Housing Tax Policy, A Series: Part 11 - Low income mortgages did not cause the recession.

I have suggested that the timeline of the recession does not point to subprime lending as the cause and that the scale of subprime lending was not sufficient to create a crisis.  But, we don't have to guess about these things.  The Federal Reserve has a nice history in the Survey of Consumer Finances.

First, regarding the Community Reinvestment Act, I have attributed the sharp upward trend starting in 1994 to changes in the CRA.  But, I have noted that the growth in home prices didn't happen until several years later, after half of the increase in homeownership rates had already happened.  So, CRA might have led to more homeownership, especially among lower income households, but that it doesn't seem to have contributed much to rising home prices.



note: the y-axis is not anchored at zero, in order to magnify changes.

Here is a graph of homeownership rates.  (There is a jump in the lowest quintile from 1989 to 1992, but this appears anomalous to the present topic.)  The growth in homeownership happens entirely above the 40% income percentile.  This could mean that the CRA, despite the evidence of its importance among some mortgage originators, didn't really affect total mortgage originations, but simply shifted credit for them.  Or, it could mean that there were large numbers of households in the top-half of the income scale who weren't being served by the mortgage market, and the CRA actually helped high income families buy homes.
This seems plausible to me.  Retired households, households headed by adult students, and rural households in low cost-of-living areas should account for a large number of the bottom 40%.  It could be that urban families who were the marginal homeowners affected by the CRA had middle-to-upper-middle class incomes, and that the high cost of urban property was an impediment to ownership for them.  So, it could still be the case that the CRA was both (1) the cause of some of the rise in ownership and (2) not responsible for mortgage growth among low income households.

Whatever the case, the commonly repeated anecdotes of janitors and checkout clerks being
handed $300,000 mortgages on a hope and a prayer do not appear to be representative.  On net, all the new mortgages went to families with incomes around $45,000 and higher.  (Don't get me wrong.  For the vast majority of new home buyers, this was a very profitable decision.  If any low income households had bought homes too large for their budget in the 1990's, it would have paid off handsomely.  Home prices are more than double what they were then.)

Here is the same chart, showing the total growth of homeownership, subdivided into income quintiles.  From 1992 to 2004, homeownership grew from 64% to 69%.  About 1.4% was from the top quintile, 1.4% from the 4th quintile, and about 1.9% from the middle quintile, even though most high income households already were homeowners.  Additional homeowners would naturally tend to skew total ownership to lower incomes, but this was, surprisingly, not the case in the 1990's and 2000's.  Throughout that period, the average relative income level of homeowners was rising!

We see the same story in household debt.  Debt payments were rising in the 1990's.  But, in the 1990's, home prices were very low.  And, furthermore, debt was rising both among owners and renters.  In the late 1990's, debt payments rose among the 40%-80% income quintiles, which probably reflects the large increase in new homeowners among these households.  But, I'm pretty sure that upper-middle-class households slightly increasing leverage to buy homes in a buyers' market is not widely considered to be a systemic problem.  Also, note that the boom in home prices would first show up in the 2001 survey, and the 2007 survey should show the first signs of distress.  During this period, there was no rise in debt payment levels.  There is a distinct rise in debt payments in 2007 among 60%-90% income households.  Then there is a distinct rise in <20% households in 2010.  These are likely the result of households dealing with the aftermath of the crisis, first through upper-middle-class households drawing on home equity to make up for the currency shortfall (in 2007 - not in 2001 or 2004) and then, households who have been moved from high incomes to low incomes by the dislocations of the crisis in 2010.

Note that, even after the crisis reduced incomes across the board, families never had debt payment ratios as high as they had been in 1998 - neither owners nor renters.

The crisis did lead to dislocations among selected, unlucky, households.  Here is a measure of the number of households who had debt payments amounting to more than 40% of income.  Again, note that this level was rising in the 1990's - when homes were inexpensive.  But, it was level in the 2000's - until 2007.  And, notice that the rise is all coming from the top half of the income distribution.

So, we have seen an unsustainable debt-fueled economy.  It happened in 2007, among high income households, after the Fed sucked the currency out of the economy.

Then, in the last chart, we see a measure of delinquency.  Notice that delinquencies are flat for owners until 2010.  They rise slightly for renters until 2004.  Possibly that is due to the rise in interest rates.  But, it is interesting that it is among renters, not homeowners.

Then, in 2010 and 2013, delinquencies rise among all household groups, across income groups (not shown), among owners and renters.

So, again, we find a shocking disconnect between the common narrative and reality.  The narrative says that low income households were pressured into overpriced homes with oversized mortgages, until the inevitable end to the charade brought everything crashing down.  First, the low income, subprime homeowners crashed, and then this led to a wider recession.

But, just as with the bank delinquency numbers, the story these household numbers tell is quite the opposite.  As home values skyrocketed (I said, "home values") in the 2000's, households retained a very reasonable level of debt and debt payments.  In the 1990's and 2000's, high income households were enticed into the housing market by the new higher value of homes (which I will argue through this series of posts was mostly a product of low long term interest rates and tax policy.  In fact, the fact that high income households were the net homebuyers, is a predictable result of homeowner-friendly tax policies, since these are overwhelmingly utilized by high income households.)  Then, as the Fed began implementing monetary austerity, high income households initially were able to counter the liquidity shock through credit expansion.  But, when the Fed refused to relent, by late 2008, households did, and subsequently incomes fell across the board.


Finally, here are two graphs showing rent payments relative to incomes.  Here, I have taken real incomes from SCF Table 1 and compared them to total rent paid by owners (imputed) and tenants, from BEA table 7.4.5 (adjusted by the GDP deflator and the census count of households).  (Some care should be taken here, because of the mix of data.  For instance, my inflation adjustment for rent is not the same as the inflation adjustment used for incomes.)

First, simply looking at real incomes, from SCF Table 1, we see that median incomes rose slowly until the crisis, while mean incomes rose quite sharply.  This suggests that as we moved through the housing boom, the distribution of homeowners skewed more positively.  In other words, the net new owners were unusually high income households.  And we see the opposite movement among renters.  They began the period with a typical positive skew (a higher mean income than median), but as we moved through the boom, the median grew while the mean remained stable.  This is because it was the highest income renters who were moving into homeownership, so the positive skew of renter income declined over this period (until the crisis reversed the trend, making many high income households renters again, or maybe more precisely turning high income owners into new low income renters).

Now, let's move to the rent to income measure.  From 1995 to 2001 - even to 2007 - rent to income was declining among owners.  In other words, owners were not moving into houses too large for their budgets; they were actually pulling back on real housing consumption as the boom matured.  Much of this shift could be simply from the fact that the new owners tended to have higher incomes, and would naturally spend less of their income on rent.  So, we see the mirror image in tenant rent/income.  As the high income households moved from renters to owners, the remaining pool of renters tended to have higher rent/income ratios.

I also want to point to the change in rents since 2007.  It has been level among owners but very high among renters.  This is a complex issue, but I believe that as I work through the details in this series, I will show that both our owner-friendly tax policies, and the severe supply shock that has devastated the housing sector since 2007, create rent inflation that falls specifically on renters.  Owners took a big hit through capital gains losses after 2005.  But, the hit to real incomes has been much heavier on renters than on owners, mostly because tax policies and the supply shock create outsized inflation on tenant rental expenses.

The solutions to this problem are (1) to allow mortgage credit to flow and home prices to rise and (2) to eliminate taxes on capital.  Don't hold your breath.

But, how to square this with the rise in subprime lending?  I suspect that there isn't that much of a correlation between subprime and incomes.  My mortgage wasn't "subprime", but I was self-employed with variable income.  So, getting a conventional mortgage was especially hard, relative to what it should have been.  How much of the subprime market was going to these kinds of households?  Or high income households investing in second homes for rental income?  I think it is plausible that the subprime boom was mostly related to high income households with unusual income profiles.  They would have unusually high default risk, even though their incomes would be high.  And, the added value (after tax) of homeownership in a tax-friendly, low interest context, would lead those households, reasonably, to take on the risk of leveraged home ownership.

Next, I will look at debt levels from SCF.