We need home equity insurance now
The housing market is struggling to recover even with the Obama administration's $75 billion foreclosure prevention program. Commentator Barry Nalebuff says to get housing back on track we need a federal home equity insurance program.
Barry Nalebuff (alum.mit.edu)
More on Housing - Real Estate, Commentaries
TEXT OF STORY
Kai Ryssdal: For all the promise the banks seem to be showing, housing is still playing catch up. The company that watches foreclosure numbers -- RealtyTrac -- reported this morning filings last month were up 46 percent over March a year ago. Today the Obama administration named the first six lenders that are going to participate in a $75 billion foreclosure-relief program. But commentator and economist Barry Nalebuff says there is a cheaper way to turn things around.
BARRY NALEBUFF: The housing market is in a vicious cycle of scared buyers, foreclosures and falling prices. In a normal world, falling prices increases demand and reduces supply. But today's housing market is far from normal. As prices fall, demand falls with it. People are afraid prices will far further, so they hold back. No one wants to catch a falling knife. Paradoxically, falling prices also lead to increased supply, due to defaults, distressed sales, and foreclosures.
One way to break this downward cycle is to offer home buyers protection against losing money on their homes. People buy insurance to protect against floods and fire. But they can't protect themselves from losing all their home equity in a declining market. With such insurance in place, many more people would be willing to buy in this declining market and thereby turn the market around.
That's why we need this type of insurance now and on a big scale. What we need is a federal home equity insurance program. How would it work? If prices fall, you're covered. The insurance would be linked to the overall house price index at a local level, not the price your home. That way, you can't sell at a loss just because you didn't maintain the house. Lenders would also be protected, with first claim on any payment from the policy. Protecting lenders should make them more willing to provide loans and help bring some leverage back into the mortgage market.
Unlike other bailout programs, providing home equity insurance won't cost taxpayers billions. Here's why. Having insurance available changes the whole market psychology. The very existence of the insurance increases demand which reduces the risk that prices will fall. This makes the insurance cheap to provide. Indeed, if the increased demand just stabilizes prices, there won't be any claims and the cost of providing the insurance will be free.
Can it be done? Yes. Six years ago, my colleagues and I worked with HUD and Neighborhood Works to develop just such a product for Syracuse. After nearly a decade of declining prices, this product helped turn the market around.
What works for Syracuse is good, even essential, for America.
Barry Nalebuff is a professor of business strategy at the Yale School of Management.
Comments
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From Houston, TX, 04/21/2009
Did I miss something in Larry's proposal? While listening to Barry talk about developing government house-value insurance, I couldn't help but wonder if he owned a few houses that have lost their value lately, and wanted the government to step in and save him.
If, as he assumes, the value of the houses in an area are just in the middle of a temporary slump, in an area that is economically diverse, and will soon recover, that is one thing. But for many areas of the country, the jobs have left the building, and won't be coming back, and neither will the values of the homes. I used to live in Flint, Michigan. It will never recover from the auto industry's problems. Buick is no longer headquartered there. The downtown Buick manufacturing plants that date back to the time Billy Durant was personally designing them have been torn down, and they aren't ever coming back. Should the government have guaranteed the value of the homes that are vacant because ex-GM workers have left?
Also, for many years I have driven around, seeing the palatial homes in burgeoning subdivisions that were going up throughout Michigan's suburbs and wondering how people could afford them. According to my taxes, my wife and I earned enough to place us in the top 5 percent income range in the United States. Yet with that, we were barely scraping by with an elderly, modest 3 bedroom home in a modest neighborhood in inner city Flint. We have three daughters, but its a good thing they are capable of bringing in lots of scholarships, or we wouldn't have been able to afford college for them. Well, of course, now we know that many of the people that bought those houses COULDN'T really afford them. I am really upset that you would now have the audacity to ask me to guarantee the value of those houses that were built to sell to people who couldn't actually afford them. Much like taxpayers guaranteeing the insurance of palatial homes that people build on beautiful beachfront property, it is asking the majority of poor people to pay for the lavish housing of a few who want to live beyond their means. It is a non sustainable concept.
From Salt Lake City, 04/21/2009
This insurance scam sounds like it would produce the same echo chamber of skyrocketing home prices that caused the housing bubble. At least this time some honesty would accompany the fact that the government is on the hook. The more short sighted government programs and solutions that get foisted upon the people, the more corruption and fraud gets piled on the national debt. This is evidenced by AIG bonuses and other abuses by insolvent megabanks.
As a future home buyer who was saving up for a solid 20 down house payment when everything fell apart, I'm glad that home prices are dropping to more realistic values. The tax credit incentive gives me a certain comfort level for a small short term loss. People can look at historical home value trends before 2000, and should feel safe buying quality properties in those ranges. They will be in good shape because the impending inflation from all of the money we are currently printing will help keep the dollar value of their mortgages constant. I think renewing a new home buyer tax credit in the fall will be a necessary step for propping up home prices, and can be done without all the risk of even more poorly designed insurance.
From us, CA, 04/20/2009
It is estimated that Obama's plan could benefit 8 to 9 million homeowners from the new modification procedures. So how do you know you qualify for the Mortgage Modification? Check the website http://obamamortgage2009.blogspot.com/ to see if you qualify. I was also in trouble and I am glad I did check it before I talk to my mortgage company and it helped - John Mayer, California
From Bethel, CT, 04/20/2009
Frankly, my first reaction was negative, for reasons which some of the other comments have noted.
But I'm impressed that Prof. Nalebuff actually submitted his ideas to a real-world test; empirical trials are far too rare in economics.
Insuring against investment loss is not always as exotic as modern derivatives and hedges; crop insurance and commodities futures contracts have long been an accepted part of the business of agriculture. Note, though, that widespread crop failures (due to drought, for example) generally require the Federal Government to step in as the insurer of last resort.
That is the major concern that I have here -- a national downturn in the real estate market like the present one results in losses so widespread that no private insurer could survive them. The second concern is -- we don't seem to be very good at correctly pricing rare but large-scale catastrophe. Many credit-default swaps appear to have been far too cheap, while private insurance against flood or earthquake is prohibitively expensive. Third, six years of data in one market is better than no data at all, but hardly enough to justify a national roll-out.
How about continuing field trials of equity insurance, with an eye to eventually substituting it for the mortgage-interest deduction on Federal income taxes? Given what we know about loss aversion, I think many people would prefer the smaller, recurring loss of the deduction, which could pay the premium for the insurance against the large potential loss of equity.
From oak park, CA, 04/20/2009
It is estimated that Obama's plan could benefit 8 to 9 million homeowners from the new modification procedures. So how do you know you qualify for the Mortgage Modification? Check the website http://obamamortgage2009.blogspot.com/
to see if you qualify. I was also in trouble and I am glad I did check it before I talk to my mortgage company and it helped - John Mayer, California
From oak park, CA, 04/20/2009
It is estimated that Obama's plan could benefit 8 to 9 million homeowners from the new modification procedures. So how do you know you qualify for the Mortgage Modification? Check the website http://obamamortgage2009.blogspot.com/
to see if you qualify. I was also in trouble and I am glad I did check it before I talk to my mortgage company and it helped - John Mayer, California
From Studio City, CA, 04/18/2009
I have high respect for Nalebuff. The lessons of his first book have made me a lot of money out on the street in the real world.
With that said, he needs a reality check for his ivory tower. His proposal is not politically feasible now. Simply replace every reference to "insurance" with "derivative", and you get the idea. Why? because insurance IS a derivative. A contract on an asset (house) for the other party to perform if an event happens (it burns down).
There is already a way to protect your equity. You can short futures contracts of the S&P Case Schiller index. It does not behave exactly like insurance, but if you keep up with renewing the contracts, it locks in your price for the house. The cost is the broker fees you pay for renewing the contract, and you can choose when to be value fixed, and when not to.
Also, I think Nalebuff, in this case, is wearing the same beer goggles that the AIG mathematicians were wearing. Or, he is suffering from selective storytelling. I believe this because the Syracuse program stared around 2001. Was it his program, or did the market bubble attract buyers to Syracuse? I imagine the high sales volume of 2006 and 2007 cancelled out a lot of insurance contracts, saving him from a 2008 disaster.
Insuring debt works, and on both small and huge scales. But insuring equity sets the put-strike price at the market on the first day. And with an illiquid underlying asset, this means the insurer takes the place of the house owner, where the insurer "borrowed" the down payment from the "real owner" and the "real owner" pays "rent" to the mortgage company. This tells you what the cost of the insurance needs to be - and I guarantee you 1.5% of value is too low. The real owner is the owner in name only, and the government essentially owns the house on day one, but without the up-side. Huh, what? That’s right, it’s insurance, so without the up-side.
The nation’s housing needs a dose of honesty and simplicity. We need owners financially invested in their homes with a decent down payment, and appraisers chosen through a blind system. Should it be against the law to borrow more than 85% of the value of your home? I can't believe I just typed that!
See how far we have fallen? next we will be eating our young.
From San Marcos, TX, 04/17/2009
I can't believe that Marketplace even let this run. We're in the condition we're in now *because* insurance companies were insuring the housing bubble without fully understanding their complexities (well, one of many reasons). Marketplace has been - for months - constantly reiterating this fact over and over again to its listeners. I don't understand how this same program can, in good conscious, have allowed this to even air. How Mr. Nalebuff thinks that his proposal is somehow more secure and can withstand a "burst" of another kind, when for an unknown reason houses throughout the country lose value overnight, is beyond me. This is just another AIG waiting to happen. This should have been easily filtered by the Marketplace staff and shoved in a drawer somewhere. And Mr. Nalebuff needs not only his head examined, but needs to return his MIT diploma (or how about giving it "honorarily" to President Obama?).
From Irvine, CA, 04/17/2009
Totally insane idea, the government has nothing to do securing a transaction between two private parties.
From Columbus, OH, 04/17/2009
No, no, no. This is starting to sound like Farm subsidies. The last thing we need right now is any incentive that might result in builders building more houses until all the unsold houses sitting in inventory all over the place are sold.
Next thing you know the government will be buying houses and plowing them under, like tomatoes.
04/17/2009
If a private firm wants to experiment with this, sure, let them be. If the government does this, it is nothing more than price control.
From New York, NY, 04/17/2009
This is so completely boneheaded, I cannot believe this isn't a belated April Fool's joke.
I have a great idea, along the same lines, to get auto sales going again: I think we should invent "equity insurance" for cars. It's not fair that I buy a new Ford for $30,000 and 3 years later I can only sell it for $10,000!
Insurance can pay me the difference when I go to sell it to somebody. After all, the asset is clearly worth the same amount in the future as when I paid for it.
Did Yale invent mark to market rules too? Cause I forgot to mention my car is actually worth $1 million. I'm not planning on selling it at the moment, but it's really unique and special and there are NO other Fords that have the same markings (scratches, door dents, smells, etc.) so that's what it's worth.
From St. Louis, MO, 04/17/2009
Stupid idea. Really stupid - as in A.I.G. stupid.
Capitalism is based on risk and reward - put your money down on an investment and reap the rewards and the consequences. Insurance warps this process and makes people more comfortable to make stupid decisions they wouldn't dare make if they were to lose their own money.
There are some valid reasons for insurance - FDIC is certainly one of them. But a home purchase is more of an investment than a bank deposit. Real estate is a tangible asset that doesn't pay anything until sold, rented or refinanced. In all cases it is subject to market conditions. Your bank deposits are not. $100 in the bank today is still $100 in the bank tomorrow regardless of the stock value of the bank or Dow Jones. Your home is not.
Not only that, but not in the event of a downturn like this one - such an insurer - even the US government - would go broke trying to cover claims.
Remember AIG - they insured investments and are now broke and teetering on bankruptcy/insolvency.
From Reedsville, WI, 04/16/2009
As someone who spent many years working in the housing market in various capacities, I must say I agree with Barry and think this is a terrific idea. Many people aren't buying because they are concerned that either they could get a better deal by waiting and/or the prices will continue to go down and they will be left hanging. Lenders have this type of insurance, it's called "private mortgage insurance" so why not the buyers? As Barry said, it would not be based on the value of that particular home at that time, but the price index at the local level. Home prices in most areas have dropped so low that people who had good downpayments and are keeping up with their payments (even though they struggle after losing jobs) can't afford to sell. This would not artifically keep prices high, but would solve the immediate downturn and keep the lending process going so there are more buyers.
From Cookeville, TN, 04/16/2009
All right, any more of this koolaid and I find a way to short NPR and this show. You know what? I think I just figured out a way.
From Davis, CA, 04/16/2009
As someone who is currently looking to buy a house, I vehemently disagree with his assertion that people aren't buying because they're afraid that prices will fall. I expect the value of any house I buy to fall in the short term, but the investment value of a house isn't how much you can sell it for at a later date, as far as I'm concerned, it's the security of eventually not having to worry about paying rent after retiring and being on a fixed income.
I find the idea of home price insurance absolutely ridiculous - it and other proposals to stop falling house prices completely miss the point that the reason house prices are falling right now is because in many areas they rose to unaffordable levels for the average person working there. Propping the price up at these inflated values will cause more problems in the long run than it might solve in the short term.
From East Setauket, NY, 04/16/2009
I was appalled by this story. Propping up home prices. Obama seems to be in favor of this, too. I live on Long Island where it takes two, three or more solid incomes to afford one small home. Prices are falling a bit but they are insane and it's not sustainable. I understand that there are areas in the country where home prices are insanely low now, on the order of $17,000, but many areas are still way too high, unrealistically high. They need to fall to the point where one person with a median income can afford a home. And then the second income from a spouse or partner can be used to save up for a safety net -- the way it should and used to be.
We were in a massive, unrealistic bubble and reality is going to set in. We need to let this happen. In case this person doesn't get it yet, wages are also frozen or going down.
From WA, 04/16/2009
I walked in while this was playing and thought it was a spoof. Decoupling risk from ownership is what got us into this mess.
Extending that mistake is just gaming the system for short-term results, and once those results are baked in, the benefit would never be unwound.
From Davis, CA, 04/16/2009
Home equity insurance would protect people that already own unaffordable homes. However, it hurts people that have not yet purchased a home by propping up values at unrealistic and unsustainable values. It never ceases to amaze me that free market advocates always want to scrap those ideals when the market isn't working in their favor.
From New York, NY, 04/16/2009
Insurance is not the solution, it is the problem. It was default swaps insuring risky assets including residential mortgages that started this mess.
04/16/2009
I thought we already have one.
It's called AIG.
From New York, NY, 04/16/2009
This nutty idea has all the earmarks of a "quick fix." The "downward cycle" will be broken naturally when house prices return where they should have been in the first place. I don't invest in real estate, but I do invest in stocks. Where's my insurance against losing money on the NYSE?
From Saint Augustine, FL, 04/16/2009
Bravo Barry
I concur with your analysis: The current economic and financial crisis is rooted in a glut of homes on the market forcing prices down, and so reducing that inventory is the essential solution.
Insuring home buyers and financers from losses, as you propose, would promote financing and so increase demand. I support that strategy, but I wonder if it is enough. With 3.5 million homes for sale, we have two million more homes than a healthy 3-4 month supply in a market that is now seeing 4-5 million sales a year. And there are perhaps millions more distressed homes headed to market over the next several months, even if demand begins to increase, because so many homeowners have properties with values well below their mortgage debt.
It seems to me that we need to swallow a bigger pill to end the crisis now. I believe that the US needs to buy the surplus, or at least a substantial chunk of it. At the current median home price (which is now a good price relative to median income), two million homes would cost the US $300-400 billion, which is less than 15% of the bailout funds directed at the damage downstream thus far; and with the equity insurance you are proposing, that would be a no-risk purchase that would thus deliver a profit to taxpayers as the properties are resold over several years, even after the added expenses of management and maintenance. And critically, the large reserve would forestall another round of speculation while we continue with the record low interest rates necessary to rebuild.
Combine these strategies and the economy turns around now.
http://twomillionhomes.net
From Loisville, KY, 04/16/2009
Home equity insurance? Totally insane. All this does is to prop up current housing prices and put an artificial floor under obscenely high prices. An open and fair auction would do much more. Home equity insurance protects the seller by ripping the purchaser.
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