Hope prof authors plea for change in home mortgage financing
Housing finance in the U.S. played a major role in triggering the global recession — and could again — unless the U.S. adopts some major changes supporting affordable financing for homebuyers, according to a new book by an economist at Hope College.
Kim Hawtrey, who has been a member of the Hope College faculty since 2007, is the author of “Affordable Housing Finance,” published this fall by Palgrave Macmillan of New York City and Hampshire, England.
The book outlines the nature of “housing stress” and explains why capital markets need to be an essential part of the housing solution. Hawtrey, who is from Australia, compares the issues in the U.S., the United Kingdom and his native country.
Describing the sub-prime mortgage crisis that prompted the recession as “the largest economic upheaval of a generation,” Hawtrey believes that indications that the current crisis is abating — as reflected by stabilized housing prices and growing sales — shouldn’t be mistaken for a sign that all is well.
“The short-term cyclical downturn has been arrested, but the real issues are long-term and structural,” he said. “It’s clear that if we don’t find more sustainable ways of supplying housing and financing housing, we could have a repeat of the crisis,” he said.
Humans have three basic needs: food, clothing and shelter.
"Those needs have a dynamic of their own," said Hawtrey, "and will not be easily denied."
"The desire of the population for affordable housing is an underlying driver which is trending up over time," he said. "The financial system tried to meet that demand with the supply of sub-prime mortgages — and, as we know, with tragic consequences.
"The way bankers went about it was essentially the wrong way," he said.
Housing is typically viewed "as a consumer durable," said Hawtrey. "It's rarely looked at in its asset role — its financial function — and that's what caused the financial meltdown."
He noted the obvious fact that housing is the biggest purchase that the most people will make in their lifetime, and is usually the largest element in their financial portfolio. But Hawtrey also notes that residential housing is a major component of the global economy, with a value in excess of $40 trillion, accounting for nearly half of all tangible capital assets in the developed countries of the world.
When taken as a whole, “housing is the most valuable asset category on earth,” he said.
Hawtrey said the current financial models for making housing affordable are inadequate, with harmful results for individuals, society and, ultimately, the economy overall.
In the U.S., he said, some 30 percent of households are defined as experiencing “housing stress”— meaning that they are spending more than 30 percent of their income on housing. Some 17.7 million of U.S. households are defined as “severely burdened,” meaning that they are paying more than half of their income for housing.
A key word in the business world is "infrastructure," and that's how Hawtrey sees the role of housing in the economy. The business sector is typically focused on business and not as much on the consumer side of the economy, but housing is key infrastructure in the economy, he said, as much as roads or telecommunications or the legal system.
Lack of public access to adequate and affordable housing has a cost, he said.
"The housing stock is where the workers live, and increasingly we're finding — especially in the big cities — that essential workers like nurses, firemen, police, janitors, IT people … can't afford to live there."
The business sector needs to view housing as "an important dimension of infrastructure to make business competitive, not only locally but globally."
"Other countries are moving ahead of us in their strategy" for affordable housing and that affects global competitiveness, said Hawtrey.
While the U.S. has many policies that are ahead of other nations, Hawtrey said there are lessons to be learned from Europe.
If it were in his power, he would increase the range and flexibility of the financial industry here in regard to mortgages, said Hawtrey.
In corporate finance, there are many different varieties and types of funding, "but in the housing sector, this has not happened. We're still basically operating on the traditional mortgage model."
Two alternative types of mortgages that are much more common outside of the U.S. are shared appreciation mortgages, or SAMs, and shared equity mortgages, or SEMs.
In an SAM, the homebuyer can get a lower interest rate on a mortgage because the lender will be sharing in the future appreciation of that property value. The challenge for the bank is determining that the property will appreciate enough to make the trade-off in a lower interest rate worthwhile. Despite the drop in housing values that followed the collapse of the sub-prime mortgage industry, Hawtrey noted that history has shown that "in the long term, house prices do appreciate."
In an SEM, which is more common in Britain than the U.S., there is a third-party investor involved. In essence, the SEM is "expanding the volume of finance available," said Hawtrey.
"At the present time, it is difficult for professional investors (in the U.S.) to find appropriate vehicles" for investing in housing, he said.
According to BusinessWeek, shared equity financing in the U.S. has often involved parents helping their adult children buy a home they could not otherwise afford. The parent gets his or her money back when the home is sold or refinanced. If the house is sold, the parent might also get a share of the increase in value. However, in some cases, the parent's name isn't even on the mortgage, and the terms may be based only on a hug or a handshake. The parent-backed mortgage can be perilous for family harmony.
Hawtrey's book argues for innovation in the financial industry and "imagination to expand the menu available by which funding for the wider range of housing types and housing buyers" can be arranged.
"Affordable Housing Finance" also makes a strong case for increased transparency in the mortgage process, said Hawtrey.
"One of the problems in the financial crisis was that the credit-rating agencies that are charged with evaluating housing instruments and so on, simply didn't see (the collapse in home values) coming. There was a lack of information, a lack of transparency," he said.
Going forward, we need "to make sure the different types of instruments are transparent, that they are properly credit-rated, and the price reflects the true information about the nature of the borrower, and so on," he said.
"In the corporate finance sector, we are dealing with savvy, well-informed customers, but in the household sector, we are dealing with relatively unsophisticated, less-informed consumers. So the need for government to ensure clarity of information is greater," he said.
Are housing prices really starting to stabilize?
"Tentatively," said Hawtrey. "So far, we have a patchy, fledgling, unsteady recovery. But it is a recovery."
While we are in an early phase, and there are some "conflicting signals," Hawtrey said there is no doubt in his mind that “we have turned some kind of corner.”
According to Palgrave Macmillan, before joining the Hope College faculty, Hawtrey was chief economist at Colonial Bank in Australia, and economic advisor with the Central Bank. In 2003, he chaired the Affordable Housing National Research Consortium, a policy committee of executives from leading housing industry bodies and other organizations in Australia.
Hawtrey has written several books and more than 30 scholarly papers for publications including the North America Journal of Economics and Finance, Applied Financial Economics, Reformed Theological Review, and the International Writings in Economics series. He serves on the editorial board of the Finsia Journal of Applied Finance.