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On Housing Defaults

I’ve not wanted to weigh in on the housing market too much over the past couple of years, perhaps out of bitterness from getting crushed in the crash. But I feel better now. Some of the more reasonable people out there are recommending very simple reforms to the housing market, in particular eliminating all of the exotic loans and refocusing on the traditional, plain-vanilla type of mortgage loan.

That loan is a 30-year fixed rate mortgage, with a 20% downpayment. There are many simple and complex reasons to desire this. The major one is that these loans are far less likely to default – both the statistical models used by investors, regulators and housing agencies prove it, and common sense proves it.

It is believed that these loans are safer for two reasons. First is that the 20% downpayment provides a lot more cushion for the borrower if house prices fall. If I only have 5% down, then two years of small house price declines put me underwater and perhaps incentivize me to stop paying my mortgage. But if I have 20% down, then I am less likely to leave if I still have 10% or 15% still into the property. The second reason is psychological, or so I am told. Folks with 20% down rather than 0 down or 5% down, have more “invested” in the property and so will have a greater attachment to it. I am not so sure about that.

My point is that a big giant elephant is in the room (not ominous) when it comes to the reason why these “loans” (they are people, not pieces of paper) are better behaved. Perhaps there is something unobservable about people that have had the prudence and discipline to put away enough money for a 20% downpayment that makes them less likely to default than an otherwise similiar person who has not done the same thing. Note that what I am talking about is independent of income, education, etc. – I am making a ceteris paribus claim.

Why should you care? Well, if reforms go through allowing only this one type of loan, yet you are one of the people with the discipline and intention of staying in your home and making payments, then it will be harder for you to get a mortgage. That might be a good thing – after all, renting is not the end of the world. But if you like to have the option of buying a home, then perhaps you should be slightly worried. Credit scoring is supposed to take care of some of this problem by the way, but that process is being looked at as being discriminatory and otherwise undesirable.

2 Responses to “On Housing Defaults”

  1. harry says:

    Wintercow, my sympathies, in several ways. Generally, when anyone in government tries to determine how the market should behave, they invariably screw it up. I’m not sure whether they ever got it right.
    This is not to say that reserve requirements for FDIC – insured banks have not contributed to stability for decades, or that laws requiring consistent accounting standards help people guard their property. I’m just worried when Chris Dodd and Barney Frank are at the helm, and are in bed literally and figureativellay with the guys who run the bank. Who are they to get in between you and someone who wants to take the risk of lending to a principled, upstanding, professor from Rochester, for whatever reason, provided that the lender takes the risk with his own money?

    I know the story about buying two banks, one which bets interest rates rise, and the other that bets interest rates fall. Our system should prevent, not encourage, them from doing that with other people’s money.

  2. harry says:

    Guess that’s figureatively

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