Mike Konczal says that all mortgages should be prepayable without penalty. He’s right — but in fact he doesn’t go far enough. As Tyler Cowen notes, it would be even better if mortgages could be prepaid at a discount when mortgage rates rise — or property prices fall.

The result would be a sharp rise in mortgage prepayments: you’d repay when mortgage rates rise, by repurchasing your mortgage at a discount, and you’d repay when mortgage rates fall, by refinancing. Mortgage rates in general might have to go up somewhat in order to make up for all this new prepayment risk, but to offset that there would be significantly less default risk. And right now, when mortgage rates are low, is a good time to implement something like this: the damage you cause to a bank when you prepay a low-rate mortgage is very limited.

It’s true that prepaying at a discount doesn’t work as easily in the heterogeneous US as it does in the more homogenous Denmark, but there are ways around that; at the very least, homeowners should be given the opportunity to offset their mortgage liabilities in the broader capital markets. There’s got to be some way of doing that, and I’m not talking about zero-sum games like Bob Shiller’s housing futures.

As Stacy-Marie Ishmael says, “there has been an outbreak of contrarian thinking on the links between ratings, securitisation and the mortgage market” of late. She points to a paper by Ronel Elul, while Zubin Jelveh, who has been following the contrarian line for a while now, picks up on a different paper by Ryan Bubb and Alex Kaufman.

But the fact is that none of these findings are all that powerful. Elul, for instance, essentially confirms that securitization causes a decline in performance: “a typical prime ARM loan originated in 2006 becomes delinquent at a 20 percent higher rate if it is privately securitized,” he writes, and the fact that a similar pattern can’t be seen in subprime loans is basically just a function of the fact that “very few subprime loans were actually held in portfolio” — substantially all of them were destined for the securitization machine.

As for the Bubb-Kaufman paper, the chart that Jelveh picks up on shows a good 90% of subprime mortgages getting securitized. Can that really suggest, as Jelveh says, that securitization might not be to blame for the decline in lending standards? If lending standards dropped at the same time as the securitization rate soared, I’d say there’s a strong correlation between the two, and a pretty good prima facie case for a causal relationship too.

At heart, it all comes down to information: loans are stronger and more desirable than bonds, because a bank intends to hold its loan to maturity and does a lot of underwriting, shoring it up with covenants. Bonds, by contrast, are often held only briefly, and are often bought by investors who do precious little fundamental analysis; what’s more, they simply don’t have the kind of granular information that bank lenders have. And securitizations are even worse than bonds — no one really knows what’s in them, and they’re ultimately based more on models than on shoe-leather underwriting. So it’s entirely predictable that the boom in mortgage securitization was bad for the overall quality of the debt. And attempts to show otherwise are ultimately doomed.

Rosealea Yao reports:

Roughly 80 per cent of China’s urban residents own their homes – an astonishing number for a country that only began to privatise its housing stock in 1998.

Astonishing is right — and frankly, given the absence of any sourcing, I’m not sure I believe it. The high point of the influx from rural to urban China might be behind us, but it isn’t over yet, and all those poor Chinese workers looking to make their lives in the big city are unlikely to jump straight onto the bottom rung of the housing ladder. There might be some shenanigans going on with the definition of “residents” here — are all city inhabitants really included in the denominator?

That said, no visitor to China can fail to be astonished at the sheer quantity of housing stock which is going up in high rises across the country. If Yao is right, then substantially all of that stock is sold rather than rented, which helps to explain the astonishing amount of money in the Chinese construction industry. But it also means hundreds of billions of dollars of mortgages in the Chinese banking system, which I doubt were underwritten with particular assiduousness, and which have been written at extremely high price-to-income ratios. China could yet suffer a mortgage crisis of US proportions.

What year is this? 2005?

Ashley-Gayle Boothe and her husband Scott have applied for a USDA-backed loan to buy their first home, a three-bedroom house 30 minutes north of Tampa, for $127,500. “We didn’t want to put anything down,” says Ashley-Gayle Boothe. “We figured we’d have to buy appliances.”

Of course, the clue that this is happening right now is the lender — yes, USDA as in the Department of Agriculture. Somehow it’s got its hands on $10.5 billion to lend out as no-money-down home loans. And of course taxpayers have nothing to worry about:

The agency argues it adheres to strict underwriting standards, assessing each borrower’s credit, income, and cash flow.

What could possibly go wrong?

(Via Moore)

Kenneth Harney has got his hands on a fascinating new study from Experian and Oliver Wyman, which looks at the prevalence of strategic mortgage defaults, a/k/a “jingle mail” or “walking away”. Unsurprisingly, it’s financially sophisticated borrowers in non-recourse states like California who are doing this in droves: apparently there were 588,000 nationwide strategic defaults in 2008, more than double the total in 2007.

This is a perfectly rational and ethically defensible thing to do, but subprime borrowers, almost by definition, tend not to have the sophistication to default in the most financially-advantageous way.

Interestingly, the Experian-Wyman study (if anybody has a copy of it, do send it on over) recommends “that lenders and loan servicers take steps to screen and identify strategic defaulters in advance”. I’d love to know how lenders are meant to do that. Credit score obviously isn’t a good indicator, so what is? Financial literacy?

When Tishman Speyer bought Stuyvesant Town and Peter Cooper Village for $5.4 billion in 2006, they knew that they couldn’t cover their mortgage payments with their rental income. But that was OK: they expected that rents would rise significantly as the housing market continued to rise and as rent-controlled tenants moved out.

Naturally, that never happened, and now they’re in trouble. As Bloomberg reported earlier this month, quoting an investor in the Stuy-town deal:

“Rents are not going up like they normally would, landlords are making concessions like free rent and people have not moved out at the rate anticipated,” said Williams, who came to the SBA after nine years as a managing director at Fir Tree Partners, a New York hedge fund.

Manhattan apartment rents fell as much as 10 percent in August from a year earlier, the Real Estate Group of New York said on Aug. 25.

All that I understand. And I understand too that there’s a big risk that the owners will have to refund a lot of previously-paid rent if they lose a lawsuit saying that they improperly deregulated 3,000 apartments. But they haven’t lost that lawsuit yet, and already their revenues, far from being even flat, seem to have fallen off a cliff:

Jerry I. and Rob Speyer and their partner, BlackRock Realty, who paid $5.4 billion for the quiet middle-class redoubt near the East River, have seen the property lose more than half of its value, and the income from rent — down 25 percent from its peak — covers less than half of their debt payments.

How on earth can rental income be down 25%? More than half the apartments are rent-regulated, and we know the income from those apartments hasn’t fallen. Meanwhile, the owners have been putting a lot of money into tarting up the complex and making it more attractive to yuppies, in an attempt to be able to raise market rents significantly. Even if those rents haven’t gone up, I can’t see how they could have fallen by a third, or whatever the number would need to be in order for total rental income to be down by a quarter. Something has gone spectacularly wrong here, and I’d love to know what it is.

My distant cousin Dominic Lawson (I was named after his grandfather, Felix Salmon) has a column saying that cutting bankers’ bonuses would do more harm than good. He might be right, but his argument is a little bit odd:

When people get a cheaper mortgage because some financial whiz-kid on the trading floor did some clever forward buying in the currency markets, they don’t feel any particular sense of gratitude to the bank. Even in the good times, politicians are not likely to be misjudging the public mood if they propose to do something a bit nasty to bankers…

If a Treasury minister tells a Today programme interviewer that “we are imposing greater capital requirements on super-senior tranches of securitised mortgage obligations”, it is unlikely to resonate with the bleary 7am listener wanting to hear the noise of a banker having his head rammed hard into a wall.

The problem here is that never in the history of finance has a bank reduced its mortgage rates because it made lots of money in the currency forwards market. Banks aren’t charitable institutions which cross-subsidize their consumer-facing products from profits elsewhere: to the contrary, they will constantly attempt to maximize their profits in every business.

On the other hand, it was commonplace for people to get cheaper mortgages because banks had stupidly low capital requirements on super-senior tranches of securitised mortgage obligations. Thanks to those stupidly low capital requirements, banks could sell off “all” the risk associated with the bonds they originated, and keep billions of dollars of leftovers for themselves, without having to hold much if any capital against them. Since banks love to think of themselves as being in the business of buying and selling risk assets, they were happy to originate low-interest mortgages just so long as they could flip them for an immediate profit.

In other words, it’s systemically-devastating things like badly-structured regulatory structures and capital requirements which are likely to bring down mortgage costs and otherwise directly benefit the public. Large bonuses for traders, by contrast, will not benefit the public at all — they just benefit the traders in question.

More generally, anything which contributes towards people getting a cheaper mortgage is equally likely to contribute towards a housing bubble. Sometimes it’s very hard to tell whether a certain financial product is good for consumers or not.

A fantastic catch from Nemo after Paul Wilmott appeared on CNBC this morning to make a very good point: that there’s still a huge amount of model risk in the system, that the sheer size of financial institutions still poses a massive potential systemic risk, and that high-frequency trading, in particular, does a bad job of efficiently allocating long-term capital, which is the primary purpose of the markets.

Larry Kudlow then proceeded to respond in the the only way he knows how:

Is there an asset class that looks cheap to you from a pricing standpoint?

Let’s look at gold, energy, commodities. Let’s look at stocks, let’s look at bonds, for example… I’m just asking you, off the top of your head, what looks rich and what looks cheap now?

Let me rephrase it. Is there an asset class that looks cheap to you right now?

Your judgment. Somebody gives you a billion dollars. What looks cheap? What would you buy?

Poor Paul eventually gets bullied into some semblance of an answer: essentially he says “buy options”, since there’s a significant chance of a huge move, one way or the other. Which of course garners the only possible response, from Trish Regan: “I, I, I don’t understand…”

Matt Yglesias buys my argument that the phenomenon of empty storefronts is a function of long commercial leases, “but only to an extent”:

If you look at suburban strip malls, the same long lease dynamic applies, but widespread strip mall vacancies are normally a sign of specific economic distress. The current recession has less to a lot of them, but in normal economic times you tend not to see this. Instead, even depressed areas reach a low-rent equilibrium. Possibly this is because strip mall property is less speculative in nature than urban property. But I think the specifically urban nature of the problem probably has something to do with the level of regulatory uncertainty surrounding new retail endeavors in most American cities combined with the reluctance of many neighborhoods to play host to the sort of “uncool” national retail chains that could better manage the risks involved.

Karl Smith then cuts through all the wild guesses and nails the real real reason why strip malls don’t have empty storefronts:

The difference is that a mall has a single owner who internalizes all of the externalites associated with vacant storefronts (and trash and crime, etc). An ugly mall is a less popular mall and thus commands lower rents overall. Typically its worth for the mall owner to take a hit on one store if he can make it up in higher rents for the others. This, of course breaks down when demand for the whole mall declines.

If one landlord owned all the shops on Broadway, she could happily rent a few of them out to banks at high rents, while renting others out to high-prestige, low-profit artisanal shops at much lower rents, all in the interest of maximizing total rental revenue. (I’m reminded that at the Time Warner Center, the landlord actually paid a set of bold-face names like Thomas Keller and Jean-Georges Vongerichten to open up restaurants there: they would never have opened up in the middle of a shopping mall otherwise.) Those cross-subsidies can’t work when there’s a multiplicity of landlords.

So yes, one solution to the problem of empty storefronts would be for a single landlord to take over a large shopping area. But I don’t think many people want that: you invariably end up with something which feels like an outdoor mall.

Justin Fox has a very good post on the broken state of the commercial real estate, pointing to empty spaces on Broadway and in Newcastle, Australia. I could easily add my own street, Avenue B, which has an inordinate number of empty storefronts, or could point to Centre Point, in London, a skyscraper which stood empty from its completion, in 1966, until 1979.

Justin is absolutely right about the corrosive effect of bank rents on New York rental rates: all landlords want the kind of rents that only banks can afford, but of course not all landlords can have a bank as a renter. But the bigger picture is that commercial real estate in general often stays empty for extremely long periods of time — something which harms neighborhoods and lets huge amounts of economic value go to waste.

Why is this? I think the answer lies in the fact that commercial leases tend to be very long-term things — so long term, in fact, that the discounted cashflow from any given lease is likely, in a normal (non-bubbly) property market, to be more or less the same as the value of the commercial property itself. Looked at this way, a developer spends a certain amount of money on putting up (or simply buying) a building, and then sells that building, in lease form, for a profit.

If prevailing leases are low, or tenants hard to find, the developer will quite rationally choose to keep the property empty. Leasing at a low rate will lock in a loss, while keeping the property empty has significant option value: at some point in the future, rents might well rise, and the developer can at that point lock in a profit instead. This is why successful property developers generally need very deep pockets: anybody who needs immediate cashflow, in the form of rent today, is in an invidious bargaining position and is likely to lose out over the long term.

Marcus Westbury has manged, in Newcastle, to implement the obvious solution to this problem: short-dated leases, often just 30 days long, which roll over so long as the landlord hasn’t found a permanent tenant. That’s good for the neighborhood, and helps drive up prevailing rents, so everybody wins — except, of course, for the commercial real estate agents, who are disintermediated and who in any case are never going to make any money brokering 30-day deals. But many businesses are never going to find that kind of deal acceptable, even if they’re already in the space in question — remember that Kenny Shopsin, for instance, refused to extend his lease on the space he had occupied for years in the West Village by one year. “A one-year lease,” explained Calvin Trillin with no further elucidation, “is obviously not practical for a restaurant”. Yet somehow a brand-new teahouse in Newcastle manages to operate on a shorter lease yet.

My feeling is that commercial real estate in general has always operated on extremely long timescales, which can seem ridiculous to those of us not in the business. And it always will. Occasionally someone like Marcus Westbury will come along and shake things up. But more generally, many empty storefronts are likely to remain empty for years on end: it’s just how the business works.