Updated: September 1, 2010 13:24 IST

When ‘affordable housing’ went haywire

D. Murali
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Title: Fault Lines, How Hidden, Fractures Still, Threaten the World Economy. Author: Raghuram G. Rajan.
Special Arrangement Title: Fault Lines, How Hidden, Fractures Still, Threaten the World Economy. Author: Raghuram G. Rajan.

While it may be normal to expect that top ‘news’ reports about ‘affordable housing’ originate from the developing countries, a Google search at the time of writing this speaks of how Google is ‘a big player in affordable housing.’ It has invested over $100 million in eight affordable housing projects this year -- all outside of Mountain View -- including $19 million for a 124-unit senior housing complex in Sunnyvale where a groundbreaking is scheduled this week, informs Daniel DeBolt in a story dated August 31 (

As if in contrast is a headline dated September 1, from California again, in by Melanie Hicken, that ‘Affordable-housing project stalls’ because the Glendale City Council ‘put the brakes on a potential affordable-housing project after several members said the process had run afoul of established procedures.’ The home page leads off with the ‘LA Times’ alert that despite home prices rising in June, a drop may be looming because expiring federal tax credits are feared to have a negative effect.

Closer home, however, the scene is bright. Sample these: ‘Newcomers eye affordable housing’; ‘the International Finance Corporation is in talks with several real estate developers to create large affordable housing projects in India’; Godrej sees ‘a huge demand in the affordable housing segment’; ‘25 acres affordable housing projects in Noida Extension’…

Promoting homeownership

A key question that regulatory authorities and governments in developing countries face is on the level of push they should give to housing. And it assumes importance in the face of what was witnessed in the mature economies not long ago. For a perspective on this topic, a suggested read is Raghuram G. Rajan’s ‘Fault Lines: How hidden fractures still threaten the world economy’ (Collins), which has an instructive section on ‘affordable housing.’

The author traces how the US passed the Federal Housing Enterprise Safety and Soundness Act in 1992 to promote homeownership for low-income and minority groups. And wryly observes, “Whenever Congress includes the words safety and soundness in any bill, there is a distinct possibility that it will achieve exactly the opposite, and that is precisely what this piece of legislation did.”

Risk ignored

As housing boomed in the US, agencies such as Fannie and Freddie found the high rates available on low-income lending particularly attractive, and the benign environment and the lack of historical experience with low-income lending allowed them to ignore the additional risk, Rajan narrates. Fuelling the fire was the Department of Housing and Urban Development (HUD) which steadily increased the amount of funding it required the agencies to allocate to low-income housing.

“Some critics worried that the agencies were turning a blind eye to predatory lending to those who could not afford a mortgage. But reflecting the nexus between the regulator and the regulated, HUD acknowledged in a report in 2000 that the agencies ‘objected’ to disclosure requirements ‘related to their purchase of high-cost mortgages,’ so HUD decided against imposing ‘an additional undue burden.’”

Rekindling the dream

The book cites from a 1995 document that laid out a strategy to expand home ownership in which the then President Bill Clinton called for ‘a plan to boost homeownership in America to an all-time high by the end of this century.’ Expanding homeownership, he said, will strengthen our nation’s families and communities, strengthen our economy, and expand the country’s great middle class. “Rekindling the dream of homeownership for America’s working families can prepare our nation to embrace the rich possibilities of the twenty-first century.”

To Clinton, it was dismaying that the major impediment to purchasing a home for many potential homebuyers was the lack of cash available to accumulate the required down payment and closing costs. And, that other households did not have sufficient available income to make the monthly payments on mortgages financed at market interest rates for standard loan terms. Therefore, “Financing strategies, fuelled by the creativity and resources of the private and public sectors, should address both of these financial barriers to homeownership,” urged Clinton.

Creative ways

Simply put, the Clinton administration was arguing that the financial sector should find creative ways of getting people who could not afford homes into them, and the government would help or push wherever it could, the author paraphrases. “Although there was some distance between this strategy and the NINJA (no income no job or assets) loans and ‘liar’ loans (loans for which borrowers could come up with creative representations of their income because no documentation was required) that features so prominently in this crisis, the course was set.”

The tale of ‘New Century Financial,’ founded in 1995 with about $3 million of venture capital, and growing to $60 billion in mortgages by 2006, is a telling example of crisis in crescendo. Brokers liked working with New Century because it was ‘very easy,’ and the company ‘rarely demanded reviews of the appraisals on which loans were based.’

It does not take a genius to push loans to those who have credit problems, and New Century did not penalise brokers for the quality of loans they originated until in early 2007, when it was too late, recounts Rajan. Among the quotes from legal proceedings are snatches such as these: “You have a loan application where the income section is blank. How does it even get past the first person who looks at it?” as a borrower’s lawyer demanded. New Century’s underwriting standards were so low ‘that they would have sold a loan to a dog,’ as Ohio’s assistant attorney general, Robert M. Hart, opined.

Guided by applause

The author notes that many of the parts played by the key actors in the crisis were guided by the preferences and applause of the audience, rather than by well-thought-out intent. Politicians may have tried different messages until one resonated with voters, he reasons. “That message – promising affordable housing, for example – became part of their platform. It could well be that voters shaped political action (much as markets shape corporate action) rather than the other way around. Whether the action was driven by conscious intent or unintentional guidance is immaterial to its broader consequences.”

In a chapter titled ‘let them eat credit,’ there is an example of credit being used as a populist palliative in India, drawn from a study by Shawn Cole, a professor at Harvard Business School. “Indian state-owned banks increase their lending to the politically important but relatively poor constituency of farmers by about 5 to 10 percentage points in election years. The effect is most pronounced in districts with close elections. The consequences of the lending are greater loan defaults and no measurable increase in agricultural output, which suggest that it really serves as a costly form of income redistribution.” Populism and credit are familiar bedfellows around the world, concludes Rajan.

Suggested study, before entering the home market!

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