October 28, 2004
WELL, SURE IF THEY DIDN'T HAVE TO PAY RENT INSTEAD...:
When Home Buying By The Poor Backfires: For many families, a house can be a bad investment (Peter Coy, 11/01/04, Business Week)
Mildred Wilkins calls it "falling out the back door." It's what happens when low-income families who have bought their first houses are forced out because they can't keep up the mortgage payments. Says Wilkins, an Indianapolis consumer advocate who once worked for Fannie Mae (FNM ) selling foreclosed properties: "I don't care if you put five families in the front door if three families fall out the back door." [...]The most important argument of those who advocate increasing homeownership among the poor is that instead of throwing away money on rent, they can automatically save money and build wealth by paying off their mortgages. [...]
On top of that, returns on housing tend to be lower than returns on stocks -- and the risk is high when the vast majority of a family's wealth is tied up in a single, undiversifiable asset. Economists William N. Goetzmann and Matthew Spiegel of Yale School of Management argue that low-income homeowners would do better investing in lower-risk, more-liquid assets such as stocks and bonds. In a 2001 paper, they wrote that "it seems likely that sometime in the next 20 years a substantial number of the 'beneficiaries' of this policy [of promoting low-income homeownership] may find their meager savings severely diminished, if not totally depleted." [...]
Advocates of wider homeownership correctly observe that a house is the only asset a family of limited means can buy with a big loan, which juices returns. "Because home buying is a highly leveraged investment, potential increases in the values of homes can bring rich returns," the HUD study notes. [...]
When congress passed the Community Reinvestment Act in 1977, it was because banks wouldn't make loans in poor areas. But the tide has turned. Now many banks and finance companies specialize in high-rate loans to low-income families -- generating so many loans that federal regulators are proposing to exempt small banks from the rules. Subprime lenders earn enough money on the loans that don't go bad to swallow some foreclosures. That would be fine if investors bore the full cost of those losses, but they don't. The most important losses are felt by the families who lose their homes and the neighborhoods they live in, says Paul Bellamy, executive director of the Lorain County Reinvestment Coalition in Ohio.
Homeownership does have some important social advantages. Economists such as Harvard's Edward L. Glaeser have found that homeowners are more likely to vote for measures that have short-term costs and long-term benefits, such as new roads. People also take better care of properties they own. Studies by Donald R. Haurin of Ohio State University and others have found that children of homeowners do better in school than children of renters, holding other factors constant.
We'll set aside for now Ms Watkins argument that she'd rather no one succeed than that some fail and the absurd notion that if these folks weren't buying homes they'd be buying stocks with what's left after they pay rent and that's a better deal--the most important point here is that at a fairly low failure rate such home ownership has exactly the social consequences that advocates promise, making the owners and their kids better citizens. No small feat that. Posted by Orrin Judd at October 28, 2004 8:26 AM
I'm continually amazed on the bad advice that these magazines pass off on unsuspecting readers and novice investors. There is never any follow-up, criticism, or blame acceptance when their recommendations don't pass the test of time.
The cost is tragic for those who couldn't afford the risk, but followed their "advice" anyway. If they had made sound financial decisions instead, it would've made a huge difference in their upward mobility and greatly improved their well-being.
Posted by: capt mike at October 28, 2004 9:10 AMOne of my acquaintances who lives in a very upscale neighborhood here in Atlanta complained about the effects of the CRA - people living in giant houses yet not a stick of furniture in the entire house. The folks default on their loans in a 9 months, a year or 18 months.
I suppose investing in a lesser neighborhood would have met with success. I am not sure what the lesson is here.
Posted by: Bruce Cleaver at October 28, 2004 9:21 AMBruce,
I think the answer is that too many people treat investing as gambling and don't understand the risks involved in either activity.
Posted by: capt mike at October 28, 2004 9:45 AMI have noticed the same: families buying the absolute most house they can afford (probably down to the last $1 per month), and then barely surviving. But is that really a function of too much hope for appreciation, or just too much lust in wanting the biggest possible house NOW?
I fail to understand why Ms. Wilkins is upset that 5 - 3 = 2. Isn't +2 better than 0?
Posted by: jim hamlen at October 28, 2004 10:22 AMHow are stocks a better investment than a home? It would seem that the leverage provided by the mortgage, even better with deductible interest, would make a home a much better investement.
Posted by: Jorge Curioso at October 28, 2004 11:28 AMCertainly many families do not know how to financially plan, but our schools never teach it. They also can't rely on their parents adive because the lending situation is so different now. They probably expect the experts they use - real estate brokers and their banker - to give them the right advice.
Too bad neither actually cares about putting them into a home they can afford - they just want to make money. So the broker shows them expensive homes he can make a tidy profit on, and the banker doesn't care if they default because they can just seize the home and the overall usurious rates they charge on these people make up for the default rate.
There is an excellent book called THE TWO-INCOME TRAP that talks about this along with other ways families go bankrupt.
In terms of social policy, we should discuss whether the social costs of having so many bankrupt people outweigh the benefits of those poor who now have homes. If they do, we need to change the laws even if it means some people won't own homes. If they don't, then we can keep them even though some people will be severely hurt.
With the repeal of the usury laws, credit cards and banks are taking advantage of a lot of people. I hear more people complaining about them.
Posted by: Chris Durnell at October 28, 2004 11:41 AMJorge Curioso
"even better with deductible interest"
Interest on loans to buy stock is also deductible, isn't it?
Posted by: h-man at October 28, 2004 1:36 PMSimilar story in NYT. My real estate adviser forwarded it to me last week with a note that he sees some signs of it here.
Here, of course, being a place where the average house costs $750K.
Anyhow, Orrin, as an FDR fan, I thank you for your generous praise of his finest program.
Posted by: Harry Eagar at October 28, 2004 2:07 PMReal estate is probably not a good investment right now as the interest rates are as low as they will go. Since people decide on what house they will purchase based upon how large a monthly payment they will be carrying, any increase in mortgage interest rates will result in a concomitant decrease in housing prices unless there is some countervailing variable, such as increased family income.
Posted by: Bart at October 28, 2004 2:54 PMJeff,
Their house will not appreciate in value over time in a significant fashion, barring a return to Carter-era inflation numbers, or a dramatic increase in per capita income, neither of which appear on the horizon.
I pointed out in another thread all the really dangerous products out there. Negative amortization loans are rearing their ugly heads again.
Posted by: Bart at October 30, 2004 6:25 AMJeff,
Their house will not appreciate in value over time in a significant fashion, barring a return to Carter-era inflation numbers, or a dramatic increase in per capita income, neither of which appear on the horizon.
I pointed out in another thread all the really dangerous products out there. Negative amortization loans are rearing their ugly heads again.
Posted by: Bart at October 30, 2004 6:25 AM