Monday, January 16, 2017

Housing: Part 200 - Dodd-Frank

In the previous post, Ben Cole referred to this recent Washington Post article.  The article is about research from Foote, Loewenstein, and Willen that finds that there is little evidence for blaming the housing boom on credit to low income households.

My research explains why Foote, Loewenstein, and Willen are right that marginal lending wasn't a cause of the boom, why Mian and Sufi were mistakenly led to think there was, and why, by ignoring the importance of rent and geographic exclusion through housing, they are all wrong to miss the importance of supply in the middle of all of it.

In short, Mian and Sufi focus on the difference between homes in the top tier and bottom tier of each city, and control away the differences between MSAs.  The difference between MSAs is the story.  FLW argue that since credit and the bust extended across the spectrum of households, that irrational exuberance and speculation must have also extended across the spectrum.  But, incomes and rents in the Closed Access cities where homes were bid up to the highest prices have continued to rise just as strongly as they had before, if not more strongly.  So, despite our national efforts to keep money out of housing, home prices in those areas have also been strong.  If the country was full of housing speculators, they were prescient speculators.

As Willen says in the article: “Our understanding of asset prices is still quite primitive,” he said. “We don’t have a really good explanation for why house prices went up as much as they did.”

I do.  I hope they believe it when they see it.  It confirms their findings.  Notice that even the heterodox researchers of the housing bubble, when left with a gap in understanding, default to the speculation thesis.  This bias is deep and broad.

The article ends:
Alan Blinder, the former vice chairman of the Federal Reserve under President Bill Clinton, said that the decisions made on Wall Street merit scrutiny, even if subprime lending was only one aspect of the broader problems in the market.“There was a big housing bubble, a craze, and house prices just went through the roof,” Blinder said. “That by no means exonerates Wall Street.”
Contrary to Rep. Jeb Hensarling (R-Tex.), chairman of the House Financial Services Committee, and his Republican allies on Capitol Hill, Blinder warns that another major financial overhaul could give bankers too much leeway.
“It would be a horrible mistake to dismantle Dodd-Frank,” he said.

I think I have posted a version of this graph before.  It compares the relative home prices of the top and bottom quintile zip codes of each group of MSAs since 1999.  I had been concentrating on the divergence between the top and bottom quintiles after the GSEs were taken over and the Fed finally messed up badly enough that even they started providing nominal support in early 2009.  Top tier homes stabilized after that, but bottom tier homes continued to fall.  The GSEs basically stopped lending to the bottom tier.

But, I had neglected to pay much attention to that odd false nadir in relative home prices in mid 2010.  Guess what was passed in July 2010?  Notice the difference between top and bottom tier home prices before and after July 2010.

Beware the public official seeking "prudence" in the midst of a crisis.


  1. There is a thicket of misinformation out there.

    Your book should be sold alongside a chain saw.

  2. Why would Dodd-Frank alter the attractiveness of one mortgage vs another?

    1. CFPB and qualified mortgages. They set a risk standard below which banks are protected and above which banks are given extra liabilities. Riskier borrowers have more liability attached to them.

  3. Surprised as I was to see WaPo actually give air time to any other than the conventional narrative on the housing crisis, the ending was pretty disappointing. They all but concede that Sufi and Mian's explanation is inconsistent with the data, they leave us with the impression that 1) Willen et al. failing to provide a good alternative hypothesis somehow negates their solid refutation of the standard hypothesis, and 2) that, even though, if Willen at al. are right, and bank lending standards weren't the cause of the crisis, we should still increase regulation on them because 'better safe than sorry' or something, as though over-regulating the financial sector has no down side and won't gratuitously suppress productive economic activity.

    Never mind that, even we accept that more financial regulation is necessary, Dodd-Frank is still a horrible law because it seeks to simultaneously penalize banks for giving loans too liberally and for not giving loans liberally enough, by making it easier to sue banks for declining a loan. In other words there should be plenty for both sides of the argument to hate in Dodd-Frank.