Monday, April 16, 2018

Housing: Part 293 - How has Dodd-Frank hurt low tier housing?

I have asserted that Dodd-Frank has been especially damaging to low tier housing markets in the US.

How is this damage inflicted?

First, the data that triggers this conclusion clearly points to specific market segments as the sign of the problem.  Much of Dodd-Frank deals with banking regulations, in general.  If generalized regulations were at work here, then the effect would ripple throughout housing markets, and new entrants would find a way to issue profitable mortgages.  But, starting in the summer of 2010, with the passage of Dodd-Frank, there was a diversion in market values between top tier and bottom tier homes in many cities.  This isn't an effect on lending in general.  It is an effect on lending to homes with lower market values.

Much of the debate about Dodd-Frank revolves around those general regulatory issues.  And, as with all things housing, since there has been an erroneous consensus that bank recklessness caused a bubble followed by an inevitable bust, the premises that the consensus has been built on have defined the debate about Dodd-Frank.  Those premises include the basic presumption that home prices have generally either been correct or too high, and that drops in home prices should be generally regarded as a return to normalcy while rising prices portend danger.  These premises were so strong, that they led everyone to miss a generational defining policy error that has sapped 20% or more of market value from low tier homes in many cities.  So many problems could have been solved by simply allowing that value to be re-attained.

Not only has the peculiar shape of this dislocation gone largely unnoticed, its resolution has been ignored or even actively avoided, as when Fed officials note that rising asset prices create an additional concern for accommodating monetary policy, even as low tier housing markets are so eviscerated that homebuilders can't even fund the purchase of lots to build them on.  (Builders seem to view this as a "shortage" of lots.  Others seem to think builders are just blind to the existence of a market that they were supposedly over-supplying 12 years ago.  All of these problems would go away if we stopped imposing a 20%+ discount on the end product.  But, a 20% increase in home prices would trigger public consternation and a policy response.)

In any case, the generalized regulatory targets of Dodd-Frank have little to do with the damage it has inflicted on working class housing markets.  I think the damage has mostly come through the Consumer Finance Protection Bureau and the regulation of "ability to pay" through the Qualified Mortgage program.  (Here is a sense of the vague liabilities the law imposes.  From the link: "Your lender gets certain legal protections when showing that it made sure you had the ability to repay your loan. Even with these protections, you may still be able to challenge your lender in court if you believe it did not make sure you had the ability to repay your loan.")

CFPB oversight applies to both banks and non-banks.

The problem seems to play out through a combination of higher regulatory requirements and higher costs, together with limits on the amount of fees lenders can charge to help cover those costs (examples 1 , 2 , 3 ).  The correlation of price behavior with Dodd-Frank passage suggests that higher fixed costs have made smaller mortgages difficult to fund.  The "ability to pay" standard may be a primary influence here, or maybe it is simply the cost of establishing the ability to pay that prevents mortgages on smaller properties from being funded.

The rise in homeownership before the crisis had been among young households with high incomes, education, etc.  The decline in homeownership since then has also been focused on both young families and families with lower incomes.  So, the net result of the boom and bust has been to reduce homeownership among households with below median incomes.  Yet, the largest drops in homeownership have been among households under 45 years of age, even if they have high incomes.  The constraint seems to be hitting low tier- and starter home markets, in general.

The drop in lending to lower FICO scores seems to have happened earlier, when the CDO panic happened, the financial crisis hit and the GSEs were taken over.  There isn't any further shift in originations with Dodd-Frank.  There isn't any obvious shift in the rate of delinquency or foreclosure, either.  Yet, there is this shift in pricing behavior that happens coincidentally with the passage of Dodd-Frank.  The effect of Dodd-Frank seems correlated with the market value of the property.  And, this shift in prices should be surprising.  If it hadn't been swamped by the scale of everything else that had happened, it should have led to much public concern.

In a way, I am simply applying the same type of analysis that has been applied to mortgage markets during the boom.  Researchers used changing prices to infer the effect of credit supply.  There were forms of credit which were more flexible than they had been previously.  At about the same time, it seems that prices in low-tier housing markets increased.  It is difficult to attribute price changes to each individual lending decision, so the connection was inferred.

I am doing the same thing here.  There was a shift in public policy - here that had the explicit goal of removing credit access from certain borrowers.  A price shift happened at the same time.  There are mechanisms that could create that shift, mainly in the regulations through the CFPB relating to qualified mortgages.  I am inferring a connection.

Your first reaction to this should be that this weakens my argument, because I am using the same method of inference that I have objected to in the analysis about credit supply during the bubble.  The difference is in the scale of the evidence.  The relative shift in market values is greater, in scale, rate of change, and the number of cities that are affected.  In the handful of cities that did see low tier prices rise relative to high tier prices during the boom, I have presented a counter explanation for the cause.  It is possible, I suppose, that some counter explanation could explain why low tier home prices dropped in most cities after the summer of 2010.  As of today, I don't think there is any analysis published before the passage of Dodd-Frank that establishes a framework that led to an expectation that low tier properties would move roughly in line with high tier prices and then dramatically drop off after the summer of 2010 in cities like Atlanta, Seattle, and Chicago.

There are mysteries here, but if the argument that credit supply caused the housing boom was compelling, then this argument regarding Dodd-Frank seems at least as compelling.

Here are two graphs showing the home price behavior in the "other" cities that I described in the previous post.  (In these graphs, all prices have been indexed to 2000, and the measure is the monthly measure after 2000 of the average price of top quintile zip codes divided by the average price of the bottom quintile of zip codes.  The axis is inverted so that when low tier prices are declining relative to high tier prices, the lines move lower.)  These are cities that didn't generally take part in the housing "bubble".  Prices did rise in some, especially in Washington, Seattle, and Minneapolis, but as you can see in the graph, there wasn't much difference between low- and high-tier prices during the boom.  As I have described elsewhere, that was a phenomenon limited to a few cities where home prices were extremely high.  The only significant diversion between low- and high-tier prices in any of these cities during the boom was in Washington, Philadelphia, and Baltimore, where high-tier prices increased by more than low-tier prices.

In a few of these cities, low-tier prices had begun to drop before Dodd-Frank - Washinton, Detroit, Atlanta, and slightly in a few other cities.  But, the most common pattern here is for low-tier prices to remain within 10% of high-tier prices and then to diverge from high tier prices in 2010, so that after a few years relative high tier prices eventually were 20% to 80% higher than low-tier prices. (A measure equal to 1 means that high and low tier prices had changed by the same amount since 2000.  So, if the measure is 1.2, that means that high-tier prices had increased by 20% more than low-tier prices.)

I don't necessarily have a complete story here.  Maybe there isn't a way to directly connect the higher fixed costs of lending to specific changes in the market.  But, as with so many aspects of the issues I have uncovered, before we even address the gritty details, we should keep in mind how radically off-base the conventional narrative is for most cities.  Low-tier homes didn't explode to some unsustainable value, fed by loose credit, then inevitably collapse.  In most cities, prices across the city moved, more or less, in tandem.  Then, generally after the summer of 2010 - after the recession, after most mortgage delinquencies had happened, after employment began to recover, etc. - low tier prices in most cities experienced a relative valuation shock that was larger than anything which had happened before.

This has surprised me as much as anyone.  The scale of events during the boom and bust led me to miss the significance of Dodd-Frank, also.  Only recently have I noticed how late and how peculiar the home price deviations were in most of the cities that weren't Closed Access or Contagion cities.  And, I don't think this has much to do with the foreclosure crisis.  Many owners in these markets are long-time owners with large amounts of home equity.  So, rather than showing itself in more crisis-like dislocations, this has mostly affected two different markets: (1) older, working class homeowners who have lower net worth because their homes' values have been knocked down, and (2) young, first-time aspirational buyers who have delayed the purchase of their first home.

I think that is partly why this has gone unnoticed.  The effect is mostly on things that have not happened.  Households who haven't purchased a first home.  Households who didn't tap home equity to get through tough times.  Households who didn't move because they either didn't want to sell their undervalued home or they couldn't qualify for a mortgage on a new home.  These are less dramatic changes than foreclosures and failing banks, but they aren't necessarily less damaging to the broad march of economic healing.

PS.  Thanks to Zillow for all of this great price data.

PPS. A new paper from Bordo and Duca that finds a similar effect of Dodd-Frank on lending to small business. (HT: Tyler Cowen)


  1. Remarkable insights. Excellent blogging.

    I wish your general message would get out. It is not access to credit that creates house price booms, it is a good economy married to artificial housing scarcity.

  2. A grim chuckle for Kevin Erdmann.

    The Hong Kong Monetary Authority is tightening up, trying to keep its dollar pegged against the US dollar.

    "Reflecting gradually tightening conditions in the banking system, the three-month Hong Kong interbank offered rate or Hibor rose 4 basis points to 1.26 per cent. Interest rate swaps (IRS), derivatives used for hedging against future rate expectations, rose at an even faster pace. The one-year IRS jumped 12 basis points to 1.89 per cent and five-year IRS climbed 11 basis points to 2.61 per cent.
    Analysts expect the combination of higher interest rates in the financial system would mean commercial banks also have to raise the important prime lending rate too, raising risks of piercing the city’s massive property bubble."


    As elsewhere, people say Hong Kong has fantastically expensive property, including housing, due in large part to easy monetary policies. They have not a property bubble, but a "massive bubble."

    In fact, the government of Hong Kong seems to work with developers to slowly regentrify one neighborhood after another, in succession. This works to the benefit of connected developers and bank lenders. Maps of Hong Kong reveal the island-peninsula has plenty of…farmland left. Yes, farmland. Also undeveloped hills.

    But even more basically, many neighborhoods could sprout high-rises, but are awaiting their turn.

    Housing has become so expensive that Hong Kongers are building and buying "nano flats," 200-300 square feet or so to live.

    As on the West Coast USA, many HK residents take a cynical view of developers, who they think plan to evict them from their long-standing average-quality neighborhoods, to effect an upgrade for rich people.

    Since the government is in fact following such a game plan, it is difficult to refute this point of view. The macro view is lost (by consensus).

    Property zoning is a disaster.

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