Mortgage Crisis

In Debt We Trust

Going in the wrong direction (privatedebtproject)

Going in the wrong direction (privatedebtproject)

As Slate writer Henry Grabar pointed out this week, the US reached a symbolic (but, admittedly, arbitrary) milestone in March when the total amount of household debt measured by the Federal Reserve reached $12.73 trillion, surpassing the previous high in 2008.  There’s nothing inherently wrong with holding debt - capitalism can’t function without it - but the type of debt that Americans now hold has changed considerably, especially in the last ten years, and the trend is troubling.  This change is inescapably linked to the affordable housing crisis and the larger crisis of late capitalism that we are slowly waking up to. 

Home mortgages make up the vast majority of household debt ($8.63 trillion, 68%), which is to be expected, but student loans ($1.34 trillion, 11%) and car loans ($1.17 trillion, 9%) have risen as a share of total debt to a remarkable degree just in ten years (from 5% and 6%, respectively).  Credit card debt ($764 billion, 6%) and home equity credit ($456 billion, 4%) are the other large debt categories, but like mortgage debt, their relative share of total debt are about the same over 10 years.

I pointed out earlier that the milestone of $12.73t is basically arbitrary because it’s not adjusted for inflation and doesn’t contextualize the overall growth of the economy.  Relative to the size of the economy, this level of debt is 67% of GDP, down from 85% of GDP in 2008 at the height of the crash.  You could argue that this shows we are in better shape than 10 years ago, which is true, but it also shows that even “better shape” is not very good.

So what does this all mean? And how does this inform the affordable housing crisis?

Basically, all of these numbers reinforce the narrative that Americans, particularly of the younger and poorer variety, are struggling to gain security in today’s economy at an unprecedented scale – even as the economy continues to grow and corporate profits continue to increase.

Having a degree, having a car, and having a house used to be affordable ways to gain entry into the middle class.  But these assets are exponentially more expensive today than 30 years ago and we are going into greater debt to get them.  What's worse, they aren’t the guarantees of security they used to be.  That’s not a sign of a healthy economy or society.

There is one simple explanation for why this is happening: workers are not getting paid enough.  Since 1973 the average economic output per worker has grown by 72%.  That’s a steady clip of increased productivity (though it has slowed down) and is partly the result of the Information Technology revolution in the work place.

However, during that same period, average wages have only gone up by 9%.  Since 2000, this gap has gotten even bigger. Productivity has increased by 21% but wages have only increased by 2%.

As the Economic Policy Institute points out in a 2015 report, this was no accident. The explosion of compensation at the top end of the pay scale and the concentration of profit at the shareholder level (as opposed to labor) are the direct results of 30 years of federal regulatory, trade, and tax policies.  We live in a deeply unequal period as a result of a particular form of government intervention.

(As the recent American Airlines effort to raise wages shows, even corporations that try to buck this trend are punished in the market.)

It’s no surprise that by the late 1970s household debt started rising rapidly while personal savings decreased rapidly. By the early 1990s, the average Americans household had more debt than savings (as the picture at the top of this article shows). This trend has only gotten worse, despite a slight dip during the Great Recession. 

Our consumer culture didn’t adjust to a decrease in wages (or even put political pressure on increasing wages.)  It simply created new financial tools to allow us to keep spending.

There has long been the basic idea that there is “good debt” and “bad debt.”  Good debt is an investment in the future, like taking out a loan to build a bigger factory, which pays for itself in the long run. Bad debt is borrowing from the future to cover today, like a pay-day loan or covering operating costs with capital budgets. That rarely works out.

The problem today is that it’s no longer clear what debt is good and bad.  Student loans were generally seen as good debt - an investment in acquiring skills that will pay off in the long run in a higher salary - but its unclear what skills will be valued and at what salary in the near or long term economy.  The cost of undergraduate and graduate degrees have also increased dramatically as we have placed more importance on them as a society – all while their value has become more uncertain.

Nowhere is this debt doubt more apparent than homeownership. Even though homeownership rates are at the lowest they have been in 50 years, 64% of Americans still own their home. This represents the bulk of American households’ wealth and financial security.

As I’ve written before, that’s no accident or organic market outcome either.  It has been a concentrated policy effort at the federal level for 80 years.  We spend $134 billion a year subsidizing homeownership in this country – more than the entire budget of the Dept. of Justice, Education, and Energy combined.

The thinking was (and still is for the most part) that homeownership drives economic growth nationally and economic security personally.  (We really don’t know if that’s the case objectively because our society has been built around subsidizing this theory.) But, despite all of this intervention, these two basic conceits are not holding up in the modern economy. 

First, the idea that homes are guaranteed financial security is largely not true over the long run.  Robert Schiller has written often about how, despite the hype of house flipping or the recent bubble, home values on the national level haven’t increased at all.  For every hot real estate market like Las Vegas, there is a dying one in Youngstown, Ohio. 

Additionally, the foreclosure crisis never really ended.  There are still 3 million Americans underwater in their mortgages and many millions more that are dangerously close.  There has been a steady, if slow, increase in foreclosures in several markets.  Another downturn and we could see another spike.

Finally, and perhaps most troubling, there is an entire generation of suburban homeowners in certain markets (the Northeast and Midwest in particular) retiring whose wealth is tied up in homes that no one wants to buy.  The paper wealth associated with a home is only real if someone buys it at that price.  Long term demographics and economic development trends should cast serious doubt on the value of many of these homes in the near future.  

Second, the emphasis on homeownership (particularly in far-flung suburbs) is terrible for the national economy’s future.  All signs point to millennials wanting to own homes just like any other generation, but that doesn’t mean they will want to live where cheap single-family homes are available, because those areas don’t generally have a concentration of accessible, high-paying jobs.

On the flip side, high-paying jobs are increasingly concentrated in cities with highly regulated land use and, not surprisingly, housing prices have skyrocketed.  The economic benefit of high wages are largely gobbled up by big down payments and expensive mortgages, which limits the ability for a household to invest in other purchases.  

The federal government has consciously created the affordable housing crisis through debt on two fronts.  On the one hand, they have spent decades, along with billions of dollars, encouraging suburban homeownership through subsidizing mortgages among other policies, which has counter-intuitively created an asset class that has little re-adaptability as the economy changes along with demographics. Millions of Americans have wealth tied up in their homes that might simply vanish in the coming decades.

And on the other hand, they have instituted 40 years of economic policy that has frozen wages for the majority of Americans while lavishing profits on the top individuals and biggest corporations.  They have allowed increasingly exotic and pernicious financial tools to mask this scandal by allowing people to build massive amounts of personal debt.  Only after the crash did they properly regulate the mortgage market (now 60% of mortgages go to individuals with high credit scores, double from a decade ago) while other debt markets (particularly car loans) are largely under-regulated. 

Because there is no such thing as the free market without government intervention, we must re-examine what economy we want our government to create.  Do we want a debt-riddled society that is financially vulnerable at a near-permanent level? Do we want a society that politically and financially rewards a tiny percentage of the population at the expense of the rest?

Our government has created a homeownership society that is increasingly based on higher levels of debt. It has the power to create an affordable housing society that doesn’t rely on debt.  It’s up to us to make it do so.

Meet Your New Landlord, America: Wall Street

What mortgage crisis? (NYT via RealtyTrac)

What mortgage crisis? (NYT via RealtyTrac)

The New York Times has been running a series about the quietly dominant role private equity firms have started to play in many aspects of our lives - from responding to 911 calls to writing local laws - but this week it finally addressed what I think these firms are having the biggest impact on: buying and renting homes.  I've written a number of blogs about how the mortgage crisis never really ended and that is partly because private equity firms swarmed the housing market as banks retreated after the 2008 crash. Despite putting billions of dollars into housing, these firms have only masked the crisis and have not solved it by any means.

Over the past 6 years alone, a small handful of private equity firms have bought up over 500,000 homes across the country while avoiding regulations that banks were subject to which were intended to prevent foreclosures.  As a result, instead of fundamentally addressing the structural causes of the foreclosure crisis, we have in many ways maintained the same problem with fewer policy tools at hand to address them.

I won't rehash all of the details of the 2008 crash here, but want to point out that an estimated 10 million Americans lost their homes during the crisis, representing the single largest collective migration of Americans in history.  

The basic formula for the crisis, as I've seen it, had three pillars:

1. Unfounded societal preference for homeownership.  

2. Excessive governmental support for homeownership.  

3. Reckless financial exploitation of homeownership. 

You simply can't create such a devastating, slow-moving event like the 2008 crash without indicting everyone.  We've crafted the American Dream to include a house and a green backyard as opposed to an apartment and a public park. We've created 80 years of laws to subsidize homeownership for some while excluding most minorities. And we've actively or passively encouraged financial practices that range from unethical to illegal. So the next time you hear someone say "Well, that person should have known they couldn't afford a $600,000 house," remember that everyone was telling that person that they could and should. The deck was thoroughly stacked against them.

When the crash occurred, millions of homeowners were defaulting on mortgage payments and the institutions backing those mortgages came under considerable financial pressure, particularly Freddie Mac and Fannie Mae, the federally-sponsored private companies that back most private home mortgages in the country.  As I've previously discussed, there is an ongoing debate about how much trouble Freddie and Fannie were actually in, but the Bush Administration and then the Obama Administration balked at pressure from financial leaders to deem the companies at-risk and took them over, infusing them with nearly $500 billion in tax dollars. 

At this point, the US Government had several options to solve the crisis. They could 'bail out' the financial institutions providing liquidity for the mortgage market and hope that the market self-corrects; they could 'bail out' homeowners and reduce principal payments on individual mortgages relieving millions of Americans of the risk of losing their homes; and they could prosecute rouge actors in the market and further regulate how banks provide mortgages to homeowners. They could also begin to address the underlying economic and cultural conditions that led to the crisis in the first place.

Technically, the US Government has done the first three, but realistically the main trust of the government's intervention, the Troubled Asset Relief Program (TARP), bailed out financial institutions and ignored homeowners and bad actors. Of that $500b I mentioned earlier, only a small portion went to actual homeowners, resulting in only about 1.2 million who received even modest principal reduction on their mortgages.  As for sending people to jail, only some of the smaller, egregious actors in the market were prosecuted while major banks such as Wells Fargo and Bank of America escaped with slap-wrist fines.  And finally, there wasn't much discussion about root causes of the crisis or what broader policies could be created to address them.

Ironically, it was some of the regulations introduced during this period, and further flushed out in Dodd-Frank, that caused banks to turn away from mortgages, leaving a vacuum for private equity firms. Whereas banks were required to seek out low-income homeowners and to resist foreclosures at all-costs, private equity firms do not face any such restrictions or mandates.  Why? Because banks borrow money from (and are accountable to) the government and private equity firms don't, relying instead on private investors. 

What is more troubling is the government's eagerness to work with private equity firms in the housing market despite not obtaining the same policy compromises from banks. Federal housing agencies have sold off over 100,000 homes with trouble mortgages to these firms in the last few years, often at steep discounts of 30%. If the US government valued low-income homeownership and averting foreclosures so much, you would think it would require similar concessions from private equity firms in order to get such good deals.

In theory, private equity firms buying these troubled mortgages have some positive effects.  By one count, 10% of mortgages sold to these firms were abandoned homes that were put back on the market.  This obviously is good news for some buyers and surrounding homeowners.  The billions of dollars put into the housing market have also stabilized housing prices nationally, certainly helping millions of other homeowners. This has dulled the overt signs of distress from the mortgage crisis.

In practice however, it appears that private equity firms are not having a completely positive impact on the communities they are operating in.  By most accounts, they are more likely to foreclose on residents than banks.  The NY Times found that one company, Lone Star, has foreclosed on 20% of the properties it has bought from the federal government and only restructured about 9%. This has proven especially true in certain markets that have rebounded faster than the country as a whole.  Parts of Florida and Ohio where these firms own homes have seen higher foreclosure rates than other states.  These firms are clearly clawing back and flipping houses that are recouping value quickly and sitting on ones that aren't until they do. They don't appear particularly concerned about the impact those decisions have on the residents and communities affected by them and, in their defense, they don't have to be.

Far from restoring the housing market, this type of massive speculation further warps it by encouraging more foreclosures that harm families and communities (often by massive conflicts of interests within these companies), removing housing stock in attractive markets from local buyers (or putting more pressure on prices), and by trapping people in false foreclosure proceedings through clerical errors due to amassing millions of mortgages in a short span of time. 

As many housing advocates, housing lawyers, and, increasingly, government officials are starting to notice, private equity firms are no better at handling the crisis than banks or government agencies and might be worse. They have not kept enough people in their homes. They only focus on markets that probably would have recovered anyway while ignoring potentially needier markets.  They are also only beholden to investors - and the returns on the bonds created by these assets have been keeping them happy.  (A further irony is that some of these investors are public pension funds that likely have members that are being affected by the crisis.) This is the best outcome we can hope for?

This is why I maintain that the mortgage crisis has never ended.  Those three basic housing pillars that led to it are still in place.  Unless we question and reassess all three of these pillars, we're just going to recreate the crisis over and over again.  We can't keep relying on exotic financial products to 'cure' the housing market whether they come from private equity firms or banks. We must create policies that create affordable housing in a variety of forms in a variety of places. We can't keep allowing the government to warp housing policy which gives away too much tax money while preventing too many Americans from actually finding a secure home.  We must steer federal policy towards housing as a right and not a wealth-vehicle. Finally, we can't keep clinging to the false notion that homeownership is the key to the American Dream. Perhaps it is for some Americans, but surly having a safe, affordable place to live whether you own it or rent it should be obtainable for all Americans.

Right now our public and private sectors are failing us all in housing.  We can keep punting on addressing the economic conditions that make it so difficult for Americans to afford a decent home on the one hand but make it so attractive for powerful financial institutions to exploit it on the other. We can keep papering over the dire conditions that many homeowners and renters are currently in hoping that the economy bails us out. Largely because of private equity firms stepping in as our nation's landlord, many of us have stopped worrying about it altogether. Recent history should make us wary of stopping there.