Ban Mortgage Prepayment Penalties at the Federal Level, 1: Texas

Prologue

So I’m glad Texas is making waves about seceding from the United States right now, since it leads nicely into my first ever weekly project here at Rortybomb. I don’t know the specific talking points of the Texas Teabag Protestors, but if they have a feeling that they did something right while everyone else was doing something wrong during the 2000s, they may have a point.

In 2007, when everyone first started to realize en masse how bad the housing landing was going to be for the country, I remember telling a friend “I bet Texas is going to be a giant crater when this is over.” From my mind, I’ve always associated Texas with the worst boom-and-bust cycles in everything, housing above all. The next day I checked the numbers and realized I was entirely wrong.

Let’s look at some data. Here’s the Case-Shiller numbers for the 20-city US index, Phoenix, Arizona, and Dallas, Texas, seasonally adjusted. (For some reason, Case-Shiller does Dallas instead of Houston. These numbers are generalizable though).

case_dallas

Now Phoenix and Dallas have a lot in common. And so does Texas and Arizona. Yet somehow Texas, which seemed perfectly engineered to replicated the problems of Nevada and Arizona, as well as California and Florida, avoided the fate of the “Sand States.” The value didn’t jump high then crash; they rose a nice 25% over the decade (it looks small on the chart, but only because it is overshadowed by the boom/bust).

From USA Today, we see Texas is right around the median of housing foreclosures, with a normal 1%; Arizona, Florida, California and Nevada all have 4% and above. When you start digging, you see all kinds of signs that the Texas market is fine – it is the first everyone expects to start going again.

So what gives? I’ve thought about this a lot, and have come to a simple three word conclusion: “No prepayment penalties.” Right there in their state law:

§ 343.205. PREPAYMENT PENALTIES PROHIBITED. A lender may not make a high-cost home loan containing a provision for a prepayment penalty.

And, in general, a consumer’s bill of rights:

No Balloons – a high-cost home loan may not provide for a payment that is more than twice as large as the average of earlier scheduled monthly payments within the first sixty months of the loan.
No Negative Amortization – a high-cost home loan may not provide for a payment schedule that may cause the principal balance to increase.
Borrower’s Payment Ability – the lender may not make high-cost home loans based on the collateral value of the property without regard for the borrower’s repayment ability, including current and expected income, current obligations, employment status, and other financial resources.
No Prepayment Penalty – a high-cost home loan may not contain a provision for a prepayment penalty.
No Charge for Service Not Received – a lender on a high-cost home loan may not charge a borrower for a service or product if the borrower does not receive it.

I think all these are good ideas to be brought back to the federal level. It was not always this way, determined at the state, or in a way friendly to whatever banker and consumers could agree on. As part of a wave of deregulation in the late 1970s and early 1980s, Congress passed AMTPA, which allowed the subprime market to be built. That wave of deregulation was a series of experiments; it is in the nature of experiments to sometimes succeed, and sometimes fail. It is our job to determine which is which among the wreckage, and my argument will be that these prepayment penalties created the worst incentives for banks.

I understand that we don’t want to regulate the previous crisis. The Democratic Party is busy with trying to fix the Recession and the banking crisis, while the Republicans are busy heroically fighting the One World Currency and the FEMA internment camps. During 2007, we heard from candidates Hillary Clinton and Chris Dodd that they would want to ban prepayment penalties. We haven’t heard it from President Obama; I would like to see pressure to do so, while Change is in the air.

So I’ll spend a few days talking about this in detail, from empirics, to financial theory arguments, to a model as to why this happened, hopefully accessible to any educated reader. Feel free to skip if you are already bored. I want to consider doing some policy wonk finance stuff here (and perhaps more generally with my life), and I’ll possibly try to expand into a formal paper, one which also keeps its finance and economic chops up – so please criticize away, even if you agree with me.

I also want to get away from the duality of thinking of the subprime crisis as evil banks looting homeowners or evil lenders tricking banks. With the genius of prepayment penalties, banks didn’t have to make money by lending loans to credible homeowners – they could form a de facto company with unqualified borrowers to bet on house prices rising. The prepayment penalty was the bank’s equity in this endeavor. Or another way to say it is that the banks found a way to hire a person to sit in a house they wanted to gamble on; this was a subprime loan with a prepayment penalty. More to follow.

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53 Responses to Ban Mortgage Prepayment Penalties at the Federal Level, 1: Texas

  1. Terry Ivanauskas says:

    Hi,

    I am looking forward to reading your next posts, but I would like to add already a question. I don’t know about Arizona, but I heard from a friend that property tax in Texas are higher than in the rest of U.S. Since property tax affects the value of houses, couldn’t it also explain the behavior of home prices in Texas?

    Terry

  2. Sue says:

    [Yet somehow Texas, which seemed perfectly engineered to replicated the problems of Nevada and Arizona, as well as California and Florida, avoided the fate of the “Sand States.” The value didn’t jump high then crash; they rose a nice 25% over the decade (it looks small on the chart, but only because it is overshadowed by the boom/bust).]

    You do know why Texas is different, right? Check the 1980s bust – a lot of what we hear about thse days happened then in the 80s – jingle mail, developments left unfinished, property prices plunging and it took 15 years or more to get back to even in some locations . A lot of the restrictions in the mtg market in Texas (eg no kitchen table closings) and the consequent lack of the same scale of bubble (though there are and have been local smaller bubbles) are because of what happened then. I’m just commenting since I didn’t see the 80s mentioned in your post, it hit hard in Texas and is still fresh in many people’s minds.

    http://www.dallasnews.com/sharedcontent/dws/bus/stories/072108dnbusBankCrash.76a5c90e.html

    (Since the article above was written Texas has descended into recession too, now is losing jobs)

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  4. Mike says:

    Crowd-sourcing, awesome. Thanks for the good comments.

    Terry, I’ll check out the property taxes issue. That would definitely cool a market – I’m curious as to how it compares to CA.

    Sue, the 1980s bust is what I had in mind when I thought Texas would be a crater. I had assumed that their legislation/regulation response was too weak, and their turnover of population high enough, that they’d do it a second time as farce instead of tragedy. I think the argument will stand without Texas, but I wondering how well it will do as a case-study; checking out their regulation as an actual response to similar housing bubble is a good idea.

    • Dan says:

      Property taxes should only cool a market to the extent that they rise unexpectedly and are not proportionately accompanied by increased or improved public services that people value. Existing levels of taxes should already be capitalized into prices, so they should not affect changes in prices across metros.

      I am not sure the prepayment penalty argument holds up due to preemption abilities by national banks and thrifts. If there was “demand” (albeit lender stimulated) for PPs, I think the national lenders would have stepped in more.

      It is true that home equity lending has been relatively restricted in Texas, so that may have had some impact. This may have slowed the development the subprime mortgage market in the state generally, which was generally developed in the late 1990s as a primarily refinance market…fewer mortgage brokers, etc. When the incresae in subprime in home purchase lending hit (and it hit in many metros that were not bubble markets — e.g., Atlanta, etc., just not to the same degree) there was perhaps just less infrastructure in TX.

  5. racerx says:

    There’s real merit in your arguments (there was a lot of discussion last year at Calculated Risk in regards to the issue, should be detail in the archive) but other states have similiar restrictions as well (NC and GA both have strict rules regarding prepay penalities). One thing Texas has going for it that it has some of the strictest guidelines available regarding cash out refinances. Homestead owner-occupied properties can have an LTV no higher than 80%.

  6. jkm says:

    Hey Mike! I am seriously looking forward to the upcoming posts–bravo in advance! Could you provide a link to something that tells the uninitiated like myself what a prepayment penalty actually is?

  7. pebird says:

    Texas was hit by a double-wham in the 80’s & 90s – as Sue said, the S&L crisis and also the big oil bust. I don’t know if you ever watched “Dallas” – the late night soap opera TV series that had it’s peak in the mid-80’s – but that was the peak of Texas culture – big houses, big family business, ranching & oil. All came down roughly the same time. Hit a lot of families that were long-time Texans – not as many transplants back then.

    It might seem a little odd that Texas would pass such relatively progressive laws – but there was a lot of local anger back then.

  8. Mike says:

    racerx, I’ll go dig for the links during my lunch break, thanks! “Homestead owner-occupied properties can have an LTV no higher than 80%.” I keep seeing that there – so that means a first time homebuyer needs to have a 20% downpayment?

    jkm, I’m going to post that tomorrow probably, don’t worry, it’ll probably be too long.

  9. surferdude says:

    texas also did not allow home equity loans until 1997 and when they were allowed, much stronger protections were put in place to limit the combined ltv to 80%.

    see http://www.expertlaw.com/library/finance/Texas-home-equity.html

    high ltv lending plays a major role in this bubble. home prices could have never escalated without it. very few have the ability to put 20% down ($100k) on a $500k property. going back to 20% downpayments puts a natural cap on the rate the home prices can rise. when paired with limiting home prices to 3-4x of a buyers gross income, there is little chance for a bubble to happend. this is banking 101, somehow this got lost along the way as bankers rushed in to create more volume so that earnings, share prices, and bonuses go up.

  10. Sue says:

    Mike said – [“Homestead owner-occupied properties can have an LTV no higher than 80%.” I keep seeing that there – so that means a first time homebuyer needs to have a 20% downpayment?]

    No – racerx was referring to cash out refis. BTW a lot of lenders won’t do refis in Texas, can’t guess why.

    We recently refied in TX, no cash out, low LTV, the Very Big Bank sent appraisers to take photos of interior (LOL, had to spring clean early) and triple checked everything (salary, tax returns etc) – definitely they are being cautious here in TX on a 5-figure fixed loan significantly under 1 x 1 income. Some other states could maybe take notice ;)

    20% not required – Same Very Big Bank will lend on say low end 150k property with 10k down at under 6% (full doc, depending on credit history, maybe need to sign away first and second born entire lifetime earnings too)

  11. Jacob says:

    Mike, I’m an NC native, and you’ve got another good case-study in Charlotte (likewise Raleigh isn’t included in Case-Shiller but the numbers are representative of what I’ve seen there). Charlotte has a line almost identical to Dallas’ on your chart above. (ref: http://www2.standardandpoors.com/spf/pdf/index/CSHomePrice_History_033114.xls)

    I think you may be on to something by focusing on lending policies. See this:

    http://www.responsiblelending.org/policy/state/north-carolina/NCfaqs.html

    The Center for Responsible Lending is a good resource on the topic in general.

  12. racerx says:

    Mike, Here’s a link from consumer reports’ on TX home equity laws

    http://www.consumersunion.org/finance/policy-rpt1002.htm

  13. Jacob says:

    Just looked a little more closely at the CS numbers, and it appears 6 of the 20 cities had a less than 40% run-up since January 2000. The other 14 all look more like bubbles; there’s a pretty significant gap between these six and the peak of the next lowest city (Chicago, at about 70% over 1/1/2000 numbers).

    The six cities were Dallas, Charlotte, Denver, Atlanta, Detroit, and Cleveland. If you’re going to try to isolate the effects of lending practices, you’ll want to try to explain why there wasn’t a bubble in each of these; Detroit and Cleveland I think may be obvious given the economic difficulties they have been facing, though perhaps the law is also very strict there.

  14. JC says:

    You’ve got this totally wrong. Those Texas restrictions don’t apply to all loans, only to “high-cost” home loans. There is virtually identical federal legislation called HOEPA (Home Ownership and Equity Protection Act, part of the Truth in Lending Act). A high-cost home loan, pretty much anywhere except North Carolina, is so punishingly expensive for the borrower (and dangerous for the lender), very few are made. A standard “subprime” loan usually was made to go right up to, but not exceed, the high-cost thresholds (based on APR and/or origination fees).

    Texas, however, does have very strong constitutional restrictions on home-equity loans (these loans, because they are protected by the state constitution, are not subject to AMPTA). The lack of abusive second-mortgage lending (e.g., excessive cash-out refinancings) may be a factor here

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  16. Mike says:

    Thank you for all the comments; the home re-fi stuff is really interesting. As I’m going to discuss tomorrow, when we jump in the deep end of the SalomonSmithBarney guide to Mortgage Backed Securities and their relations to prepayments (how’s that for a teaser!), re-fis were right next to subprime in the investment banker’s mind when it came to juicing up conventional mortgage bonds.

    Big question for my Texan experts: Can I get double-confirmation that prepayments on home equity loans were outlawed? Racerx above helpfully gives me a link that says that it is:

    http://www.consumersunion.org/finance/policy-rpt1002.htm

  17. JC says:

    Texas constitutional ban on prepayment penalties for home-equity refinance loans:

    Texas Constitution Article XVI, section 50

  18. Terry Ivanauskas says:

    Hi Mike,

    Reading the other comments, it may be useful if you consider two things:

    1-) The property tax burden in Texas is high (we are talking about a state without income taxes).

    2-) The Texas legislation seems to make home equity loans more difficult and expensive (without prepayment penalties, the banks would charge more for loans).

    In general, in a world without government, a homeowner would be happier when the value of his/her house increases because home equity loans would be more accessible (and so home price bubbles more probable). I am not from Texas and I am not a specialist in Texans affairs, but maybe the same would not be true there: a Texan homeowner wouldn’t necessarily be happier when the value of his/her house increases because he/she wouldn’t have access to easy home equity loans anyway and he/she would actually have to pay more property tax.

    Terry

  19. donthelibertariandemocrat says:

    There are two separate questions from my point of view:
    1) Why are housing prices high?
    2) Why were iffy loans given out?

    On 1:

    http://www.cato-at-liberty.org/2008/09/22/blame-urban-planning/

    “So it all started with the bubble. But what caused the bubble? The answer is clear: excessive land-use regulation. Yet while many talk about re-regulating banks and other financial firms, hardly anyone is talking about deregulating land.

    The housing bubble was not universal. It almost exclusively struck states and regions that were heavily regulating land and housing. In fast-growing places with no such regulation, such as Dallas, Houston, and Raleigh, housing prices did not bubble and they are not declining today.”

    “We know that if the regulation is left in place, housing will bubble again — California and Hawaii housing has bubbled and crashed three times since the 1970s.”

    Also, in California, the geography of the Central Valley in relation to urban centers is very important.

    On 2, I would wait until the litigation involving Countrywide, for example, finishes, and we know how much of this was Fraud, Negligence, Collusion, and Fiduciary Mismanagement. We certainly know that fraud is still occurring in the marketing of help in renegotiating mortgages. You seem to believe that this is minor, while the current litigation, which even involves AIG, seems to present a portrait of systemic regulatory shopping and fraud at the retail level.

    I’m all for changing laws, by I don’t like the idea of crimes, especially ones with consequences like these, going uninvestigated and not prosecuted, as happened in the S and L Crisis.

  20. Andrew says:

    Why the insistence on using the sexually explicit and insulting term “teabaggers”, particularly after the negative usage by the press?

  21. Mike;

    The Canadian banks have operated in pre-payment penalty environment for years, and they missed the worst of the subprime bubble. So I am not sure that I would focus on pre-payment penalties which in effect are signals from the borrower to the lender than they intend to pay off the mortgage.

  22. b says:

    >> So what gives?

    There was some good research (I can’t find the paper) that suggested that zoning regulations were a huge contributor to the bubble. For example, if you look at Vegas on a map, it is surrounded by vacant land, for miles and miles in all directions. There is nothing special about this land either, it is mostly dry desert, but prices started hitting over $300k an acre for raw, undeveloped land. Almost all of it is government owned (BLM), left over booty from the Mexican-American War. So as Vegas was booming, and it needed land to grow into, the government sold it off slowly, and since they had a monopoly on it, the prices were outrageous. When the developers tried to incorporate the land into the city, the city made them set aside a huge percentage of the land for “open spaces and parks”, they made the developers build roads and schools etc – all the things that the city is usually responsible for. By the time a house was built, there was so much added cost for all these things that the homes were skyrocketing, pushing up all homes with them.

    In addition to the U.S., you have to consider Aus. Ire. Spain, U.K. etc. Zoning explains a huge percentage of the increases worldwide (at least why some areas bubbled while others didn’t).

    Paul Krugman has some info on this too:

    http://krugman.blogs.nytimes.com/2007/10/20/the-two-americas/

  23. Terry Ivanauskas says:

    About the above link:

    http://www.cato-at-liberty.org/2008/09/22/blame-urban-planning/

    It is said that: “if they have such control, they will restrict such development in the name of stopping “urban sprawl” – an imaginary problem”

    Living in a chaotic megalopolis in a developing (not -ed) country, I must say that the problem is not imaginary at all. You can deregulate land, but then you will exchange bubbles in a blue sky for heavy traffic in a very gray atmosphere…

    Terry

  24. Alan says:

    Texas does not allow home equity credit lines either. If prices go up there is not an easy way to tap into that equity to buy more houses and create a bubble.

  25. Mike says:

    Thanks all, for the wonderful comments. This is really helpful for me fleshing out my thinking on this. This series will have several more parts, probably 4, over this week. I encourage you all to read them and continuing commenting away.

    The international comparison is one that is definitely worth looking into. Michael, I would imagine Canada has all kinds of regulations both on its banking and on its home loans – they also missed the banking crisis.

    Don, re cato 1 point, I’m arguing that Texas was pretty regulated compared to most states. Arizona was not regulated. Though this was not all the difference, I think it is a key part.

    re point 2, I think a lot of people are confused why banks might have made these terrible loans, and maybe people take them too – I’ll have a theory as to why in part 4.

    People are starting to talk about the call option embedded in not having a prepayment penalty. Part 3 will discuss this option in (grave, but hopefully readable) detail, and why I think allowing people to do that is overrated. Stick around this week!

  26. Kevin Kleen says:

    Great topic, and excellent comments. Here’s my theory: the bubble was created by easy credit which resulted in an influx of buyers at the lower end of the income scale. If that’s true, you would expect markets with lower median incomes to bubble more than high median income markets. That turns out to be true – median incomes in places like Las Vegas, Phoenix, Miami, and Los Angeles are much lower than places like Dallas, Charlotte, and Denver.

    The other piece is supply. New construction is a small piece of the housing stock, so you needed willing sellers of existing stock for the bubble to form. Existing single family rental homes are obvious candidates, and in fact many bubble cities have a high proportion of such homes.

    These two variables seem to account for most of the bubble and non-bubble city performance. More at http://residentialpropertyanalytics.blogspot.com/2008/12/why-did-some-markets-bubble.html

  27. Sue says:

    Alan at 11:44 [Texas does not allow home equity credit lines either. If prices go up there is not an easy way to tap into that equity to buy more houses and create a bubble.]

    Yes it does, and here is one bank’s conditions, it’s a sample of one I plucked from the air but it could have been almost any bank:

    See http://www.compassbank.com/index.html
    and click on the link for equity loans and lines.

    Just to mention again – there have been and still are (IMO) bubbles in TX just not as big as other states. Texas is a more diverse economy than it was in the 80s when the oil bust and S&L occurred but with that diversity has come local bubblicious conditions at times – eg San Antonio recently, I-35 and US-75 north of DFW up to OK – a few counties there went way overboard with the concrete sprawl and the latest to be built are showing much more subprime and AltA stress than the older burbs, around Houston with high oil prices led to land prices rising (maybe about to correct, have not looked recently). Lake fronts shot up and are still high, local folk have been priced out by rising property taxes and million dollar homes since 2002 in some areas (tear downs replaced by McMansions have happened here as has organized mortgage fraud). Texas being a big place one size explanations don’t fit all, but over-development in some areas has resulted in wasteful local spending and higher taxes, it remains to be seen if common sense is restored as employment and recession hit. But yes, overall the restrictions put in place after the 80s seem to have contributed to the more subdued property markets.

  28. Taunter says:

    No zoning explains the difference from CA, although Dallas is restrictive by Texas standards.

    The big one for the desert southwest is net migration. TX had 19.2 arrivals per 1,000 residents in 2000-2006, which was actually up from 7.7 in 1995-2000.

    By contrast, Arizona had 87.8 arrivals per 1,000 residents in 200-2006, and Nevada had 127.5 arrivals per 1,000 residents.

    Not surprising that the AZ and NV markets were more disrupted.

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  32. Arturo says:

    In no-prepayment penalty utopia, if interest rates go down, the borrower can re-fi without penalty – but if interest rates go up the borrower can sit on the low rate and the lender can go fish – How many want that deal as lender with their personal funds at risk? – that’s why Government (you, indirectly) is behind these losing, one-sided loans. A similar warm/fuzzy feeling lead some States to mandate No-Recourse loans on residences and the effects have come home to roost in the form of abandoned, price depressing properties by those still ABLE to pay and unwillingness to lend by lenders who won’t lend because they have been sorely burned in this heads they lose/tails the borrower wins games…

  33. Mike says:

    Arturo, In no-prepayment penalty utopia, as in regularland, lenders know this risk in advance, and charge the expected value of the negative convexity of the call option onto the regular mortgage rate. Hence if you are a prime mortgage and take a prepayment penalty, you get around 25bp reduction in your rate. I believe markets are perfect and people so hyper-rational they can squeeze blood from a stone with their minds, so that 25bp must be the exact expected rate of that call option in a risk-adjusted metric space.

    That’s just financial engineering, no warm/fuzzy feelings.

    I’ll discuss this all tonight or tomorrow. I meant to be at that part of the discussion, but I’m currently napalming my throat with wal-flu (walgreen’s brand theraful). I feel much healthier drinking something that tastes like lemon and a chemical spill.

  34. ColtsChiefsTitans says:

    Great post & discussion! I think the issue is complicated and lots of factors involved. In addition to Charlotte, I would throw in other moderate growth markets like Indianapolis and Nashville where housing did not inflate nearly as much as on the coasts. Smaller cities in traditionally rural states have an ample availability of cheap land and typically lack sprawl regulation. Although Indy has had strong housing growth the prices have been contained since farmland is still cheap and the distance/time difference is still not excessive (outer burbs are still pretty close to the city). This doesn’t necessarily explain Dallas or Atlanta which have much larger footprints but whose prices did not explode. Strong net migration into an area has to be a big factor in creating housing demand in excess of supply.

  35. Mitch says:

    Another key reason for the difference may be attributed to land use laws. I would dare suggest that Texas probably has much less restrictive land use laws than Arizona (I would definitely say more so than CA, NV, and FL). The supply of available land ensured that there was always sufficient land to meet demand withouth the crazy runup in prices.

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  37. Arturo says:

    What the lender and borrower do by voluntary agreement regarding pre-payment or no-prepayment penalty is noone elses business … but if I understand the thrust of the article, Mike wants a legal mandate forcing a no-prepayment penalty on the parties regardless of their preferences or financial circumstances… that’s government engineering, not financial engineering — feel good stuff, like mandated no-recourse loans.

  38. @Arturo;

    This economic crisis should cure you of the idea that there are no externalities to private contracts.

    Good god man, the entire executive compensation scheme for bankers has produced the pollution of unwanted housing that even conservatives like Richard Posner understand: http://www.huffingtonpost.com/2009/04/20/judge-richard-posner-disc_n_188950.html

  39. Mike says:

    Arturo, please stop by again tomorrow, and I’ll be more than happy to hash it out in the comments to the next post I write!

  40. Terry Ivanauskas says:

    @Taunter;
    But so what would explain the net immigration numbers? When you say in your site that “at least until someone discovered that absolutely everyone in each city was employed in building someone else’s house”, it becomes a chicken or egg question.

    @Arturo;
    Market and regulations are like a basketball/football/soccer game (you can pick your preferred game). You need rules and judges to have a good fair game. Given the rules, how the teams play is no one else business. What you can’t have is the players playing and choosing the rules at the same time.

    Terry

  41. Texas Homeowner says:

    Great article! We Texans are very fortunate that this law was put in place in 2001. This is another example of the value of a little clear headed government regulation.

    Just wanted to give a heads up on Texas home-ownership costs. Texans typically pay 2%-3% property tax (before exemptions). Texan’s also pay the highest homeowners insurance in the nation, it ranges from about 0.4%-1% or about $1300/yr on average (the national average is about $800/yr). Also keep in mind Texan’s pay no state income tax.

  42. BJ Feng says:

    Like previous posters said, it’s the property taxes. Property taxes were the reason I looked into Texas investment properties but never bought. In fact, I never bought anywhere since California and Texas were my only two options due to management availability. Neither made sense from an investment point of view. By the way, I’m buying in California now.

    High property tax rates are incredibly destructive of real estate value. A person with money is going to look around and purchase where he can get the best rate of return. Taxes are expenses that shrink the net income a property can produce, thus the sales price of the property must be reduced to attract a buyer. Look at it this way, I want to get a 8% return on my real estate investment. The property with the higher tax rate will generate lower net income. In order for the buyer to get the same rate of return, the property will have to be sold for less.

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  44. PhilBest says:

    the core issue is how cheaply new land for houses gets brought onto the market to relieve demand pressure when other conditions for a housing bubble start to take effect. One of the best recent overview essays is “Don’t Regulate the Suburbs: America Needs a Housing Policy that Works”, by Wendell Cox and Ronald Utt. I also recommend to readers the annual “Demographia” reports on housing affordability in the English speaking world, along with the many other good references in the Cox and Utt article.

    In the introduction to the 2008 Demographia survey, Dr Donald Brash, former governor of the NZ Reserve Bank (and former leader of the Opposition) said the following:

    “Once again, the Demographia survey leads inevitably to one clear conclusion: the affordability of housing is overwhelmingly a function of just one thing, the extent to which governments place artificial restrictions on the supply of residential land.”

    I am becoming increasingly disappointed at so many intelligent analysts missing this vital point.

    The United States of America as a whole, does not have a house price bubble problem. Nearly 50% of the crisis-related losses have occurred in California alone. Another 10% has occurred in New York and another 10% in Florida. Most of the remaining 30% is also restricted to relatively few states. If it were not for these States land use policies, the USA would not have had a crisis at all.

    A state like Georgia has been marked by such affordable housing, that many of the subprime mortgage cases that have been pointed out, involve houses bought for as little as $40,000 – the same awful, tumbledown old house in California would be the subject of a $500,000 subprime mortgage. It is not hard to see which situation has contributed the most to the financial crisis.

    Canada as a whole, is similar to the great majority of the USA’s states, and has not had a house price bubble. Ergo, they have not had a mortgage-related financial crisis.

    Other countries not covered by the Demographia reports that have not had house price bubbles, are Austria, the Czech Republic, and Germany. Pro-development policies seem to be central to these countries successful avoidance of these bubbles. Contrast the UK; since their Town and Country Planning law of 1947, they have had no less than four of the world’s historically worst house price bubbles, including the current one. One wonders whether, now that these issues have become equally consequential for so many other countries as well, the penny will drop at last.

    The English economist Fred Harrison has written copiously on the phenomenon of business cycles dominated by house price bubbles, using the UK experience to develop his theories. He has been credited with correctly predicting the latest one. Yet even he seems to have missed the point that these bubbles were unique to the UK until such time as other countries instituted similar land rationing policies.

    Nations with no house price bubble, that are suffering a downturn, such as Germany and Canada, have genuinely been affected by non-domestic factors such as poor quality overseas lending and falls in exports. But in most countries, opportunist politicians and media are using the crisis in the USA as a scapegoat for what are actually domestically created troubles, for which the mechanism is identical to that of California – regulatory land rationing followed by a house price bubble, which monetary policy, taxation, and finance law becomes increasingly impotent to control. Ireland and Spain are the worst affected, along with the UK. Hugh Pavletich, one of the authors of the Demographia survey, has been pointing to the Gold Coast of Australia, now the least affordable housing market in their survey, as the next California in the making, with potentially disastrous consequences for the Australian economy.

    Time will tell whether more attention should have been paid to this issue sooner. If the land supply issues are not resolved, we can expect these massively destructive bubbles to become regular cyclical economic fixtures just as share market bubbles have been for a long time but without the same destructive effects. House price bubbles are much more destructive precisely because they affect almost everyone, they involve much greater sums of money, and very much greater assumption of household debt, whether for purchase of a home or for collateral-based spending.

    One last point. A lot of analytical literature fails to distinguish between house price bubbles, and house construction bubbles. The latter has happened regularly before, but the current bubble in house prices is a different and altogether much more damaging phenomenon. A bubble that is an oversupply of new homes actually keeps prices low throughout, and brings about its own demise as customers fail to materialize. A house price bubble, though, absent a supply vent, is self-perpetuating right up to the point at which it brings about collapse of the whole economy. “Land banking” and similar capture of available land by investors, can and has resulted in price bubbles even in the face of authorities releasing “enough” land for population increase based demand. It would seem that either a totally free supply in land, or “performance based planning” as Hugh Pavletich aptly describes it, based on actual prices, not bureaucratic calculations of supply requirements, is necessary to avoid this phenomenon in future.

  45. Dan says:

    Were prepayment penalties ever allowed in Texas? I’m aware they are banned now as well as negative amortization loans. http://www.bankapedia.com/mortgage-encyclopedia/state-mortgage-laws/635-texas-mortgage-laws

    How many states are working towards banning prepayment penalties and what is required to make that happen?

  46. Ron Stone says:

    I agree that pre-payment penalties should be banned but I also think ARMs should not be allowed. During the hot sub-prime period, they almost always went hand in hand. Unfortunately, the regulators were asleep at the wheel. Many still haven’t fully awakened and we are all paying a very high price now. I think of it as someone chained to a time bomb and not knowing where to turn for help.

  47. Brian says:

    Sounds to me like Texas learned its lesson and made sure that it didn’t happen again, shame they didn’t get the rest of the country to follow suit.

  48. Dcdubbs says:

    I don’t agree that PrePays should be banned, but they should be re-regulated. During the boom a lot of everyday folks got exceptionally greedy. People seem to forget it wasn’t just the banks. I owned a large brokerage in Las Vegas and you routinely saw people flipping homes months after they closed. Or refinancing with a new lender only a few months after they bought the house to take the cash out.

    The original lender had to pay a substantial commission to the broker and unless if the purchasers don’t stay in the mortgage for at least a yr – the broker is out the money.

    So unless we also decide to ban Yield Spread – you can’t really ban prepays

    Here are all of TX’s mortgage laws

    http://www.bankapedia.com/mortgage-encyclopedia/state-mortgage-laws/635-texas-mortgage-laws

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  52. Ron Stone says:

    I was a mortgage LO until the big banks had the government put us out of business by creating an unlevel playing field and I saw many a case of where a PPP held people hostage. There is no end to what the big banks will do to squeeze every dime they can out of the consumer.

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