. However, a renter can easily move once his lease expires. Workers have become less mobile in recent years, which has hindered the economic recovery. Difficulties in selling their homes is a reason why.
The third reflection is that down payments should be encouraged. If someone puts 20% down on a mortgage, house prices have to fall by more than 20% for the mortgage to be underwater. If there is no down payment and house prices fall, the mortgage is instantly underwater. This gives the purchaser an incentive to simply walk away from the mortgage and let the house fall into foreclosure. This amplified the wave of foreclosures during the crisis.
The fourth reflection is that the “originate and hold” model of mortgages needs to return. Mortgage lending used to be done by banks that would then hold the mortgage in order to earn a profit from the interest paid by borrowers. Such a system gave banks incentive to issue high quality mortgages to safe credit risks, since the issuing bank directly bore the cost of default.
Now, mortgages are issued by an issuer and then sold to a different bank. This bank packages different mortgages together into a bond, which is then sold to investors. Because the original issuer does not hold the mortgage, it does directly bear the cost of default, which reduces its incentive to issue high quality mortgages with a low risk of default. Moving away from this type of lending would also avoid the types of mortgage bonds that amplified the crisis and brought down Wall Street, as was seen in the movie, The Big Short.
Financial crises, unfortunately, happen on a regular basis. Making sensible reforms in the areas outlined would help ensure that housing is not part of the next one.
