Should US restrain borrowers?

Ughh... so now people aren't responsible for their own financial stupidity because they were "forced" into it by being good parents. Sorry, I don't buy it. There were so many other alternatives (e.g., renting in the same "must-live" districts), that this is a just a lame excuse for those who like to play the victim. Face the facts: you over-borrowed and over-paid because of your own poor planning (and in some cases, greed).

TOugh one.

Ideologically I believe people should take responsibility for their actions, and that society will not function unless it is composed of citizens, not children who are dictated to.

On a practical matter, I saw loan products being sold in the recent bubble to people who had no business getting those products, and no understanding of what they were getting into.

There are people for whom an option arm is a good loan, but I'd say they were less than 5% of option arm borrowers.

I think the regulatory answer is thus appealing, but it should be done properly - by regulating loan securitization so brokers and banks have economic interests that last the life of the loan - skin in the game, as it were. In such a case, people who make loans will actually take seriously whether the borrower can afford them. Under the current regime, the loan salesman gets the commission up front, and doesn't care about borrower defaults down the road. This is a clear incentive to put people in loans that may not be ideal.

Aligning incentive structures is far more efficient at producing results than the sort of simplistic populist regulation Massachusetts tends to be drawn too.

I think your question should be reworded as thus: Do we need rules to protect us from ourselves?

The answer to that question is, of course, "yes." We need government to set boundaries or people lose control. The challenge, of course, is where to draw the line in the setting of boundaries? Extremes are always bad, and during the past 25 years we went from one extreme (too much regulation) to the other (too little regulation).

I think it is not true to say that people, who bought real estates between 2002-2006, were overpaid. I would say it true if there were few selected buyers, however, it was pretty much anyone who involved in buying a real estate during this time period. Nobody likes to overpay for anything, it was the price the market valued at the time. I would say it was just unfortunate. Fortunate for sellers.

In my opinion, if there weren't mortgage brokers, the housing market wouldn't be in this mess. Heck, during this period, there were pretty much "mortgage this / mortgage that" companies every square mile.

This post is an open invitation for an Ayn Rand orgy.

Should it be legal to buy oxycontin at will? Should we stop inspecting meat? Should we pull up all the stop signs and let the market control traffic through fatal accidents? Why can't every American own an M-1 tank if he wants to? Shouldn't we all be free, free, free?

These may be fascinating questions to college sophomore boys, their minds uncluttered by any knowledge of the real world. However, here in the non-Bizarro universe, we stand on the brink of economic collapse brought on by the ruinous failure of laissez-faire ideology. And in this world, we have to face the facts.

First of all, the government is heavily involved in markets, and always will be. There would be no US housing market right now but for Freddie and Fannie. The problem is that the regulators refused to enforce the rules we already have, much less press for the additional regulation they need. Only now are central banks coming to agreement that asset bubbles are devastating to economies and should be nipped in the bud. Only now are we recognizing that unregulated, off balance sheet transactions drove the financial system off the cliff.

It's fine to say, let people get themselves out of their own messes. The problem is, they make a mess for us, too. So instead of stopping people from engaging in stupidity, the rich get bailouts we all have to pay for. And regular folks leave behind foreclosure ghost towns that damage their neighbors' financial health.

It's always this way. There are no free marketeers in foxholes. Everybody gets a bailout when bets go really bad. It's a lot cheaper to stop people from making really bad bets in the first place.

I have no doubt there were people who bought for the reasons he describes. I doubt very much it was a very high percentage but still, all buyers are responsible for the decisions they make and the risk they accept.

I don't like government regulation but, as charles points out, there should be some disincentive to prevent mortgage brokers and banks from giving bad loans.

From what I see there are no innocent victims of this mess. Any bailout just encourages more irresponsible behavior in the future.

It is a tough one. It makes sense to me that parents of young children looking for good schools played a significant role in driving up house prices. As a parent of two young children who moved out of the city last year, I understand.

But you have to be reasonable even if the market isn't. You have to know what's an acceptable stretch and what will doom you to foreclosure. What good will it do your kids to spend a couple of years in a good school system only to be pulled out again when the bank takes your house back?

I like something along the lines of the ideas mentioned above: regulation forcing lenders to stick it out with the borrower. Would this mean regulating the secondary market basically?

Frank's got a nice theory. I'm just not sure he's got the data to back it up.

He's riffing off of Harvard's own Elizabeth Warren, who first floated this bidding-war theory in 2005, when she noted that even as many other costs had held constant, the average family was spending 69% to cover its mortgage. In part, she writes, that was attributable to the advent of two-income families, and in part to more liberal mortgages. It wasn't a terrible theory when she wrote the book, based on the information then available.

So let's grant the correlation. Middle class familes are getting squeezed by rising housing costs. But is competition for good schools really the causal reason?

Actually, the Census Bureau gives us a good way to gauge that. Its 2005 housing survey looked at roughly 6.8 million households who had purchased a home in the previous year, and found that about 1.1 million identified better schools as a key factor in choosing the home they did - and only 518k put it as their top reason. So there's probably some effect, but that's a long way from causing the bubble. Plus, we might expect competition for good schools to be offset, to a degree, by non-child households relocating to equivalent neighborhoods with inferior schools, pursuing cheaper housing.

And none of this accounts for the fact that foreclosures have been overwhelmingly concentrated in economically marginal areas. Does anyone really think that housing prices soared in Lawrence or Brockton because upwardly-aspirational families were clamboring for access to their school systems? If only. And yet, by the evidence, that's where middle-class families stretched their commitments furthest past their limited means in order to purchase housing they couldn't really afford.

So, if you want to know why upper-income areas appreciated most rapidly during the boom, it's possible that demand for good schools had some effect. But that's probably not what drove prices in most areas, including those where prices beame most detached from what families could actually afford to pay. And even in those few affluent communities, other things - the rapidly swelling size of the average home, the growing income gap - probably had a much greater impact on rising prices. If the opposite were true, you'd expect to see foreclosures most densely clustered in good school districts, and prices dropping most rapidly there as underwriting standards have been tightened, preventing the bidding war. Don't hold your breath.

@ni, just because everybody (or "the market") is doing it, doesn't mean that they aren't overpaying. At the height of the tulip bulb mania, people were paying $35K in today's dollars for a single tulip bulb. There is no question that they overpaid, despite that being the market price.

No. No. No. No.

This column by Robert Frank is all wrong.

He writes: "PRIMARY responsibility rests squarely on regulators who permitted the liberal credit terms..."

Wrong. "Primary" responsibility rests squarely on the borrowers and the lenders.

To streamline your logic. People who bought houses in the 70's and 80's would say to the people who bought houses in the 90's as being overpaid fools.

Today I am still thinking that I am overpaid for gasoline when it was less than a dollar for premium in late 80's but I still buy gasoline anyways. Hmmm yes my penny worth something in the late 80's; I could buy a candy for a penny and yes I am overpaid now. I paid $15K/year tuition for neu in the early 90's and now it's $33K in '08. I could say to these unfortunate freshmen...you fools you are overpaying!

Historical data is just that...history. It's good for all data analysis and for computing trend etc...but when come down to any purchase decision it's irrelevant. The decision is based on today's value. Overpaid? No! Unfortunate under the circumstances? Yes!

Ni,
If you feel that the percentage of income you spend on gas is too high, what do you do? Drive less, buy a car with better gas mileage, use public transportation? Many of the people who bought houses did not use this kind of logic. Their options were to rent, buy a smaller house, move to another area etc. Owning a home is not akin to consuming food and water - it is not essential.

I agree with Dan E - we need some level of regulations and rules. Not just to protect the homeowner, but to protect their fellow taxpayer who shoulders some of the burden.

I agree with the premise of the article, but I don't think that it was just good schools that determined the run-up. The problem was that there was an incentive to buy right then, rather than to save money and buy later, even if it meant overextending yourself. If you had kids and could get them into a better school district, you had even more reason to jump into it.

As house prices were rising rapidly, it could actually be a worse financial decision to wait. The increase of house prices were increasing faster than you could save for a 20% down payment. Let's say a couple could save 10k / year and houses were increasing at more than 50k per year (10k = 20% of 50k). In this case, they would actually have a lower down payment (percentage wise) and have to pay more by waiting a year than by buying right then. But, if they stretched and bought that house with an ARM and PMI, and the house did indeed go up 50k, they would soon have enough equity that they could refinance and get a lower fixed rate. In this case, it made sense to slightly overextend themselves *temporarily* because the market at the time was set up that you could get yourself out of being over extended but only if you bought then.

Of course, this was all based on the premise that the prices would keep rising. And by having more people trying to get the houses (more demand, higher prices, faster increases), more people were in the situation that they should buy right then.... Until it couldn't go up anymore and the most recent buyers and those most overextended were left holding the bag.

Regulation in the 80s from the SNL crisis led to the advent of Mortgage Backed Securities. These in turn led mortgage brokers giving out loans in which they had zero stake it.

Now we need more regulation? I think not. MBS are not going to be worth very much in the near term. Lenders will be far more careful.

The downside (in some peoples opinion) is, people will qualify for less-- and therefore be able to afford less. House prices will fall. Imagine, someday your kids might actually be able to afford a home in your neighborhood.

T

@ni, by that logic, it's impossible to overpay on anything. Why do we even have the word then?

You're also conflating paying a higher nominal price with overpaying. That is in no way my argument. Most people who bought real estate for most of this decade overpaid not because nominal prices were higher than in the past but because prices were a higher percentage of income than what is normal and prudent.

what I am trying to say is that one cannot buy something today and then five years later thinking that he/she overpaid especially on an item that has no production life time constraint (home does not discontinue). Since one cannot fortell the value of a home in the future, there is no telling you're are being overpaid. The purchasing price at the time of purchase is the right price. I'll take an automobile market as an example because the items (cars) have production life time constraint where each model year discontinues. I don't buy '09 model year car today and expect the value to go up in 5 years. Since I know the product has life time constraint, I expect the value to depreciate. Unlike homes, I cannot be 100% certain about the value so I based my decision on assumption and hope that it will appreciate in the future. Fast forward to the future (2010), if I buy a '09 model year car at the MSRP or even at the dealer invoice price, then I would say I am overpaying because I could pay the same price for the current model year car.

@Eric, Buying a car with higher mileage per gallon doesn't make any financial sense just to save a few cents per gallon of gas. Even if you still own the car for the next five years, it's bad logical choice. Taking public transportation? Not everyone is working in Boston. Even if you live where public transportation is available, let's say N. Andover, and you work in Beverly. Do you take commuter rail to North Station and transfer to Beverly commuter rail line to Beverly? Let's say this is a logical choice, how do get from Beverly station to your work place? Time is essence here. Really! it's not a logical choice. You have no choice to drive less if you work outside public transportation service, even if available, sometimes it's a not a logical choice. If you rent, you may have a better flexible choice by moving closer to where you work.

You know that homeowner pays taxes like everyone else's too. Despite we live in a democracy nation, if the government wants to use tax money to help struggling homeowners, even me, you, and everyone else who are against it -- what could we do?

ni, no you can't know what the exact market price will be 5 years from now, but you can still compare the price to the fundamentals to see if you are overpaying. The price to income ratio is a pretty good indicator in that respect - it is roughly constant over time, usually. If it is much higher than normal (as it was), then that is a pretty good sign that you are probably overpaying. So this isn't a determination that is limited to hindsight. Plenty of people were saying in 2005 that people buying then were overpaying - this isn't a retroactive determination.