Historical article note: This article was originally published on 2018-01-13. Rates, policies, home prices, statistics, product names and qualification standards reflect the environment at that time and may have changed. This archive is for historical record and general education only. It is not mortgage approval, investment, legal or tax advice.
————After reading "House Debt"
"House Debt" (authored by [American] Atif Mian and Amir Sufi) is a popular economic book that specifically introduces housing debt and summarizes the lessons of the U.S. subprime mortgage crisis. I have read several books about the subprime mortgage crisis, and this one is the best. Since April 20 last year, due to the implementation of some related policies to control housing prices and tighten loans, Toronto's real estate market has begun to cool down. Prices of different housing types in different regions have dropped to varying degrees. "Housing debt" and "mortgage", which were once sought after by angels, suddenly turned into devils. Let us follow the footsteps of this book and see what kind of losses housing debt has caused people in the United States, and for whom housing debt is the devil.
Content summary: From 2007 to 2009, the Great Recession in the United States claimed 8 million jobs and 4 million families faced foreclosure of their property ownership. From 2000 to 2007, household debt in the United States doubled to 14 trillion yuan, and the household debt-to-income ratio climbed from 1.4 to 2.1. In the 1920s, the rise of installment financing changed the way people purchased large-ticket consumer goods. It is more acceptable to buy goods on loan. When borrowing is used to purchase new products, savings are reduced and autonomous expenditures experience a large and sustained decline. The "big five" banking crises of Spain in 1977, Norway in 1987, Finland and Sweden in 1991, and Japan in 1992 were all due to the collapse of asset prices, resulting in large-scale bank losses and the economy falling into a sharp recession with very slow recovery. These five economic recessions were all accompanied by sharp increases in housing prices and excessive national foreign debt. Recessions caused by banking crises are much more severe than ordinary recessions. There is a strong correlation between the (magnitude) of credit increases during an economic expansion and the extent of the recession that follows. The economic costs of financial crises can vary, depending primarily on debt leverage during the credit expansion phase that preceded the crisis. Banks are just intermediaries, and depositors are the lenders of home loans. Generally, savers who have a large number of financial assets and basically no housing mortgage loans will not suffer much loss in their net asset value when house prices fall. This is because savers, through their deposits, bonds and other financial assets, ultimately enjoy first claim on housing in the economy. Although home prices may fall significantly and priority claims may suffer losses, they suffer much lower losses than borrowers. The complete concentration of losses on debtors will inevitably be linked to wealth inequality, as low-net-worth households bear most of the losses. Before the collapse of house prices, savers held 80% of the value of the house, while property owners held 20% of the value of the house; after the collapse of house prices, property owners were completely excluded from home ownership, while savers held 100% of the value of the house.
Comment: The supply side of housing debt is the people who deposit their money in the bank, and the demand side is the mortgage debtors. Most of the time, housing prices rise. When housing prices rise, the income of the supply side of housing debt is fixed and cannot receive dividends from rising housing prices. However, debtors can arbitrage between the established debt and rising housing prices. This is the biggest temptation of housing debt for low-net-worth families. These families dream of catching up with high-net-worth families in terms of wealth through the leverage of housing debt. When housing prices plummeted, especially during a historic period, it was a rare opportunity for the author to look at the nature of housing debt from both the supply and demand sides simultaneously. This was not a matter of reasoning, but an empirical way to show the world the impact of falling housing prices on the wealth of debtors. Although banks are intermediaries, they are an absolute barrier to guarantee the priority of depositors' debts. Judging from the rescue situation of the US subprime mortgage crisis, Bernanke learned the lessons of 1929 and did not hesitate to protect banks and depositors, which ultimately caused serious losses to overborrowers. Because the banking functions were not destroyed and the banks were preserved, the United States was able to recover from the unprecedented real estate crash in less than ten years. Japan spent the lost two decades amid the bursting of the real estate bubble and collective bank failures.
Content summary: The debt of the poor is the property of the rich. As we move from poor property owners to wealthy property owners, debt decreases and financial assets increase. The poorest property owners are also the most leveraged. At the same time, most of them have almost no financial assets, and the impact of real estate risks on them is greatest. When the combination of high leverage, falling house prices and a lack of financial assets is catastrophic for society's most vulnerable households. The poor are poor, and when debt funnels all the fall in house prices directly into their net worth, the poor lose everything. The basic characteristics of housing debt: huge losses from falling house prices are imposed on families who are already penniless. In 2011, 11 million homes in the United States, accounting for 23% of all homes with mortgages, were in negative equity. For every 1% increase in the number of properties subject to foreclosure auctions, home prices fell by 1.9%. After the housing market bubble bursts, economic resources need to be reallocated. In the past, too many renters became homebuyers, too many homebuyers moved into homes they could not afford, and too many homes were built. When markets collapse, debt-ridden economies can no longer reallocate assets in an efficient manner. As a result, debt leads to asset sales, exacerbating net worth losses. The essence of asset sales: It is the process of transferring assets that are valuable to the borrower to the lender, but the lender is unwilling to hold this asset. Lenders don’t want such assets, and borrowers can’t afford them. Lenders are forced to sell such assets at reduced prices. When lower asset prices cause more borrowers to default, this leads to more defaults. Contrary to insurance, debt is a tool that concentrates risk, not a tool that spreads risk. Debt is a tool that concentrates risk among those with the lowest risk tolerance in society, amplifies inequality in wealth distribution, drives down home prices through foreclosures, destroys the net worth of indebted homebuyers, and halts consumption by these households. Debt can ultimately concentrate losses on those households with the least equity.
Comment: Because the poor want to get rich quickly, they use leverage to leverage large amounts of assets, arbitrage, and realize the American dream as soon as possible. When housing prices rise, this statement is constantly reinforced by reality. People who originally did not believe in this myth also believe it. Driven by animal spirits, the poor flock to real estate in droves, losing their resistance to the temptation of housing debt. The pragmatic approach of working as a renter for a few more years and then buying a house after accumulating sufficient financial assets is regarded as outdated. Once the idea of making quick money by taking out a loan to buy a house is put into practice by the poor, the situation is different. When housing prices fall, the poor lose their only shirts and become poorer.
Content summary: Faced with a decrease in housing prices of the same magnitude, households with more debt will correspondingly reduce their expenditures to a greater extent. This response of expenditures is called the marginal propensity to consume housing wealth. Highly leveraged households have a higher marginal propensity to consume housing wealth. Recessions are caused by lower household spending because your consumption is another person's income. By holding financial assets, depositors have priority rights to claim on mortgaged houses. The rich are protected when house prices fall, not just because they are wealthy but also because they have priority ownership of their homes. Defaults lead to foreclosures, foreclosures lead to auctions and asset declines, which lead to more defaults, self-reinforcing, leading to a downward spiral in home prices. The most catastrophic impact of reduced demand caused by leveraged losses is a massive increase in unemployment. In an economic crisis caused by leveraged losses, people's natural reaction is moral judgment and anger. There is talk of irresponsible homebuyers borrowing too much and doing so at their own peril. But such moralizing during a crisis accomplishes nothing. Once leveraged losses occur, a rapid decline in spending and a painful increase in unemployment are almost inevitable. Because foreclosures and losses are concentrated among indebted households with the least economic net worth, debt further amplifies falling asset prices. Because indebted households are extremely sensitive to the shock of falling net worth, they will significantly reduce their spending when their net worth begins to decline. The housing market collapse has widened wealth inequality by destroying the equity of poor, indebted homebuyers.
Comment: Consumption is affected by the wealth effect. When housing prices rise, everyone's willingness to consume increases, and restaurants and restaurants are overcrowded. When housing prices fall, everyone tightens their wallets and restrains consumption, which leads to unemployment. This is a typical consumption and real estate economic cycle. Compared with inventory and investment cycles, consumption and real estate economic cycles are longer. Fortunately, Bernanke spread money in a timely manner, boosting consumption and driving real estate out of its trough quickly. Of course, this also benefited from learning lessons from history: In times of economic crisis, banks must be protected while giving money to consumers.
Content summary: Why would people take on more debt unless they thought they would have more wealth in the future? The peak in borrowing caused the rise in house prices, not the rise in house prices caused the peak in borrowing. The main driver of asset prices is almost always an expansion in the supply of credit. Asset price bubbles depend on credit growth. Asset prices should equal the sum of the expected returns on those assets. Bubbles can only exist if the buyer is an "optimist" or if the buyer believes that there will be "bigger fools" to accept the asset when the asset price rises higher in the future. While debt increases the future purchasing power of optimists, it also increases the probability of bigger fools. Asset securitization reduces banks’ incentives to review and supervise borrowers, directly encouraging irresponsible lending. Inflation can reduce debt by transferring purchasing power back to debtors. Rising prices and wages make it easier for borrowers to use rising wages to pay off fixed debt loads. Rising prices also reduce the value of interest payments to creditors. Government income is taxed on income rather than property.
Comment: All the economic behaviors in this world that are about buying up and not buying down are just trying to see who is more stupid and who is the last fool. This is true for real estate and even more so for the stock market. Smart investment is to buy when it is low and sell when it is high. Only in this way can you make profits. This is normal thinking. When we find that a large number of new investors are pouring into areas that they are not familiar with, we should be careful. The later they come, the more stupid they are. The original investors can consider selling their assets to the later fools. Regarding real estate, what I want to say is that if you can't afford it, don't be fooled by carrying debt. The government will not provide any assistance to people who borrow blindly. The U.S. government will not rescue, China will not rescue, and the Canadian government will not rescue. As a practitioner, I have always been unable to accept the behavior of encouraging people with weak financial ability to buy a house. Some people even hold public lectures to teach poor people how to sublet the basement after buying a house, or even let the owner live in the basement himself, to use their reputation as "renting to support the house."
There is nothing wrong with housing debt, but fools disturb themselves. Housing debt is a devil for low net worth families, but an angel for families with high net worth and good management of housing debt. The Golden Horseshoe region of Ontario has a population of 7.14 million, of which 120,000 own more than one house. That is, 1.7% of people can not only manage one house and housing debt of their own, but also manage more houses and housing debts. These 120,000 people are not landlords who rent out basements, and their experience is worth learning from. I have some friends and clients who have considerable experience in housing debt management. I am sorting out and summarizing the materials in this area, and plan to organize a "multi-suite investment group" so that everyone can learn from and exchange experiences, and manage and use the double-edged sword of housing debt well.