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although the subprime crisis seems to be
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showing some signs of easing debate over
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what caused it whether it could have
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been prevented and how long it might
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last will continue for some time to come
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knowledge at wharton asked wharton real
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estate professor todd sinai for his
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perspective on the latest economic
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developments welcome professor sinai
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well thank you for having me
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homes have long been thought of as a
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rock solid investment the thing that
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always gained value and never let you
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down
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and uh now in the last decade or so a
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lot of people seem to have started to
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look at their homes as investments and
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not just speculators but ordinary people
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who thought there was a huge value that
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they could tap in their homes
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and we've seen that now they're behaving
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like investments like stocks which
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sometimes go down and don't always go up
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has the real estate market
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evolved or changed or is this just part
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of a regular cycle that we see from time
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to time well that wow let's start with
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the doozy of a question the uh
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there's a lot of answers to that so to
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take the last part first uh the real
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estate has changed but still a lot the
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same so let's start with the fact that
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you started with that that house values
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are behaving like stocks now and they
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didn't behave like stocks before this
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that they're exhibiting more volatility
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now than they used to
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i don't think that's really quite true
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right so what we're seeing now that we
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haven't seen in the past is actual
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declines in house prices
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nominal house prices at the national
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level
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we've seen actual declines in house
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prices at the local level before now if
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you owned a house in boston that you
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bought in 1988 by 1992 you were
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underwater on your mortgage even though
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you have put 20 down right so house
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prices have fallen before
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the thing that they've done at the
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national level is they've fallen in real
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terms and they've always gone up in
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nominal terms well back in the 70s and
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even the 80s when we had lots of
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inflation
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it was easy for house prices to go up a
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lot in nominal terms but
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uh still be losing real money in real
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terms in other words the price went up
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but when you factor in inflation is
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you're really losing value absolutely
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right so so comparing comparing
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your house price to
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nothing happening to keeping money under
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your mattress is probably the wrong
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thing to do comparing it to what you
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could have made some other investments
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probably the right thing to do and you
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know housing has dropped a lot in the
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past right so it's a volatile kind of
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asset now having said that uh to think
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of houses as an investment
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i think it's somewhat different and
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i think it's part because
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for people who are living in their house
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they're going to use as a primary
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residence there's not a lot of
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investment value to it
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okay and what i mean by that is that
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i bought a house say in mid condo in
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midtown manhattan
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let's say i paid 500 000 for it in the
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mid 1990s and it's worth a million five
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now
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um
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well if i sell that and i still want to
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live in midtown manhattan i'm still out
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a million five to buy another one right
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so my investment has gone up a lot but
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it just covers what i need to buy with
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it which is a place to live
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and the difference between housing and
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the stock market is that when you sell
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the share of stock and it's doubled in
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value or tripled in value you can buy
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more stuff
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right if your house doubles or triples
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in value you can buy the same amount of
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housing
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unless you're going to move somewhere
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else for housing prices didn't rise
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quite as much so it's a very different
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thing to think about in terms of
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investment and i think when people say
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that people are using it as an
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investment what they mean is they're
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using it as a line of credit
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right now we saw we saw prices just
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soaring in in the early and mid part of
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this decade
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what was behind that
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well there's a host of factors behind
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that so you have to keep in mind that
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1995 was the absolute rock bottom in
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most cities for the housing market right
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so it wasn't until 2000 that we actually
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had house prices that reached the
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previous peak which is about 1988 1999.
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so for most people's memories
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uh half of the run-up that we've seen
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over the last 10 to 12 years was just
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catching up to where we had peaked at
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before
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the rest of it's due to a couple of
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factors
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about two-thirds of the run-up on
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average for the country
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appears to be due to
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essentially
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it's cheaper to to finance your house
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and the way to think of that is that if
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you were to invest in stocks
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by the time you went from 2000 to 2005
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uh the kind of return that you or yield
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you would have gotten on the stocks
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would gone down a lot right same with
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bonds houses actually end up being
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priced a lot like bonds when bond yield
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required yields are lower bond prices go
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up
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with houses if the cost of your money in
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terms of where else you could have
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invested it or the cost of borrowing for
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housing goes way down then the prices go
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up to compensate now it's about
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two-thirds of it a third of it just
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seems to be what we call momentum
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looking backwards and saying hey prices
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have gone up it's going to go up uh uh
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in the future uh in that sort of a
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behavioral or psychological kind of
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bubble kind of story and part of it i
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take it is that when interest rates are
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low a person of a given income can
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qualify for a larger mortgage they have
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more money to spend they can bid up
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prices and it's hard to tell how much of
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it is that qualification mechanism that
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people spend to their their how much
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they're allowed to spend and how much of
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it is really people in effect behave
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like a really rational asset price or
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would in the bond market and i don't
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think you can distinguish between those
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but in essence your tuition is right
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which is if i'm thinking of buying a a
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hundred thousand dollar house uh and the
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interest rate is about ten percent uh
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it's going to take me to say finance the
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whole thing ten thousand dollars a year
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if the interest rate drops to five
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percent that's five thousand dollars a
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year
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and
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you know if i'm willing to spend ten
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thousand dollars a year then i can pay
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for two hundred thousand dollar house
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right well a large chunk of that
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increased willingness to pay
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leads to bid up house prices in markets
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where it's hard to build housing because
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people are competing with each other
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getting to those houses
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in markets where it's not hard to build
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housing that increased willingness to
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pay just means developers say wow profit
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and they come and build more houses
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because now the value of the house once
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they build it is greater than the cost
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of construction and that's what we saw
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in south florida that's what we saw in
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phoenix that's what we saw in las vegas
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that's what we saw in central california
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one of the things you notice if you
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drive around in in
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suburbs around major cities
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is you compare the newer neighborhoods
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the older neighborhoods the the proper
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the lots may be the same size but the
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houses get bigger and they're more
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elaborate and uh
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they have more stonework and and all of
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these sorts of things and i'm wondering
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to what extent is the housing market
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kind of a fashion industry that people
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just feel they need to have the house
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that has all these bells and whistles
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uh you know i think there's
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there are
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changes and tastes for what we call the
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structure part of housing
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uh
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if you were to look at
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what has really driven the the growth in
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the the
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prices house prices in these markets
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what we call house prices we mean the
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combination of the structure in the land
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that's built on
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uh
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most of it if you can decompose it can
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be decomposed down to growth in the cost
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of the underlying land
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so
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the
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rapid rise in house prices in la or san
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francisco and new york was not so much
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that people are buying these fancier
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condos in new york
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or fancier apartments in san francisco
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or fancier houses in la it's that the
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cost of just getting a place in that
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market has gone up a lot
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having said that the people who can
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afford to get a place in those markets
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are also the people who like granite
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countertops and massive home theaters
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and lots of square footage and all the
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other things that go along with being a
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high-income household they also have
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mercedes and bmws in the garages and all
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the other stuff
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so
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the kind of fancy housing goes along
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with the higher spending
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but it's not driving the higher spending
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and i think really what's driving the
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higher spending is that
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basically there's just a lot more rich
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people in the u.s than there ever used
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to be some of them
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were born here some came from other
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countries
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but they're just a lot more people
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willing to spend a lot more money on
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housing and there are only so many
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places that they want to live
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now it's long been government policy to
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encourage home ownership and we now have
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a rate that is somewhere in the high 60s
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i believe
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and i'm wondering whether this
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was something that helped feed this
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subprime mortgage problem
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i don't think
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government policy
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uh
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towards homeownership um
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explicitly fed the subprime problem
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and i have really no idea about what's
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implicit in your question which is uh
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did that lead to a degree of lack of
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regulation and oversight in in the
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housing finance industry that led to the
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subprime problem um
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i think in large part the subprime
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problem
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came from a a
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uh a lending sector banks uh uh in in
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finance companies uh that were in a hunt
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for yield
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right they had capital they needed to
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put to work and they needed to get yield
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and you could take an
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abnormally low yield in traditional
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bonds or you could put it into housing
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and you could uh do it knowing that you
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were taking on risk
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you might not have known exactly what
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the parameters of that risk was but you
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knew that you were taking on risk and it
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was still worth it because then you
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could actually make a bit more money or
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the same amount of money i
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i think whatever regulation the
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government had done
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wall street would have had if you have
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found a way to circumvent so it was
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really is really a search for high yield
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investments rather than the government
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saying
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you've got to go out and make sure
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you're doing loans in
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poor communities and all those sorts of
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rules that we've seen over the years
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ah you know i think that
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the run-up in house prices that we have
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seen uh if they were explicitly
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contained in poor communities
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then you'd have an argument for that
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policy
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um
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certainly uh we we think that the
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communities that have had
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more
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you know subprime lending uh have seen
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larger growth in in-house prices that
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has been a portion of the run-up has not
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been nearly all of the run-up uh uh in
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in house prices explain a little bit the
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differential i can't explain all the
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differential between those communities
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um
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so
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you i i
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i i think the
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the thing to keep in mind that they're
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traditionally poor communities
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are not the ones that have generated the
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bulk of the price growth
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right san francisco is no longer poor
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right it is the rare poor person who can
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live in the san francisco metropolitan
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area and they had 200 some odd percent
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house price increases over the last
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uh eight to nine years
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now
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the subprime uh mortgage is kind of a
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dirty word today but as recently as a
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year ago
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a lot of people were defending it and
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saying well look yes
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a larger portion of them go bad than
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other types of mortgages that's expected
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but but the whole impulse here is to
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make more mortgages available and home
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ownership available to people who
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couldn't get standard more mortgages as
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their credit is no good or their incomes
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are low or or some sort of problem like
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that so has this been a failed
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experiment to get money uh to those
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people uh or is it something that just
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shouldn't have taken place in the first
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place oh i hope it's not a failed
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experiment i mean i think
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this is the market that's terrific
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i think that
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the
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excesses and abuses
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the jury is still out about what has
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actually happened here and i think we
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need to wait a bit before the for the
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things that come in um
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the problems
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that are coming happening i think are
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not because subprime is subprime uh
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that is that subprime has
00:13:07
you know negative amortization where you
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you you pay below market interest and
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your principal goes up i don't think
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that's inherently a problem uh i don't
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think adjustable rate mortgages that
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turn into fixed rate mortgages after a
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low teaser rate are inherently a problem
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those are all good things that lend
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borrowers should be able to have access
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to and i think we actually have real
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evidence that um
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credit markets get worse when you rule
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those things out
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when you have
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no documentation of income
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when you have
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people saying yes i'm living in the
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house they're not actually living in the
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house
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that's when the model breaks down
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because the investors need to be able to
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know
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that
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uh
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what the actual risk of default is from
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the borrower and they need to be able to
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know that the borrower is actually
00:13:57
living in the house because historically
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if you're living in the house you have a
00:14:00
much lower rate of default than if
00:14:02
you're an investor who will default much
00:14:04
more strategically that's if if the
00:14:06
house value drops below the loan amount
00:14:08
and so for an investor make a proper
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decision they need actual accurate
00:14:12
information on that and they were taking
00:14:14
risk that they may or may not have known
00:14:16
about in that
00:14:17
borrowers may not have been completely
00:14:19
truthful with of course the complete
00:14:22
consent of the
00:14:23
mortgage originator to not actually
00:14:25
check
00:14:26
um
00:14:27
that's a regulation problem right that
00:14:29
is a
00:14:30
borrowers need to be fully informed
00:14:32
about the loans that they're taking and
00:14:34
investors need to actually know exactly
00:14:37
what uh
00:14:39
the risk characteristics of the actual
00:14:42
borrowers are and so we have full
00:14:43
information there but the structure of
00:14:47
adjustable rate mortgages or negative or
00:14:48
amortization mortgages those are all
00:14:50
fine structures for people to be able to
00:14:52
borrow through
00:14:53
and the truth is that
00:14:55
for someone like me
00:14:56
um i should have an adjustable rate
00:14:59
mortgage right it is less expensive on
00:15:01
average
00:15:02
uh i take interest rate risk but i have
00:15:05
enough liquidity in my life if interest
00:15:07
rates go up i can still afford to pay it
00:15:09
out of cash flow i don't become illiquid
00:15:11
it's like going to las vegas can i
00:15:14
gamble in las vegas well if i have the
00:15:16
bankroll to back it
00:15:17
it's okay it's my decision to take that
00:15:19
gamble or not and adjustable rate
00:15:21
mortgages are taking interest rate
00:15:23
gamble
00:15:24
it's probably a bad match
00:15:26
for someone who doesn't have the
00:15:27
resources to take that gamble but it
00:15:30
doesn't mean that the product shouldn't
00:15:31
exist
00:15:32
now how should we ensure that the people
00:15:34
who take on uh mortgages that have all
00:15:38
sorts of features that are hard to
00:15:39
understand
00:15:40
are fully informed of what they're doing
00:15:42
is there a do you need a license to get
00:15:44
a mortgage or should should you have to
00:15:46
go through a seminar or read a pamphlet
00:15:49
uh who should be responsible for
00:15:51
delivering that kind of information yeah
00:15:53
that's an excellent question that i'll
00:15:54
have a good answer to i think there are
00:15:55
lots of possible answers to this
00:15:58
i think it is relatively straightforward
00:16:00
to improve disclosure on these products
00:16:02
right so if you go and take out a
00:16:04
mortgage you should get more information
00:16:06
than just uh if the interest rate
00:16:09
environment does not change this is what
00:16:11
your payments will be which is about the
00:16:13
information you get right now
00:16:14
right you can disclose to investors how
00:16:17
much in your cash flow
00:16:19
payments could go up how much could they
00:16:21
fall
00:16:22
historically where the odds of those
00:16:24
things happening right so better
00:16:26
disclosure that's mandated uh is
00:16:28
probably a good thing
00:16:30
those are fairly basic things that that
00:16:32
you don't have to be an economist or
00:16:34
financially sophisticated person to
00:16:36
understand that
00:16:38
if if interest rates rise to normal
00:16:41
levels from the subnormal levels of the
00:16:43
mid part of the decade
00:16:45
your monthly payment may double and then
00:16:47
you can figure am i going to be able to
00:16:48
pay that anyone can pretty much
00:16:51
understand it if it's explained in a
00:16:53
straightforward way is is that right oh
00:16:55
i mean
00:16:58
if the calculation is done for you you
00:17:00
can do it uh a lot of these products you
00:17:03
know i have smart students at warden and
00:17:05
i would say any student i've had before
00:17:07
taking a class
00:17:09
would not be able to figure out what
00:17:11
their payments would be if their
00:17:12
interest rate changed
00:17:14
right that is not easy calculation to do
00:17:16
for a wharton student it's hard to be
00:17:18
presented in a table or or a figure or
00:17:21
something absolutely graphic way that
00:17:22
you could really understand but that's
00:17:24
only part of it right i mean there's
00:17:25
there's a whole host of things that you
00:17:28
know do you need a license well
00:17:29
financial education clearly needs to be
00:17:30
improved i mean there is a
00:17:33
a
00:17:34
large bundle of things that probably
00:17:36
need to be done to help people be better
00:17:38
consumers in this market that's the
00:17:39
combination of consumer protection and
00:17:41
consumer education but wiping out
00:17:44
the whole bunch of financial products
00:17:46
is probably not a good idea
00:17:49
well in some to some extent the market
00:17:51
seems to have handled that already i
00:17:53
gather there aren't a lot of subprime
00:17:54
loans being issued right now
00:17:57
uh you know hopefully they will return i
00:17:59
mean there aren't a lot of subprime
00:18:00
loans being issued right now because the
00:18:02
investors who bought the bonds in the
00:18:04
end the the source of the capital uh
00:18:06
aren't willing to invest until they
00:18:08
understand what the risks are and one
00:18:10
thing that uh subprime investors counted
00:18:13
on when they invested in bundles of
00:18:16
these underlying mortgages
00:18:18
was that defaults
00:18:20
would not be correlated among them all
00:18:22
that much that is some might go bad
00:18:25
because people lose their job and they
00:18:27
default but the whole thing on mass is
00:18:29
not going to to go into foreclosure um
00:18:32
and they're discovering that they
00:18:33
weren't quite right about that
00:18:34
uh and i think they don't know quite how
00:18:37
wrong they were and it's hard to figure
00:18:38
out whether you should invest and feel
00:18:40
comfortable investing until you have a
00:18:42
sense of what that risk is and so
00:18:44
they're waiting on the sidelines and i
00:18:45
expect at some point they'll come back
00:18:47
and this market will re-emerge in some
00:18:49
form because it's a fairly efficient way
00:18:51
of providing capital to the housing
00:18:52
sector
00:18:54
now there's been a lot of talk in uh
00:18:55
washington and elsewhere of ways to
00:18:58
help the homeowners who are in trouble
00:19:00
over this and they run across the the
00:19:03
board from things like
00:19:07
buying the the mortgages from the
00:19:09
investors who own them and
00:19:11
writing them down and reissuing
00:19:13
mortgages with fixed rates at lower
00:19:15
rates
00:19:16
others would postpone the resets that
00:19:19
will raise payments to some future date
00:19:22
a whole basket of things have been
00:19:24
proposed but you've written that um
00:19:27
there are dangers inherent in any kind
00:19:29
of bailout uh and i take it that one of
00:19:31
the problems is that inevitably you're
00:19:33
going to favor one group over another is
00:19:35
that right yeah yeah i think i mean
00:19:38
absolutely i mean um i think the
00:19:40
fundamental uh issue is the issue some
00:19:43
people call it fairness or whatever um
00:19:46
is that if you bail out people
00:19:48
expose based off of the outcomes that
00:19:51
they face
00:19:53
then you were favoring a group who
00:19:56
through often through choices that they
00:19:58
made
00:19:59
ended up in a financially bad situation
00:20:01
and the question you have to decide as a
00:20:04
society it's do you want to reward that
00:20:06
group so for example
00:20:08
if you look at the data
00:20:10
there are lots of people who you can see
00:20:13
who could have taken out what we would
00:20:15
call a subprime mortgage say a low
00:20:17
adjustable rate for two years and much
00:20:19
higher fixed rate for the remaining 28
00:20:21
years
00:20:23
many of those people chose not to
00:20:25
some chose two
00:20:27
and when they chose to do it they did it
00:20:29
at a point where
00:20:31
there's a good chance they could not
00:20:32
afford the the payment when it jumped up
00:20:36
um
00:20:38
a bailout proposal if you're going to
00:20:40
bail people who are in trouble bails out
00:20:42
the people who made the the financially
00:20:45
unwise choice and basically doesn't give
00:20:48
anything to the people who made the
00:20:50
financially sound choice because the
00:20:52
financially sound people didn't get into
00:20:54
trouble
00:20:54
um as a society you might still want to
00:20:57
do that right you might still want to
00:20:59
say look for the greater good of not
00:21:02
having neighborhoods empty out you know
00:21:05
because all these people have to leave
00:21:06
their houses because they've been
00:21:07
foreclosed upon
00:21:08
we're going to bail them out even though
00:21:10
it's uh inequitable but it's inequitable
00:21:13
and you need to weigh that in
00:21:15
now i i gather also that
00:21:18
the the use of the the the the people
00:21:21
who are in trouble are not evenly
00:21:22
distributed around the country and and
00:21:25
in in
00:21:26
different income groups that there's
00:21:27
certain geographical pockets and certain
00:21:30
income pockets can you explain that yeah
00:21:31
i mean well i mean not surprisingly when
00:21:34
you look at the proliferation of
00:21:35
subprime mortgages uh most of the
00:21:38
dollars of subprime mortgages are in the
00:21:40
markets where there are lots of dollars
00:21:43
of housing to be financed
00:21:45
so if you look at california in new york
00:21:47
uh california alone has about 26
00:21:51
of the outstanding subprime mortgage
00:21:53
debt
00:21:54
and
00:21:55
you know in large part it's because
00:21:57
there were two factors
00:21:58
one is that housing was very expensive
00:22:01
so when you borrowed money you borrowed
00:22:02
a lot of it and another is that housing
00:22:05
was expensive for the people who want to
00:22:07
get in and so
00:22:09
taking mortgages that had favorable
00:22:12
initial terms allowed you to get into a
00:22:13
house that you otherwise would not have
00:22:15
been able to buy
00:22:17
um and so even markets like texas which
00:22:20
is very very large market ends up being
00:22:22
something like fourth on the list in
00:22:23
terms of dollars because the houses
00:22:24
there were just not very expensive
00:22:26
um
00:22:28
i think there's a tendency among people
00:22:30
to think of subprime as being an issue
00:22:32
that you know faced by poor people right
00:22:35
because they couldn't get credit before
00:22:37
and they can get credit now
00:22:39
that is not supported by the data i'll
00:22:41
give example in the in the high house
00:22:44
price growth markets so san francisco's
00:22:46
et cetera
00:22:47
um
00:22:49
subprime usage goes all up and down the
00:22:51
income distribution in fact it increases
00:22:53
as you get higher up in the income
00:22:54
distribution
00:22:55
right and largely because the way that
00:22:58
you got into
00:22:59
you know the 1.2 million dollar house
00:23:01
that you really couldn't afford rather
00:23:03
than 900 000 house that you could with a
00:23:05
30-year fixed mortgage is that you took
00:23:07
out a subprime mortgage and that enabled
00:23:09
you to get to the house you wanted
00:23:11
um
00:23:12
in the markets where you don't see a lot
00:23:14
of house price growth cleveland
00:23:16
cincinnati detroit
00:23:18
uh subprime usage there is skewed to the
00:23:20
bottom end of the distribution people
00:23:22
who would have been renters before
00:23:24
get into the houses
00:23:26
by taking out subprime mortgages
00:23:28
and and i think we should explain that
00:23:30
one of the appeals to the subprime loan
00:23:33
was its very low teaser rate
00:23:35
and you might start out at three percent
00:23:37
or or some very low level and your
00:23:40
ability to qualify for the loan was
00:23:43
based on that rate and whether you could
00:23:45
support the payment that that rate would
00:23:47
require uh
00:23:49
the the question was sort of left
00:23:51
unanswered about whether you could
00:23:52
afford a rate that would be higher
00:23:54
sometime later absolutely and that's why
00:23:56
you had both wealthy people who were
00:23:58
trying to reach even further to get a
00:23:59
bigger and bigger house uh taking out
00:24:02
subprime loans as well as what we tend
00:24:04
to think of as the typical
00:24:06
consumer which was the poorer person
00:24:08
absolutely and you can think of the
00:24:09
following example which is that you can
00:24:12
imagine a 30-year fixed-rate mortgage at
00:24:14
whatever the the going rate was
00:24:17
could have carried a thousand dollars a
00:24:19
month payment on a two hundred thousand
00:24:22
dollar house
00:24:24
um
00:24:25
if you took out a teaser rate
00:24:28
on that same house you maybe would have
00:24:30
had eight hundred dollars a month in
00:24:32
terms of payment initially or even seven
00:24:34
hundred dollars a month uh or if you
00:24:37
could afford the thousand dollars a
00:24:38
month then you could go and buy a two
00:24:40
hundred seventy five thousand dollar
00:24:42
house and say that two hundred thousand
00:24:43
dollar house uh and your payment would
00:24:45
remain the same
00:24:46
at least initially but it would reset
00:24:48
later
00:24:49
now uh some people who are looking for
00:24:51
remedies to this problem or ways to
00:24:53
prevent a recurrence
00:24:55
are talking about changing the
00:24:57
underwriting standards so that people
00:24:58
would not qualify for a loan based
00:25:01
solely on whether they can afford the
00:25:03
teaser rate but would qualify on some
00:25:05
longer-term view of whether they could
00:25:08
afford
00:25:09
rates that might be higher in the
00:25:10
payments that might be higher do you
00:25:12
think that there's merit to this idea
00:25:14
yes and no so for any
00:25:18
mortgage that is implicitly guaranteed
00:25:21
by the government so for example a
00:25:22
mortgage that would get bought by fannie
00:25:24
mae or freddie mac
00:25:26
which are
00:25:27
ostensibly independent but everyone
00:25:29
believes the government would step into
00:25:32
to bail them out if they get into
00:25:33
trouble if they are mortgages that
00:25:35
fannie or freddie can buy in the
00:25:36
secondary market then i think the
00:25:38
government needs to mandate underwriting
00:25:41
standards
00:25:42
that make sure the mortgage is
00:25:44
appropriate for the expected income of
00:25:46
the borrower um and yes that be the
00:25:49
entire stream of payments on the
00:25:50
mortgage for the entire stream of
00:25:52
payments uh
00:25:53
relative the entire stream of income
00:25:55
over time of the borrower
00:25:58
if it's not going to be bought by a
00:26:00
government enterprise then as long as
00:26:02
there's full disclosure and
00:26:03
understanding by the borrower and the
00:26:05
end investor i think the originator
00:26:07
should just originate what they want we
00:26:10
need to regulate and mandate complete
00:26:12
disclosure and understanding
00:26:14
but
00:26:15
if you have a borrower who
00:26:18
you would like a different set of
00:26:19
mortgage terms in investors who are
00:26:21
willing to take on that risk
00:26:23
then there's no reason that we shouldn't
00:26:25
allow that financial product to exist
00:26:27
and probably lots of good reasons that
00:26:28
we should because it's a way of a lot of
00:26:31
families getting access to credit they
00:26:33
otherwise would not have gotten access
00:26:34
to
00:26:35
so uh
00:26:36
transparency and uh education are better
00:26:39
solutions than heavy regulation
00:26:42
uh
00:26:43
again as long as the government is not
00:26:45
backstopping it yeah all right well
00:26:47
thank you very much oh sure it's a
00:26:49
pleasure
