Monday, December 22, 2008

home ownership for the poor and boundedly rational

It is obvious again that lending too much money to people with poor credit and financial means is a bad idea, and there is a resurgence in support for the traditional mortgage in which the purchaser makes a real down payment and a 30-year fixed-rate mortgage payment and won't be lent the money if those terms can't be met. Partly in response to this I've read and heard some sympathy expressed for poor people who have no savings but are "responsible people with good credit", suggesting that home-ownership is a privilege to which these folks should be allowed. I'm not a fan of home-ownership fetishization in general — there's nothing wrong with renting, folks, and there shouldn't be a moral opprobrium thrust upon it — but if we wanted to promote home-ownership in a responsible way for this class of people, there are almost certainly better and worse ways to do it.

I want to start by clarifying who we're talking about; I would suggest that anyone with no savings is not a "responsible person" unless — maybe — they have tenure or a government pension. (Someone just out of school has an excuse; the entirety of this discussion supposes we are talking about someone who is not inclined, on an ongoing basis, to put aside something easily regarded as "savings".) Supposing "responsible" means that they don't deliberately incur liabilities they can't meet, and supposing that in fact that whatever liabilities they do incur they will manage to meet — no unanticipated drops in income — then someone who can't save up a down payment but makes their bills almost certainly suffers from a form of impulse control in which money "lying around" is calling out to be spent. This impulse control also seems to be implicit in a lot of discussions of one value of homeownership (with a mortage) being "building equity"; if you can buy a house that costs $1000 a month in ownership expenses, including mortgage, of which $100 goes to "building equity", then (ignoring tax distortions for the moment) on average, over large expanses of space and time, you can rent a similar place for $900 and put $100 a month in savings, and build your equity in a savings account. The primary difference with the mortgage is that if you don't put in the $100, you're in default; you have somebody pressing you to build equity, which you don't have with the savings account. Economics types will sometimes refer to a "forced savings" component to a mortgage, and this is what one has in mind. Whether buying or renting is the better use of money is likely to be specific to the details of the situation — how long the individual expects to stay put, how much they value being able to remodel, whether there's a special reason to believe the house will appreciate in a way that's not priced into it, etc. — and is not simply a function of buying versus renting per se.

If we want to help people with this kind of impulse control, though, short of simply giving them money (which they would presumably spend anyway), it seems we need, one way or another, a forced savings mechanism. The obvious "solution", then, is a federal mandate that renters put money into a savings account every month, which money they couldn't touch unless they move. Perhaps better, though, would be a way to allow people to choose to commit to a forced savings plan. I have two variants that seem at least plausible to me.

One is essentially a no-money-down version of a shariah-compliant mortgage: the bank buys the house and rents it back to you, allowing you to purchase a share in the house on a pre-set schedule. This can be made to look very much like a regular mortgage, except that the bank goes into this explicitly aware that it is taking on the price-appreciation risk of the house. I'm not sure, in the United States, that banks are the most obvious institution to organize something like this; REITs are. They buy and sell and manage real estate as their regular business.

The second idea is more of a rent-to-own structure; the homeowner puts together the same sort of deal, in which a higher-than-market rent is charged over a five-year lease, and at the end of the five years the lease has an associated cash-out value and includes either the obligation or an option to buy with the cash-out value available as a down payment. This even more transparently lends itself to REITs.

In the former case the forced savings, as in a regular mortgage, was hidden in the ownership of the house in the form of home equity; in this case it's hidden in the cash-out value of the lease. In either case there's a long-run contract whose terms are breached by failing to make this conversion of liquid wealth into something less liquid. In both cases, the terms of the deal should be amenable to both a buyer and a seller on market terms, so that there should be no need for a government subsidy. It might be, though, that there's a status quo bias or coordination problem in the market, where there's little willingness to try these things because it isn't much done yet and wouldn't be worth working out for a one-off; it is also possible that the mortgage interest deduction and other terms of the tax code discourage this sort of thing. If the commanding heights in Washington think long-term home ownership for this class of people is a social good, creating some kind of tax incentive or subsidy to encourage REITs to do this might be an efficient way to do it with taxpayer money.

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