Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
The Impact of U.S Housing Lending Policies on Economic Growth Nataliia Biriukova ABSTRACT The U.S. has experienced and recovered from many recessions throughout its history; the real estate market has traditionally been a powerful force in the nation’s economic recovery. Although the U.S. government expended tremendous effort and funds to minimize the impact of the crisis of 2007 and promote homeownership by subsidizing borrowing, the policies of lending institutions are slowing the nation’s progress out of the present recession. This research study investigated the impact of credit restriction policies on the wealth of potential buyers who faced foreclosure. The background of the mortgage crisis, its impact on the U.S. housing market, current lending policies and key credit restrictions are addressed in the literature review. This research used the qualitative research method of case study with a fictional sample representing a section of the homeowner market in Northern Virginia. The research found that housing lending policies impact the wealth of households and, by extension, the economy of the U.S. INTRODUCTION During the last few decades, the policies of U.S. government have promoted homeownership. This policy is in alignment with the belief of the majority of Americans, who believe that the homeownership is a smart investment in the long term. Numerous surveys show that home-owners are more likely to be satisfied with the quality of their family and community life than renters, and most renters aspire to home ownership. The recent financial crisis caused numerous foreclosures due to the defaulting of homeowners on their residential mortgages. Foreclosure is a legal proceeding in which the bank takes possession of a mortgaged property when the borrower does not meet his or her contractual obligations to pay. The choice of whether to own or rent a home is a major decision and should be given careful consideration. However, due to the credit policies of lenders, a person cannot be approved for a loan to buy a home if he/she has faced foreclosure within the last three years. That person is required to rent a home for at least three years before re-applying for home ownership. In 2010, the homeownership rate was 65.1 percent nationally, having decreased by 1.1 percentage points since 2000. This decline in the national homeownership rate is the same as during the years of the Great Depression. Still, the 2010 homeownership rate remains the secondhighest rate since the collection of tenure data began in the census of 1890 (U.S. Census Bureau, 2011). American attitude about homeownership remains strong even during the housing crisis. According to a survey conducted by Move, Inc., an online real estate company, four out of five (81.7 percent) Americans consider housing to be a critical piece of the national economic recovery (Move, 2011). LITERATURE REVIEW The literature on the current economic crisis and its macroeconomic impact is growing rapidly, although there is substantial variation across the studies in terms of their focus on different variables, methods, and sample periods. There are different views of outlook for recovery in U.S. real estate markets. Some researchers believe that the U.S. economy in a deep recession and might even worsen. Others state that the housing market has reached its bottom, and the economy is transitioning from a rescue phase to a recovery phase (Singh and Bruning, 2011). The background of the current financial crisis has been reviewed by Du, Wu, and Yang (2010). Lane and Milesi-Ferretti (2011) examined whether the cross-country incidence and severity of the 2008-2009 global recession is systematically related to pre-crisis macroeconomic and financial factors. They found a relationship between pre-crisis domestic financial factors (fast private credit growth) and external imbalances (current account deficits) on the one hand and the decline in the growth rate of output and domestic demand during the crisis. The impact of housing choice on future household wealth was analyzed by Hennessey (2003), whose study provides a financial model that can be used to analyze the impact that the ‘rent or buy’ decision has on wealth. The study suggested that home ownership might not have the positive impact on household wealth that most Americans perceive to be the case. Hatzius (2008) examined the link between home prices and foreclosures. The study estimated the impact of declining home prices and credit supply reduction on real GDP growth, and found that an additional 15 percent home price decline from 2008 levels would cause residential mortgage credit losses of $750 billion over 2007-12 and lower real GDP growth by an average of 2.6 percent per year. The study suggested that the crisis impacts the economy in the following ways. First, the decline in residential construction reduces aggregate output. Second, declining income in the housing sector decreases consumer spending. Third, negative wealth effects or a mortgage liquidity effect caused by declining home prices lowers the private consumption. Fourth, losses on mortgage credit reduce the credit supply to households and nonfinancial businesses. The analysis suggests that increasing the supply of credit would soften the current economic conditions. “The Treasury Department had committed $700 billion in government capital injections into financial institutions through its programs; further injections could significantly soften the current credit squeeze.” (Hatzius, 2008) Tsay and Zera (2010) constructed an indifference curve from combinations of house prices and mortgage payments, designed to better understand whether to buy a home now or wait until later. Gerardi, Lehnert, Sherlund, and Willen (2008) analyzed whether housing market participants underestimated the sensitivity of foreclosure rates to price changes. The study suggests that analysts generally understood the possibility of falling prices, but assigned a low probability to that outcome. Additionally, lenders must have expected either that house price affordability would not collapse or that subprime defaults would be insensitive to a big drop in house price affordability house price affordability. Swagel (2009) reviewed the governmental policy response to the 2007-2009 financial crisis. His paper addressed the legal, political, economic, and time constraints faced by government agencies in addressing the crisis. Policymakers had to choose between numerous proposals, including options of: whether to buy assets, insure them, inject capital into financial institutions, or expand federally guaranteed mortgage refinance programs. There were also proposals that would allow refinancing for low- and moderate-income homeowners through loans guaranteed by Federal Housing Administration that would have changed to the tax code to forgive the tax due from a borrower whose debt is canceled by the lender. This would have improved the operations of Fannie Mae and Freddie Mac through the continuation of financing provided by these government-sponsored enterprises. The study suggested that, from a political and economic point of view, the ensuring of loans by government agencies is preferable to direct capital injections in financial institutions, and that the Treasury response to the crisis was appropriate to the economic conditions. Tatom (2009) argued that the government: “has reacted chaotically by creating new lending programs that have transformed its credit supply from government securities to private financial institutions, and in the process, violated the first rule of central banking to lend liberally in a liquidity crisis. This failure, compounded by providing a backstop to questionable securities, has slowed market adjustment and risks lengthening and deepening the financial crisis.” The study suggested that an overall foreclosure rate of 4 to 7 percent would, at most, represent a range from $400 to $700 billion. Some estimates indicate that banks have already raised enough capital to offset the capital losses. At the end of the third quarter of 2007, banks held nearly $4 trillion in: residential mortgages ($2.2 trillion), home equity loans ($0.6 trillion) and mortgage- backed securities ($1.2 trillion), which is about 30 percent of total banking assets, and 40 percent of mortgages. METHOD This case study will be based on a scenario with a fictionalized household that recently faced foreclosure and due to credit restriction policies, cannot get a loan to buy a new home, and therefore, rented their primary residence for three years. The financial model described above by Hennessey (2003) will be applied to estimate the wealth of households renting a home versus owning a home over a three-year period. Given this estimation, the impact that credit restriction policies have on the economy was then calculated. This qualitative study includes: Descriptive statistics that will review the background of financial crisis and foreclosures. Secondary Data Analysis that will review the statistical data that indicates housing market conditions over the period from 2009-2011. Research population: US housing market Sampling: housing market in Prince William County, VA Data Collection and Analysis This study used the financial model, also referred as the housing choice model, developed by Hennessy (2003), which includes the following variables: Table 1. List of Variables in the Housing Choice Model Variable Symbol Brief description Household Wealth WN Household wealth at the end of year N House Price Co Purchase price of house + closing costs Closing Costs CC All fees required to finalize the purchase (lawyer fees, mortgage insurance, points) Down payment DP The percent of the purchase price paid by the household Mortgage Rate km The interest rate on the mortgage over the amortization period Amortization Period n The total period the household takes to pay off the mortgage Ownership Cost Ot Cost of owning the house in year t, includes mortgage, property taxes, maintenance and repairs Rent Rt Cost of renting in year t Security Deposit SD Deposit required at the beginning of rental agreement Net Downpayment NDP Cost Inflation (%) ft Net cost of buying invested NCI The difference between the down payment and the security deposit Rate at which costs and rent increase in year t The sum of the yearly series of net cost of buying invested over the period of analysis House Appreciation Rate (%) iH Rate at which housing appreciates in value Rate of Return iF Return earned on the investment in financial assets Selling costs SCn Cost of selling the house at the end of the period of the analysis (includes real estate commission and closing costs) Capital gains tax rate Tcg Marginal tax rate on capital gains income of the individuals claiming the capital gains Marginal tax rates Tm The tax rate of the individual claiming the mortgage interest and property taxes against income Period of Analysis N Total period of analysis The Hennessy model is adapted to this research to analyze the impact of renting a home versus owning a home for the three year period indicated. The adapted version of this model includes some of the variables with the following values: Table 2. List of Variables in the Adapted Housing Choice Model Variable Symbol Value Household Wealth WN To be calculated House Price Co $250,000 (average price of a single family house with three bedrooms and two bathrooms in Prince William County, VA. Source: multilisting services, www.mris.com) Downpayment DP 0% (assumed to be 0% for qualified borrowers similarly to some of loans generated/insured loans by the Government agencies) Mortgage Payment MP $1,247 (calculated using mortgage calculator) Property Taxes PT $2,500 (average 2011 property tax for the comparable houses in Prince William County, VA. Source: public tax record, www.mris.com) Maintenance and Repairs MR $300 (average spending on maintenance and repairs on national level, American Housing Survey for the United States: 2009, U.S. Census Bureau and U.S. Department of Housing and Urban Development) Rent Rt $1,800 (average rent for comparable houses in 2011 in Prince William County, VA. Source: multi-listing services, www.mris.com) Security Deposit SD $1,800 (1 month rent) Mortgage Rate km 4% (as of December 4, 2011, fluctuating daily) Cost Inflation (%) ft 3.5% (source: U.S. Census Bureau) Amortization period n 30 years House Appreciation Rate (%) iH 0% (assuming house appreciation rate is 0% for the next 3 year period) Rate of Return iF 3% (rate of return on U.S. Treasure bill) Period of Analysis N 3 years Calculations for the wealth of a household when renting a home The wealth of the household is based on the value of the net down payment invested in interest earning financial assets at the end of third year, less the future value of the cost of renting a house at the end of the third year, less the opportunity cost of investing the rent expenses into interest earning financial assets. The equation can be expressed as follows: 𝑁 𝑊𝑁𝑅 = [𝑁𝐷𝑃 (1 + 𝑖𝐹 )𝑁 − 𝑁𝐷𝑃] − ∑ 𝑅𝑡 − [𝐸 (1 + 𝑖𝐹 )𝑁−𝑡 − 𝐸] 𝑡=1 The cost of renting at the end of third year is the sum of monthly rent payments adjusted for inflation: 𝑅𝑡 = (𝑅𝑡 ) ∗ (1 + 𝑓𝑡 )𝑡−1 The cost of renting for the three year period is $67,094 and is calculated as following: 𝑅1 = $21,600 𝑅2 = 21,600 ∗ (1 + 0.035) = $22,356 𝑅3 = 21,600 ∗ (1 + 0.035)2 = $23,138 3 ∑ 𝑅𝑡 = $67,094 𝑡=1 E is the difference between cost of renting and cost of owning a house: 𝐸 = 𝑅𝑡 − 𝑂𝑡 After calculating the cost of owning the house (shown below) E equals $54,656. E = 67,094 - 12,438 = $54,656 The wealth of the household renting the house is negative, and it equals -$68,900 as follows: 𝑊𝑁𝑅 = − 166 − 67,094 − 1,640 = −$68,900 Calculations for the wealth of a household when owning the house. The wealth of the household owning the house is based on the value of the house at the end of three year period, less the future value of the cost of owning, less the opportunity cost of investing ownership costs in interest earning financial assets, is as follows: 𝑁 𝑊𝑁𝑂 𝑁 = 𝐶𝑂 (1 + 𝑖𝐻 ) − ∑ 𝑂𝑡 − [𝐸 (1 + 𝑖𝐹 )𝑁−𝑡 − 𝐸] 𝑡=1 The ownership cost at the end of third year is the sum of the mortgage payments, property taxes, and maintenance and repairs, adjusted for inflation: 𝑂𝑡 = 𝑀𝑃𝑡 + (𝑃𝑇1 + 𝑀𝑅1 )(1 + 𝑓𝑡 )𝑡−1 Unlike the Hennessy (2003) analysis, this study does not take into consideration the tax savings associated with the mortgage interest tax deduction and deduction of property taxes due to the uncertainty about whether there is a tax incentive for the household to itemize their deductions. The cost of owning the house is equals $53, 589 and is calculated as follows: 𝑂1 = 14,964 + (2,500 + 300) = $17,764 𝑂2 = 14,964 + (2,500 + 300)(1 + 0.035) = $17,862 𝑂3 = 14,964 + (2,500 + 300)(1 + 0.035)2 = $17,963 3 ∑ 𝑂𝑡 = $53,589 𝑡=1 Similarly, the wealth of household owning the house is equals $198,051 and is calculated as follows: 𝑊𝑁𝑂 = 250,000 − 53,589 + 1,640 = $198,051 The study implies that the household’s expenses are $13,505 or 25% lower when owning the house. When owning the house, on average, the household could contribute to GDP $13,505 by consuming more goods and services and/or to investing over the three year period. Calculating the impact that credit policies have on the U.S. economy Consumption is the largest component of GDP and there are many approaches to calculate GDP. The expenditure approach calculates GDP as follows: GDP= Consumption + Investments + Government Expenditures + Net Exports To illustrate the magnitude of the impact credit policies have on GDP, this study used the number of foreclosures in Prince William County, VA. The number of foreclosures is the number of bank owned homes (inventory) that were offered for sale in Prince William County in 2011. As of December 4, 2011 the number of foreclosures was 843 households that lost their homes in 2011 and would have to rent a home for at least 3 years, because lenders would not approve them for a loan to buy a new home. The estimated loss to U.S. economy, due to credit policies, is $11,384,715 and is calculated by multiplying number of foreclosures by estimated average household’s consumption as follows: 843 x $13,505 = $11,384,715 The study implies that the contribution to GDP by Prince William County would have been $11,384,715 more over the next three years only if financially capable residents could get approved for a loan regardless of whether or not they had recent foreclosure. LIMITATIONS This study has certain limitations. The data regarding foreclosure rate is complicated and includes foreclosure inventory (REO), new foreclosures (foreclosure starts), and delinquency on mortgage payments. The foreclosure rate used in this research is REO offered for sale through Multi-Listing Services (MLS). This rate differs from the actual foreclosure rate and does not include new foreclosures (not offered for sale yet), so the actual number of foreclosures is almost certainly higher. The estimation of economic impact in this study is based on the assumption that the household facing foreclosure would be financially capable of paying the mortgage on a new home. Additional research should to be conducted to evaluate the actual financial situation of households facing foreclosure and their ability to pay a new mortgage. The wealth of a household was calculated using stable prices, house appreciation / depreciation rate, which equaled zero percent. CONCLUSIONS AND RECOMMENDATIONS The credit restriction policy, which does not allow a person who has had a foreclosure within last three years to qualify for a loan to purchase a home, conspicuously impacts the U.S. economy. On average, renting a home is 25 percent more expensive than owning a home in Prince William County, VA. Due to the credit restriction policy, the estimated loss of private consumption by residents of Prince William County will be $11,384,715 over the next three years. The study suggests that, in order to increase economic growth in the U.S., financially capable persons should be able to be qualified for a new loan regardless of whether or not they have experienced foreclosure within the last three years, and lenders [should] no longer be required to practice the restriction policy. IMPLICATIONS OF THE STUDY The major users of this study are U.S. government agencies and other policy-making authorities in the banking, mortgage and housing industries. This study implies that the government should develop housing lending policies that would allow people who faced foreclosure to buy a new home as long as they financially capable to pay the new mortgage. REFERENCES Du, H., Wu, J. &Yang, W. (2010) On the mechanism of CDOs behind the current financial crisis and mathematical modeling with Levy distributions. Intelligent Information Management. 2(2). Retrieved October 25, 2011 from http://go.galegroup.com/ps/ i.do?&id=GALE%7CA222025544&v=2.1≈u=pwpls_remote&it=r& amp;p= GPS&sw=w Gerardi, K., Lehnert, A.,Sherlund, S. M., & Willen, P. (2008). Making sense of the subprime crisis. Brookings Papers on Economic Activity. Retrieved from http://go.galegroup.com/ps/i.do?&id=GALE%7CA197801526&v=2.1&u pwpls_remote&it=r&p=PPBE&sw=w Glaeser, E. L. (2010). Housing policy in the wake of the crash. Daedalus. 139(4). Retrieved October 25, 2011 from http://go.galegroup.com/ps/i.do?&id=GALE%7CA240008121&v=2.1&a p;u=pwpls_remote&it=r&p=GPS&sw=w Hatzius, J. (2008). Beyond leveraged losses: the balance sheet effects of the home price downturn. Brookings Papers on Economic Activity. Retrieved from: http://go.galegroup.com/ps/i.do?&id=GALE%7CA197801528&v=2.1& wpls_remote&it=r&p=PPBE&sw=w Hennessey, S. M. (2003). The impact of housing choice on future household wealth. Financial Services Review. 12. 143-164 Hornstein, A. (2009). Problems for a fundamental theory of house prices. Economic Quarterly 95(1). Retrieved October 25, 2011 from http://go.galegroup.com/ps/i.do?&id=GALE%7CA202078470&v=2.1&a p;u=pwpls_remote&it=r&p=GPS&sw=w Lane, P.R. & Milesi-Ferretti, G.M. (2011). The cross-country incidence of the global crisis. IMF Economic Review. 59(1). Retrieved from http://go.galegroup.com/ps/i.do?&id=GALE%7CA254959528&v=2.1&u pwpls_remote&it=r&p=PPBE&sw=w Move, Inc. (2011). 2012 presidential elections: 69.6% of Americans said housing will influence their vote. Retrieved from http://news.move.com/index.php?s=11609&item=81808 Singh, G. & Bruning, K. (2011). The mortgage crisis: Its impact and banking restructure. Academy of Banking Studies Journal. 10(2). 23-43. Swagel, P. (2009). The financial crisis: An inside view. Brookings Papers on Economic Activity. Retrieved from http://muse.jhu.edu/journals/eca/summary/v2009/2009.1.swagel.html Tatom, J.A. (2009). The U.S. foreclosure crisis: a two-pronged assault on the U.S. economy. Economics, Management and Financial Markets. 4(2). Tsay, W. & Zera, S. (2010). The trade-off between declining house prices and rising mortgage rates: Buy now or wait until later. Journal of Academy of Business and Economics. 10(3). U.S. Census Bureau. (2010). Housing characteristics: Retrieved from http://www.census.gov/prod/cen2010/briefs/c2010br-07.pdf