The Homeownership Distraction

It is not the same as housing

Kevin Erdmann writes,

The deep cut in mortgage access after 2007 was associated with a deep drop in homeownership that coincided with the collapse of housing markets across the country. (Also, keep in mind that age demographics should be associated with a relatively steep upward trend in homeownership over this period.)

Everyone does what Erdmann does here, which is to conflate the homeownership rate with the demand for housing. But I would caution against doing that.

The demand for housing comes from the demand for a place to live. We can think of this as taking place in the rental market. When there is a lot of demand for living quarters relative to supply, rents will be high. When supply is abundant, rents will be low.

The demand for homeownership comes from the pros and cons of having the owner and the resident being identical. For a household, owning vs. renting is a lifestyle choice (it is also an investment choice). It need not have anything to do with the market demand for housing.

The main determinant of homeownership is the nature of your household. If you’re in your twenties and have no kids, you will rent. When you are over 70, you might revert to renting. Meanwhile, close to 90 percent of households own a home at some point.

Imagine that all housing units were identical. Supply and demand for housing is balanced by the rental cost of housing. Some houses are owned by landlords, and some houses are owned by their occupants. But the proportion owned by landlords can change from 60 percent to 40 percent without affecting rents or house prices.

In the real world, housing units are not identical. Neighborhoods are different. Structures are different. This can complicate things quite a bit. But I still think that it is useful to think in the following terms:

• The supply and demand for housing is balanced in the rental market

• The proportion of housing owned by landlords vs. owned by occupants depends on lifestyle preferences and lending standards

My view of what happened during the housing boom of 2003-2005 is that there were self-fulfilling expectations for rapid increases in house prices. This caused an increase in supply, which kept rents lower than they otherwise would have been.

More people wanted to own homes, both to live in and to hold as assets. Many purchases were for non-owner-occupied homes, with the buyers thinking of perhaps renting out to others or perhaps just “flipping” in a rapidly-appreciating market. Lenders were accommodating buyers of all types by relaxing lending standards.

Starting in 2006, house prices lost their upward momentum. This made many of the earlier purchase decisions uneconomical. The process of unwinding homeownership back into rental is very costly and time-consuming, so the housing market was distressed for a long time. Meanwhile, both lenders and regulators tightened lending standards, which made the adjustment process more painful.

In this story, the rise and fall of house prices was not caused by changes in lending standards. It was a case of expectations of rising prices that were self-fulfilling until they could no longer be sustained.

Loose lending standards raised homeownership rates above what they probably should have been. And perhaps standards tightened too much after the bubble popped, lowering homeownership below where it might have settled.

Fluctuations in homeownership had major financial repercussions, because of the way that mortgage securities markets had evolved. And foreclosure is a costly process. Otherwise, the transition from a high rate of homeownership to a lower rate would not have been such an important part of the story.

I think that housing policy places too much emphasis on trying to move the needle on homeownership. The government gets too involved in the mortgage market. Starting from a blank slate, I would not have government involved in the mortgage lending business. But starting from where we are now, I would keep existing government mortgage agencies like Freddie Mac and Fannie Mae, while restricting them to making 30-year mortgage loans for owner-occupied purchase.

While we are at it, let us stop trying to engineer “affordable housing” by imposing requirements on developers. Get rid of affordable housing requirements and other regulatory taxes on construction. Then just let the homeownership chips fall where they may.

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