Financial Innovations and the Stability of the Housing Market

Franklin Allen, James R. Barth, and Glenn Yago

The Future of Housing Finance

NIESR/ESRC Conference

 12 September 2014

2

I. Introduction

• Over the years financial innovations have had a significant effect on housing markets

• We consider the history of innovations and this interaction in a number of countries

• What went wrong and how can the system be fixed?

3

II-III. Early History in the UK and US

• John Wood and son in Bath, England: model for urban real estate development

• In the US home ownership accompanied reform and expansion of land ownership for farming

• By 1890 2/3 of all farm housing was owner occupied

4

US homeownership rate, 1900-2012 Q2

19001920

19401960

19621964

19661968

19701972

19741976

19781980

19821984

19861988

19901992

19941996

19982000

20022004

20062008

2010201

40

45

50

55

60

65

70

75Percent

5

IV. Development of Modern US Housing Finance

• First Savings and Loan organized in 1831 and gradually spread around the country

• Granted tax advantages and developed separately from banking system

• In the 1930s S&Ls did not suffer runs because they did not take demand deposits but they did suffer withdrawals to maintain consumption and this caused failures

• In 1932 Federal Home Loan Bank System set up and in 1934 FSLIC

6

• After World War II the Savings and Loan Sector prospered growing from 3% of private financial assets in 1945 to 16% in 1975

• As interest rates fluctuated wildly in the late 1970s and early 1980s the Saving and Loan sector was put under severe strain

• Many failed and regulation was changed so they were able to become much more similar to commercial banks

7

V. Sources of Funding for Home Purchases and Homeownership Rates

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Other

Agency- and GSE-backed mortgage pools

Private-label backed mortgage pools

Savings institutions and credit unions

Commercial Banks

GSE-home mortgages

8

Sources of funding for home mortgages in selected countries, 2009

Australia

Canada

Japan

Austria

Denm

ark

Finla

nd

France

Ger

many

Gre

ece

Irela

ndIta

ly

Nether

lands

Portugal

Spain

Sweden UK

U.S.

0

10

20

30

40

50

60

70

80

90

100

Deposits Mortgage bonds, including covered bonds Residential mortgage-backed securities Institutional investors Other

Percent

9

Covered bonds in selected countries, 2010

Latvia

Poland

Slovakia

Hungary

Czech

R.

Austria

FinlandU.S.

Greec

eIta

ly

Portugal

Ireland

Nether

lands

Norway

Sweden

France

U.K

.

Germany

Denmark

Spain

0

50

100

150

200

250

300

350

400

450

500

0.1 1 5 8 11 13 14 15 27 36 37 3955

94

253269 275

295

446 457

Mortgage-backed covered bonds outstanding

US$ Billions

10

U.S.

Polan

d

Luxem

bourg

Latvi

a

Nether

lands

Italy

Austria

Finla

ndU.K

.

Ger

man

y

Irela

nd

Portu

gal

Gre

ece

Hunga

ry

France

Slova

kia

Norway

Czech

Rep

ublic

Spain

Sweden

Denm

ark

0

20

40

60

80

100

0.1 0.7 1 26 8

12 13 1419 21

24 25 25 2531 32

4450

67

100

Mortgage-backed covered bonds as percent of residential loans outstanding

Percent

11

Homeownership rates in various countries around the world

Switzer

land

Japan

Argen

tina

Russia

Canada

United Sta

tes

Australia

Turkey

New Z

eala

nd

Isra

el

Brazil

South K

orea

Norway

South A

frica

India

China*

Icela

nd

Mex

ico

Singapore

0

10

20

30

40

50

60

70

80

90

100

38

61 6264

66 67 67 68 6871

74 75 77 7782 82 83 84

89

Selected countries, 2009

Percent

12

Germany

Denmark

Nether

lands

Austria

France

Finla

nd

Sweden

UK

USA

Poland

Luxembourg

Cyprus

Irela

nd

Portugal

Czech

Rep

ublic

Icela

nd

Belgiu

m

Malta

Italy

Greec

e

Russia

Turkey

Sloven

ia

Spain

Norway

Slovakia

Bulgaria

Latvia

Estonia

Lithuania

Hungary

Romania

0

10

20

30

40

50

60

70

80

90

100

43

5456

58 58 59

66 66 67 69 7074 75 75

77 77 78 79 80 80 81 81 8185 85 86 87 87 87

9193

98

European Union and other selected countries, 2010

Percent

13

Home mortgage debt to GDP in various countries around the world

Saudi Arabia

Argentina

Indonesia

Russia

Brazil

TurkeyIndia

MexicoChina

Korea, South

South Africa

Japan

Singapore

Australia

Norway

New Zealand

United States

Switzerla

nd

0

20

40

60

80

100

120

140

1 1.7 2.1 2.1 3 5 7 1015

21 22

36

60 62

71

7881

130

Selected countries, 2009Percent

14

Romania

Bulgaria

Czech

Rep

ublic

Sloven

ia

Slovakia

Poland

Lithuania

Italy

Hungary

Austria

Greec

e

Latvia

France

Estonia

Finla

nd

Malta

Luxemourg

Belgiu

m

Germany

Spain

Portugal

Cyprus

Sweden

U.K.

Irela

nd

Denmark

Nether

lands

0

10

20

30

40

50

60

70

80

90

100

110

612 13 14 17 19 22 23 25 28

35 3641 42 42 44 45 46 47

64 66 69

8285 87

101107

European Union countries, 2010Percent

15

VI. Federal Government Involvement in Mortgage Markets

• Since the 1930s the federal government has played an increasingly important role in the allocation of mortgage credit

• Loan insurance and guarantees: Fannie Mae, Freddie Mac, Ginnie Mae

• US is one of relatively few countries in which the government provides support to residential mortgage markets

16

Government support for mortgage marketsCountry Government mortgage insurance Government security guarantees Government sponsored enterprises

Denmark No No No

Germany No No No

Ireland No No No

Netherlands NHG No No

Spain No No No

United Kingdom No No No

Australia No No No

Canada Canada Mortgage Housing Corporation Canada Mortgage Housing Corporation No

Japan No Japan Housing Finance Agency Possible

South Korea No No Korean Housing Finance Corporation

Switzerland No No No

United States FHA GNMA Fannie Mae, Freddie Mac, FHLBs

17

Total mortgages outstanding as percentage of US GDP

19001903

19061909

19121915

19181921

19241927

19301933

19361939

19421945

19481951

19541957

19601963

19661969

19721975

19781981

19841987

19901993

19961999

20022005

20082011

0

10

20

30

40

50

60

70

80

90

Percent

18

 Total home mortgages outstanding and share of home financing provided by government-sponsored enterprises in the

US

19601963

19661969

19721975

19781981

19841987

19901993

19961999

20022005

20082011

0

2000

4000

6000

8000

10000

12000

14000

0

10

20

30

40

50

60

US$ trillions Percent

GSE share of home financ-ing

(Right axis)

Total home mortgages out-standing

(Left axis)

19

Date of first mortgage-backed securitization

Year Country

1970 United States

1984 Australia and Canada

1985 United Kingdom

1988 France

1989 South Africa

1991 Spain

1995 Germany and Ireland

1996 Argentina

1999 Brazil, Japan, Italy and South Korea

2000 India

2003 Mexico

2004 Malaysia

2005 China

2006 Russia and Saudi Arabia

20

Percentage of bank assetsin residential real estate loans (2010)

AngolaIndia

LesothoVirgin Islands, British

JamaicaSri Lanka

GhanaVanuatu

SwazilandMalawi

ThailandZimbabwe

BelizeSlovakia

ArgentinaGuernsey

JerseyPhilippines

Palestinian TerritoryPakistan

RussiaBrazil

MauritiusIndonesia

Puerto RicoUgandaBurundi

GuatemalaNigeria

NepalMalta

ArmeniaChina

TurkeySingaporeBotswanaUruguay

MexicoTrinidad and Tobago

KazakhstanGibraltarEcuador

Dominican RepublicSlovenia

Bosnia and Herzegov-ina

PeruPanamaFrance

Isle of ManHong Kong, China

SerbiaAustria

GuyanaSeychelles

IcelandMacao, China

BulgariaCyprus

Cayman IslandsItaly

BelarusHondurasHungary

CroatiaVenezuelaNicaragua

FijiKorea, Rep.

BelgiumTaiwan

United KingdomGreece

Sierra LeoneMalaysia

El SalvadorFinland

United StatesCanada

ChileCosta Rica

LatviaTonga

SwitzerlandPortugal

PolandLithuania

Samoa (Western) Israel

South AfricaNorway

NetherlandsNamibiaEstonia

AustraliaNew Zealand

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

21

Percentage of securitized residential real estate loans (2010)

Angola

Armenia

Bosnia and Herzegovina

Botswana

Burundi

Cook Is lands

Cos ta Rica

Croatia

Cyprus

Dominican Republic

El Salvador

Guyana

Honduras

Hungary

India

Indones ia

Is le of Man

Is rael

Jamaica

Jersey

Kenya

Lesotho

Lithuania

Malta

Mauritius

Namibia

Pales tinian Territory

Peru

Samoa (Western)

Sierra Leone

Singapore

Slovenia

South Africa

Swaziland

Syria

Uruguay

Vanuatu

Virgin Is lands , British

Zimbabwe

New Zealand

Malays ia

Iceland

Brazil

Aus tralia

Mexico

Greece

United States

Canada

Italy

Colombia

Belgium

Netherlands

Guatemala

Puerto Rico

Seychelles

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

22

VII. Turmoil in global housing markets: Implications for the future of housing finance

• The residential mortgage market in the United States has worked extremely well over the past two centuries, enabling millions to achieve the dream of homeownership.

• But there have been periods of turmoil– The Great Depression– The late 1970s and early 1980s– The current period

23

Home prices peak in 2006 and subsequently decline(1991 Q1 – 2012 Q2; Index, 1991 Q1=100)

1991

1991

1992

1993

1994

1994

1995

1996

1997

1997

1998

1999

2000

2000

2001

2002

2003

2003

2004

2005

2006

2006

2007

2008

2009

2009

2010

2011

2012

0

50

100

150

200

250

300

350

S&P/Case-Schiller Home-Price Index10-Metro-Composite

OFHEO/FHFA Seasonally Adjusted Pur-chase-Only Index

24

Housing Problems in a Number of CountriesAverage house price changes

(Rankings of countries in parentheses)

Country Boom (1998:Q1-2006-Q2) Bust (2006:Q2-2011:Q3) Overall (1998:Q1-2011:Q3) Similar to the United States?

United States 49.9 (15) -22.6 (2) 16.0 (16) -

Australia 78.5 (7) 17.7 (17) 110.1 (3) No

Belgium 55.2 (11) 12.4 (14) 74.4 (7) No

Canada 53.3 (13) 28.5 (19) 96.9 (4) No

Denmark 79.5 (6) -19.5 (4) 44.6 (13) Yes

Finland 68.4 (8) 2.7 (11) 72.9 (8) No

France 102.2 (4) 5.1 (12) 112.6 (2) No

Germany -11.4 (18) -5.7 (9) -16.5 (18) No

Ireland 131.4 (1) -25.3 (1) 72.9 (9) Yes

Italy 53.4 (12) -7.9 (6) 41.2 (14) Yes

Japan -25.6 (19) -8.3 (5) -31.8 (19) No

Netherlands 61.0 (10) -6.9 (8) 49.8 (12) Yes

New Zealand 64.2 (9) -1.7 (10) 61.4 (11) Yes

Norway 53.0 (14) 24.3 (18) 90.2 (6) No

South Korea 4.4 (17) 6.5 (13) 11.1 (17) No

Spain 108.6 (3) -20.8 (3) 65.3 (10) Yes

Sweden 83.4 (5) 16.0 (16) 112.9 (1) No

Switzerland 10.7 (16) 14.2 (15) 26.4 (15) No

United Kingdom 112.2 (2) -7.3 (7) 96.6 (5) Yes

25

VIII. Future Innovations in Housing Finance

• Diversifying sources of capital (debt and equity)

• Structuring financial products that will promote private capital investment to support residential real estate construction, maintenance, and sustainable improvement

• Diversifying types of housing products (single/multiple family)

26

• Higher density, sustainable buildings that increase housing consumers’ cash flow and ability to service long-term debt

• Pooling savings and risk-management products

• Credit enhancement

• Using information technology to monitor and improve efficiency in housing finance

27

Financing Housing: Back to the Future

• Aligning interests of private capital funders with policy incentives

• Create a diversified housing stock by eliminating the bias against subsidies for renters

• Pooling savings to create investment vehicles

• Using credit enhancement and guarantees to manage real estate risks

28

• Creating flexible capital structures for residential developments through structured finance

• Regulating land use to limit supply constraints.

• Restoring the role of private investors (domestic and international) as drivers of homeownership and financing.

• Restoring confidence in securitization through mortgage-backed securities and covered bonds.