First 100 days: A fix for the housing crisis

February 26, 2009

Elena Panaritis – Elena Panaritis is an institutional economist. She spearheaded property rights reform while working at the World Bank, and lectures at Insead, The Wharton School and Johns Hopkins University-SAIS. A social entrepreneur, she now heads the investment advisory firm Panel Group. Her recent book is “Prosperity Unbound: Building Property Markets with Trust”. The views expressed are her own. —

In his speech to Congress, President Obama spoke of how the proper response to the economic crisis is not just a matter of immediate fixes, but also an opportunity to make investments that will serve the nation’s long-term interests. The same idea should govern the housing recovery plan. Otherwise, we get nothing more than a crutch when we need a cure.homesales

As much as short-term help is needed to keep more people from foreclosure, there is a big opportunity to get to the end of the crisis by starting at the beginning of the problem. The conventional wisdom is that subprime mortgages represent the beginning. In fact, the beginning goes back much further. The current crisis stems from the absence of a system that provides stability to the value of properties in the United States.

Instead, real estate “value” in the United States continues to be set through speculation, and that undermines the security – that is, the underlying asset – when mortgages are traded as part of complex financial instruments. We cannot ignore a simple truth of economics: if we are going to treat mortgages as securities, then they must be secured by the tangible asset: namely, land and buildings. To do otherwise has proven to be a recipe for disaster.

The opportunity before the U.S. government with a housing recovery plan is to set up a new system that will keep us from ever getting to this crisis point again. How? The devil is in the details.

It’s no accident that other countries, even those that trade mortgages as financial instruments (such as Australia and Canada) have avoided the levels of off-the-cuff valuation of property we’ve seen in the United States. The reason is that other countries have standardized the information needed to determine the genuine value of real estate and hence mortgage valuation.

This information – actual boundaries, property transfers, claims, liens, and so on – is made available to everyone. The system is sound and transparent. And where do they keep this information? In national property registries, which maintain all the data, in a standardized format, that buyers and sellers need to undertake transactions related to real property.

The United States has a broken registry system, and instead of ever fixing it allowed a title insurance industry to arise as a substitute. Title insurance is non-transparent and (at best) inconsistently regulated, yet it is the main system through which information about property valuation flows. Plus, you have to pay for the information. This leads to all sorts of problems, and fuels speculation.

The Obama Administration’s housing recovery plan ought to look forward. Help people facing foreclosure today, yes, but also establish a national, standardized property registry responsible for the collection of all titles and all information about characteristics of property. Even statewide registries would be a tremendous improvement.

The first step is to mandate an agency to gather whatever exists in state and local registries and title insurance companies around the country, no matter how inadequate, and centralize and standardize that information. Then, establish a mechanism for making this information available to all. Further, figure out how to fill in the missing information. Finally, create a system for the registry to provide remediation in the case of errors.

It is critical that we correct how the value of real estate is established. By finally securing the asset, we can guarantee long-term price stability and rid the system of the speculation that has put us in this crisis. Let’s look at the current housing crisis as an opportunity to make this long-term fix.

This isn’t about setting property prices now and letting them remain static. Rather, it’s about letting a dynamic property market flourish in a way that protects Americans from having to bail out banks or themselves in the future.

53 comments

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Standard title insurance–the kind required by banks and localities–does not insure “actual boundaries”. When my neighbor and I found out that our lots both included the same overlapping three acres, both title companies easily avoided responsibility. I would not shed a tear at their demise, but I have no confidence in some monolithic governmental replacement.

The author suggests that said monolith will avoid “off-the-cuff valuation” . I’m not sure what that means, but the implied linkage between that and speculative bubbles is not valid. To see this, we need look no further back than Japan in the 90′s.

Though title insurance is nearly useless for most of us, we should look for a culprit instead at the appraisal industry. What a lazy bunch! Comps–that’s about all they know. Fundamentals are too much work. Local consistency of price is the best they can do. Speculative bubbles are above all else consistent!

Furthermore, even if appraisals were tied to fundamentals, we would find these fundamentals subject to speculation. So I think the author’s entire line of reasoning fails. There are plenty of other reasons to stick it to the title insurance industry. Pick one.

Posted by Tom Burton | Report as abusive

interesting article, perhaps i don’t fully understand “Title Insurance” but Title has to register everything with their local county anyways so what’s missing? what is getting recorded at one and not another?

In regards to your value comment i’d have to agree. However real estate, while tangible and physical, is so tough to put a value on. I think we are about to hit dire times come May 1st when Fannie & Freddi require all appraisers be in house. Now the banks who are lending the money get to decide what your house is worth and based on that give you an interest rate. The current system allows the bank to REVIEW an appraisal and make a judgment not force a value upon a borrower for their own interest. Dire times lay ahead.

Posted by Anthony | Report as abusive

The principal cause of this crisis was allowing people to borrow more than they could ever earn, not the admittedly patchy and inconsistent system of recording the boundaries, property transfers, claims, and liens associated with different properties. If people are given more money to spend, prices will go up. When this money is borrowed based on future expected income which never materializes, they will default.

These kinds of abstruse arguments distract attention from the basic fallacy which continues to be perpetuated in discussions of the housing crisis. This is that house prices rose to an unsustainable level because their values greatly exceeded the amount of money that was actually being earned by potential buyers and the US population as a whole. Because the government, press, and homeowners are still in denial about this basic cause, there is the illusion that it will be possible or beneficial to prevent a correction to levels set by the ever-dwindling wealth of potential home buyers. Don’t forget, house prices in Japan had to fall 90% before their bubble was deflated. And by stringing it out for a decade they suffered much more than if the bubble had been popped all at once.

Posted by David | Report as abusive

I agree with the author about the title system at least in Australia. Our property records are transparent and accurate and any potential purchaser can see what defects or rights in rem belong to the current owner. Also you can see what anyone paid for their home over an historical period.

Although I am Australian, I live in a developing country and they have a highly speculative property market and a low mortgage industry because people prefer cash. This keeps people homeless and living in substandard accommodation. Unfortunately the Americans came to town with their title insurance which I could not see the benefit of simply because most of the housing is illegal in one way or another. Globally governments need to sort this out and make property valuation a transparent online accessible system. Appraisers still have their role but they have to be far more prudent (and honest) just like any professional.

Posted by Liesl | Report as abusive

Title information has nothing at all to do with home values. Values are determined by land value and the value of improvement.

While the title information may carry information about the lot size, that information is readily available in the tax rolls.

The title information carries absolutely nothing concerning the value or condition of any improvements.

Having a central registry of title information does nothing to control or check housing speculation.

Speculation in housing prices will continue as long as the two principal parties in the real estate transaction, lenders and real estate agents receive compensation based on the value of the transaction rather than the value delivered by their efforts.

Commissions are a significant incentive to push for inflated appraisals and to convince their clients that the inflated pricing is reasonable.

Fix the commission system and you cut out most of the speculation in the residential housing market.

I’m not very familiar with the American property registry system but I can provide some insight into the Australian system.

Land based taxes is one the the greatest streams of revenue for the state and federal government. All property transactions are registered at a central data base, and made available but not for free. Professional valuers are engaged by the government to assess the “market value” of all properties in their jurisdiction to determine the appropriate amount of tax charged to property owners. The assessed property value are based on market transaction as sales evidence, for the majority of properties that were not sold on open market their market value is determined through statistical analysis with respect the value of sales evidence of near by properties. Basically the market is the basis of most government valuations.

But what happens when there is excess credit that provides incentive for gearing in the market which dramatically boosts the willingness to pay for the properties traded in the market place? The median residential housing price in Australia have increased 4 folds in the last 10 years!

The government doesn’t really mind that there is this kind of property inflation going because high market value actually helps to boost the government’s tax income as well.

One of the main reasons why we haven’t seen spectacular collapse in residential property value in Australia is because to bring new supply of housing onto the market it is extremely difficult. The multitude of hurdles include obtaining planning permits, and winning the favor of powerful construction industry union to deliver the projects efficiently. And it is only the lower end of the market that haven’t seen dramatic decreases.

Certainly, more transparency would help, but it’s no silver bullet. Sound valuation practices would help as well, but what is sound valueation practice? If all information is based on market transactions, yet there is external factors that is distorting the market on the global scale how could anyone have prevented the current situation? We might need some really clever game strategists to figure this one out.

Posted by Ding | Report as abusive

I’ve been a real estate appraiser since 1984, when we come out of this down turn this will be my second complete up and down cycle that I’ve been through.
I was a commercial/residential appraiser but was forced out by the mortgage broker’s need to make the deal. I told the truth = no business.
I would like to state that there is a small kernel of truth to this column – very small indeed; about the size of BB in a box car! Appraisers in different countries use the same methods as US appraisers.
I am astounded by the lack of basic knowledge about the real estate industry by common folks let alone by this economist.

Title companies identify ownership of real estate some real property interests and lot boundaries – nothing more – No values “flow through” tile companies.
Recorded deeds at the County Recorders office are the reflection of the local real estate market. Current transactions “set the market.” Go read the deeds and talk to the buyers/sellers. See what the deeds contain – not just dollars but include personal property and some services !!
Stop the confusion — Valuation is work – focused

The cure is: Make the mortgage brokers or banks hold on to new mortgages for 3 years to “season.” The loans they make advertise and promote will be totally different and maybe us old “seasoned” appraisers will be listened to again.
Bankers and the mortgage security idustry have lost their way in valuing mortgage risk – The mortgage market investors do not believe in the banks
vetting of property owner ability to repay their mortgages.

what ignorance on the part of the author. And Reuters is allowing this to be published.

What makes the author think that sale prices of houses is not publicly available in the US. Check out the following links which shows property sale prices. Its all public information.

http://php.app.com/websr1a07/search.php
http://www.nj.com/realestate/homesales/

again this is just a small sample of the websites from where you can get this information. And for sales prices all over the united states check out

http://www.zillow.com

We really need to look at our materialistic, greedy culture to find that there is a stench of corruption in most professions and institutions. Bankers, real estate agents, appraisers, financial advisers, accountants, investors, mortgage brokers……wherever a buck can be made by exaggeration, spin, misrepresentation, turning a blind eye or ear, let’s face it, our society has done this to itself although many of the biggest victims are innocent bystanders who have “played by the rules”. And what happens to whistle-blowers? They are discredited, prosecuted, ostracized and ruined. Guess what folks, we have seen the enemy and he is us!

Posted by Jonathan Cole | Report as abusive

Registry standardization and centralization of the sort proposed would be a useful improvement. It has, however, I agree with the critics, very very little to do with the construction of over-leveraged speculation and bubbles.

Posted by AtomikWeasel | Report as abusive

Elena Panaritis writes: “The current crisis stems from the absence of a system that provides stability to the value of properties in the United States.”

I say bravo! You are exactly right Elena!! Honest property valuation is so important, and it can be done in many different ways. I would do it in tripartite fashion as follows:
1. Replace local and state property taxes with a stiff national property tax.
2. Heavily tax profits made on the sale of residential real estate with no exceptions.
3. Require a 20 per cent down payment on the purchase of a property, and require that a mortgage payment not exceed 35 per cent of a purchaser’s verifiable income.

California started this whole inflated property valuation mess in 1978 with its notorious Proposition 13. If you shield homeowners from the adverse consequences of rising property values by limiting property taxes, then homeowners will abuse that protection by using their majority status to run-up property values to enrich themselves at the expense of the community at large. The same goes for allowing exceptions to a heavy tax on the sale of residential property. The current crisis was caused by an orgy of greed by a generation of American homeowners, and now everyone world-wide must pay for their folly.

Posted by Darth Baghead | Report as abusive

Congress failed to require real, true, viable loan modification in the Housing & Economic Recovery Act as well as EESA and again in the ARRA. “We the People” have now spent or committed to spent some $2 Trillion, with trillions more to come, all without ever having addressed the root cause of this crisis…. the real estate defaults and foreclosures. In addition, proper loan modification WILL eliminate the vast majority of loan defaults that have brought about the massive increase in bankruptcy filings. Should our bankruptcy judges have the authority to modify real estate loans… most probably the answer is yes, however this is and ought to be a separate issue apart from the current economic crisis.

It has been stated that some 58% of loans that have been modified to date are back in default and foreclosure. A review of these loans will reveal that the cause for these failures has been the method of modification… the rate and terms applied in these instances have been a prescription for failure. Therefore, I suggest that congress require that any lender, brokerage, insurance company, or and any other firm that has received TARP or other federal funds, either directly or indirectly; and holds a beneficial interest in an any loan secured by 1-4 unit real estate, either directly or indirectly, be required to offer to modify all real estate loans with less than 3 years remaining to the next rate adjustment along the following lines:

WITHOUT the time consuming, meaningless process of (effectively) re-qualifying for a new loan, the existing loan balance is to be modified into a 50 year amortized loan, with a 5 year reset and an initial rate of 4%. The maximum rate change each 5 years would be +/- 2%; with a 9% lifetime cap. Loans already in default would carry a forbearance agreement added as part of the process.

This method of modification will reduce the loan payment by some 55%; while at the same time preserving the amount due to the lender. The aggregated annual savings of in excess of $150 Billion realized would, most likely, go into savings, pay down revolving debt or be spent fueling the economy through the purchase of goods and services (cars?). All of these options are positive and necessary for a cure to this crisis.

In most instances, this process would eliminate the urge to simply walk away from a property in which the homeowner has no equity. They require a home for their family; and what is better than the one that they already have. This proposal will stabilize not only the real estate and financial markets… but also the lives of these millions of Americans… while at the same time providing the knowledge and hope that, given time, they will regain the lost equity in their homes… the hope and positive attitude that my proposal brings to the table cannot be overlooked.

It is quite easy to verify that the number of families currently effected by this crisis is not, as reported 13 million, but more likely over 25 million real estate loans are in jeopardy… we cannot continue to ignore these people… as to stay on the present course, impacts every American family negatively.

Every time a homes sells as an REO or “Short Sale” the real estate tax base is reduced… the states and local governments are all reeling from these loses. This plan will put an end to this hemorrhage in tax revenue too.

I understand the idea of a more unified approach to property evaluation. For example, in Pennsylvania where I practice my trade, survey’s are not required when transferring a property, unlike in neighboring states. It seems strange that one would purchase a property, normally their largest purchase in their lifetime, without actually knowing what they own! However, title insurance protects Pennsylvanians in the event of any discreancy. To suggest that a nation system would be more efficient, I would refer you to any number of government run organizations. Could you imagine proceeding to settlement on a property in a 2 week time period? Imagine the beaurocratic red tap coordinating these transactions through a national system. Our existing system isn’t perfect, but it works. It is a free market system that allows the ebb and flow of property valuations. I’ll take that over dealing with some government agency any day.

Posted by jeff pendergast | Report as abusive

As any improvement of any registry system would be beneficiary, I don’t really think it is connected somehow with prices. Aren’t stock markets a good example that even when values are transparent they still tend to go the way from boom to bust every few years? If home prices behave that way it is not because of transparency issues but because of the idea that those four walls are sound investment. Sometimes in fact they are (I am a proud owner of bricks and mortar) but if we would like to prevent the damage housing busts do to the wider economy and the banking system we should stop encouraging home ownership. Developers will not loose their jobs because people always will need places to live. Why do you think there’s been no property bubble in Germany? Yes, it’s economy has been sluggish over the last years but just 43 per cent of the people own their homes. On the other hand, if consumers put less money in illiquid assets they should have more to spend, wouldn’t they? And maybe banks will then put the emphasis on what their clients earn, not what they are worth. Their business is about lending not investing. Isn’t that the reason why in the US you used to have investment and universal banking models?

Posted by Deyan | Report as abusive

As stated we need to get back to the basics. Basically we need to know the underlying value of real property, that means a solid appraisal. Banks tended to drift towards Broker Price Opinions (BPO’s) and AVM’s Automated Value Models to reduce cost for a appraisal of property.

When this happened especially with AVM’s the greed and fraud got worst. A computer can not tell the condition of a property period. A human being needs to inspect the property and determine value. To stabilize property values this must also must occur.

The securitized pools of loans must go back to proper valuation, proper underwriting and risk management period.

Geithner’s Mo Mod plan what I have seen addresses this very root of the issue you talk about. Mo Mod requires proper appraisal which in turn allows the financial arm to get it feet under them.

Senator Grassley from Iowa questioned Geithner last week on the Mo Mod plan for fraud detection, I would be curious on how that componet works.

I look forward on how this all works out, I hope that we do go back to the basics, and believe the Mo Mod platform is a good first step to recovery!

Posted by Frank Kellog | Report as abusive

Great post about the Mo Mod. What I have seen about it, allows un-biased appraisal valuations to occur. Since taxpayer dollars are involved, don’t we need to know what the true “underlying value” is before any correction?

Knowing that portion, will help the government determine the stress test of alot of banks. I wish Elana would look further into the Mo Mod platform for us readers. I also saw Grassley’s letter to Geithner concerning the Mo Mod, I would love to see Geithner’s response. I don’t know how much longer this country can hang on with policy in limbo?

Posted by Roger | Report as abusive

You won’t solve the valuation problem until you make appraisers completely independent. It would require a multi-step process:

1. Require full disclosure of sales prices of all property, in all states.
2. Establish an Internet-based property registry system that is accessible to everyone, by which access is gained to sales prices and critical property information.
3. Require that appraisers be competent to appraise the specific type of property they are appraising, not just have a general license.
4. Award appraisal assignments through a blind national system, that is not controlled or influenced by a borrower, lending institution,or loan officer.

Until the system is transparent, and without influence, we are going to see the current crisis repeated over and over. It is time for a change. After 35 years as a professional appraiser of commercial property, I’m tired of seeing us repeat the past. Give appraisers accurate information, and let them do their jobs honestly.

Posted by John B | Report as abusive

The real root cause of this mess is the trade deficit, which is financed by a sell-off of American assets, including mortgages. Every dollar of the trade deficit must return to the U.S. and get invested somewhere. When the stock market bubble burst in 2000, and with interest rates on treasurys so low, the hundreds of billions of trade deficit dollars turned to the housing market. With the market for prime borrowers already saturated, lenders turned to sub-prime mortgages, offering ridiculous loan terms to people whose incomes had been in decline for decades due to – what else? – the trade deficit and the loss of manufacturing jobs.

Housing won’t stabilize until the median home price falls to a level that’s affordable by people earning the median income, which is steadily declining. Want to stabilize the housing market? Stabilize incomes. That means eliminating the trade deficit and bringing six million manufacturing jobs back home.

Pete Murphy
Author, “Five Short Blasts”

This is a good idea. In Louisiana, everything is public, but the records can be so complicated you have to pay for a title search because the records are so complicated and, even then, there can be uncertainty. I say this as a lawyer who knows a lot of property law. Title insurance mostly protects banks.

In Houston, it seemed clearer, but I believe that sale prices are not made available because then people might have to pay property taxes on the real value of a property based on how much they were willing to pay for t instead of whatever lesser value they could convince the government to assign. This system also makes it much harder to value nearby properties.

Posted by Mike Guidry | Report as abusive

From looking at the Case Shiller home price index, it appears that home prices are decreasing at a rate of about 2% per month. The rate of decrease is accelerating. It used to be that home prices were decreasing by 1 or 1.5%, then 2%, soon it will be decreasing by 3% per month. The index maxed out at about $190,000 in the summer of 2006, and it has since decreased to $140,000. From the looks of it, I think that the price of homes will decrease to about $100,000 or so. That means that we are almost half way done the slide in prices.

Peak to trough, we should expect about a 40 to 50% decrease in home prices. Looking back, it was definitely a housing bubble. The banks used tricks such as the 40 year amortization period, adjustable rate mortgages and interest only mortgages to con people into thinking they could afford these expensive homes.

The worst is yet to come. People might as well sell their house now, and wait a year for the house prices to decline another 20 or 30%, and buy back at a lower price.

The government can’t stop the slide in home prices. The only remedy would be for people to get higher paying jobs so that they can afford more expensive homes, and that won’t happen any time soon.

Dow 5000, and case shiller $100,000, here we come!

Posted by Dave J | Report as abusive