Fuqua Professor Sim Sitkin recently authored an op-ed column that has generated questions and responses from readers whose interest was piqued by his views on home ownership. In the op-ed, which was published in several U.S. newspapers, Sitkin offered three suggestions for increasing home ownership in the U.S. (the text of the op-ed is included at the end of this post).
In this post, Sitkin responds to several of the questions he has received.
Responses to Questions Raised:
This isn’t a new idea, is it?
No. It is my understanding that versions of these ideas have been proposed a number of times in the past. It is also my understanding that versions have also been used in Japan (with some fatal flaws in my view) and in Switzerland, as well as Hong Kong. I desire no claims to originality — but I must say that I was unaware of much of this, as were the economists and finance experts I spoke with. To me the point is not whose idea it was originally, nor even if it is correct. Rather, my objective was simply to raise the issue as a challenge to try to stimulate some more creative thinking about how best to pursue home ownership opportunities while retaining appropriate financial safeguards. As a note of caution – the details matter. Sometimes similar ideas have been proposed ways that I believe make the basic idea fatally flawed. If as longer term loan is simply a way to allow unqualified buyers to purchase homes they cannot afford (e.g., very small payments in the beginning and then balloon payments or a significant jumps as can happen with ARMs), this is obviously a bad idea. So it must be combined with strict qualification standards, as should be applied to all loans.
Why not allow people to sell their homes sooner than 10 or 20 years?
This misreads the proposal – I am sorry if I was not clear on this point. The proposal was that lenders could not flip the loan. There was no constraint proposed on the homeowner at all, who should be able to freely sell their property or just pay off a loan.
Why is this a sensible thing to do when the accrual of equity is so slow compared with other ways of investing money?
For the same reason most people do not take advantage of 15 or 20 year loans, and some go to 40 year loans where they are available. People take out mortgages at a rate they can afford to pay back and for which lenders view them as a reasonable risk (at least this worked until the past few years).  The people this would target are those who could pay reliably and steadily (so qualify using strict standards) but not at a high monthly rate. They are probably seeing this as an alternative to paying rent (from which they capture no value), not seeing this as an option as contrasted with socking away money in the stock market. So I think that it is often a false and hypothetical trade-off you are raising, but a natural one to think about. With the proposal, individuals who take on very long term loans certainly do end up paying lots of interest but do very slowly accumulate an asset over a period of time — the other actual alternative is that they pay rent but end up with no asset. This is why people buy houses to begin with. The typical loan term was arbitrarily set at 30 years some 70 years ago — so why is 50 or 100 any less arbitrary?
Doesn’t a really long-term loan only make sense for smaller investments rather than big home loans for which so much interest is accrued?
Maybe. But if this only makes sense for smaller investments, then it might be used only for very inexpensive properties — and 30 year loans may stay the norm for middle class home while 15-20 year loans might be more applicable to homes for the very wealthy.
Why is it helpful to constrain a lender by not allowing them to sell the loan for along period of time?
The objective was that if a lender had to service the loan for a long period of time, it would remove the incentive to make bad loans for a quick buck and then pass on the bad loan to another ill-informed party. This is partly designed to address the problem that created the financial mess we are in at the moment. It would also give homeowners more control as consumers. A borrower might select a lender not only because of their rates or other terms, but also because of their convenience or high quality customer service . . . only to learn that one week after the mortgage the carefully chosen lender sold it to another bank whose customer service is unsatisfactory.
Are you requiring children to take on their parents’ debt through assumable mortgages?
No not at all. An assumable mortgage does not require that it be assumed, but it makes that an option. It used to be that one could get a mortgage that could be assumable by anyone who purchased your home. Of course, that would only be attractive if interest rates had risen. So if you got a mortgage at 6% and rates had fallen to 4%, you would never assume the mortgage, you would get a new at the lower rate. No prospective buyer was required to assume your mortgage, it was an option they could take or leave. Similarly, children would never be required to acquire the home nor to assume the mortgage — but if the conditions were right, it could be a very attractive as an option.
Sitkin’s Original Op-Ed:
How to Accomplish the Goal of Increased Home Ownership
By Sim B Sitkin
President Obama’s ambitious housing plan announced last week has the right goal in mind. It emphasizes keeping people in their homes who meet minimum requirements, while also expanding the pool of people who can qualify for loans.
Best of all, it does so in a way that ensures responsibility on the part of all parties — the borrower, the bank and the government or other guarantors of the loan.
It’s a good plan to stop the bleeding and stabilize the housing market. But what happens when the immediate crisis ends? Hopefully that day will come and, if we’ve learned anything about avoiding future disasters, we should be anticipating it now.
While the country’s attention is still focused on this issue, I would suggest we change the design of mortgages in three more ways. All three are simple, easy to implement and avoid relaxing standards for qualifying buyers.
First, extend the term of the loan from the current typical maximum of 30 years. Make it 50 years, or even 100 years. The current 30-year standard term for loans was created in response to the Great Depression, but it is an arbitrary number. If I take out a 30-year, $200,000 loan, I pay less per month (for example, $1,074 at 5 percent) than I do if I take a 15-year loan ($1,582 at 5 percent), but I still need to qualify for whatever the monthly payments are.
A 50-year loan would work the same way (the monthly payment would be $908 at 5 percent), as would a 100-year loan ($839 per month at 5 percent). While the amount paid in lifetime interest for longer loan terms would be higher, many more people would truly qualify due to the low monthly payments, fewer would lose their homes in default, more could build equity and fewer banks would be taking over properties they do not want because owners could no longer pay their mortgages.
Second, allow mortgages to be assumable at no cost by the children of the borrower. For families with lower incomes, it may take a generation or more before they actually own their own home. But why is this a problem? If we have as a goal a larger middle and working class, with more assets and more ownership, then why not provide an incentive for parents and their children to build equity across generations? Under this scenario, mortgage periods of 100 years would make sense.
Third, do not allow mortgages to be sold for a substantial period of time — let’s say 10 years, 20 years, or longer. Part of today’s crisis was caused by a financial system that puts at risk companies that were too far from the investment and the borrower. If those who lend money could not get quick bonuses and then sell the bad loan to some sucker who has no idea who the borrower is or how sound the loan is, there would be an incentive to only make loans to sound borrowers without becoming too risk averse and freezing up the system.
We are a country firmly grounded in a strong middle and working class, but our current housing and financial crisis has put us in jeopardy. Home ownership is one of the foundations of our society. Responsible home ownership policies can not only help people stay in their homes and preserve our financial institutions, but can simultaneously increase home ownership and begin to change the trajectory from a negative to a positive direction. These three steps will move us even faster in the right direction.
Sim Sitkin is a professor of management and director of the Fuqua/Coach K Center on Leadership and Ethics at Duke University.
Dr. Sitkin’s proposals are interesting from the point of view of making home ownership easier and reducing some of the risk in the mortgage financing system. However I question the fundamental premise, why in the world should the government care about home ownership? Not only does home ownership impose substantial financial risk on buyers of widely varying sophistication, but it also reduces the flexibility and employment of our workforce as it makes relocation away from depressed or declining areas more difficult. I’m not against home ownership, I happily own my own home, but have never been able to fathom why public policy favors and subsidizes it. Seems to me our best policy option is to begin phasing out the tax deduction for mortgage interest to level the playing field between renting and owning. I think our economy will be healthier if people are free to weigh such decisions without a government thumb on the scale.
From my experience, the purpose of governments’ (particularly local governments’) interest in and support of home ownership is to build and maintain neighborhood stability, which enhances revenue through increasing values, rising property taxes, sales taxes (if applicable), income taxes, attraction of business and employers, etc., etc. I think this can also benefit state and federal governments.
Although some renters take great pride in the place they inhabit and improve it by planting flowers and keeping it and its surroundings clean and neat, many don’t. An area with a greater proportion of home owners than renters often has a better overall appearance, which I think encourages renters to live up to the example set by the neighbors. Home owners invest in their property with improvements, while landlords often do not. Therefore greater homeownership in a neighborhood generally leads to rising property values (or more stable property values), while a large proportion of landlord-controlled housing may not if investments in appearance and maintenance aren’t made. Furthermore, I would expect that home owners tend to have higher incomes than renters, which would improve a municipality’s income tax base.
Rising property values, a stable population — these increase tax revenues and can attract and support nearby businesses, further increasing and diversifying tax revenues. On a local level, downtowns of cities such as Baltimore are examples where government policies encouraging homeownership and owner-occupied residences have made a huge difference in the quality, value and stability of once blighted neighborhoods and undoubtedly provided some support to the city’s tax revenues over time. The last few years created a bubble in many of these areas because of “investors” purchasing houses or condo units with little or no understanding of the area or what a reasonable price should be, in my opinion, but at its core, home ownership and owner-occupied residences (very importantly) make for a stable and inviting neighborhood.
Baltimore very effectively revitalized their downtown in part by offering dramatic incentives 20 or 30 years ago for people to purchase, renovate and live in then-dilapidated and abandoned row houses. (The investment in the Inner Harbor, etc., let those pioneers know the city, state, and likely feds had some skin in the game as well.)
I don’t believe the goal is for everyone to own a home, but for there to be “enough” homeowners to provide stability to any given neighborhood and for the possibility of home ownership to be real for those interested in it. Anyway, this is one possible explanation that certainly can explain local governments’ policies.
Recently had an opportunity to study the Delta Leadership Model by Prof. Lind and Sitkin. I have learned a lot about the fundamental concepts of the leadership. Subsequently performed a Fuqua website search about Prof. Lind and Sitkin and found this new article by Prof. Sitkin. I agree with the opinion(s) of the Prof. Sitkin , Trevor Hicks and Joanna. However, I have few questions about the effectiveness in the macroeconomic perspective in order to calibrate my thinking.
If we look at the evolution of mankind and property ownership, it is evolved from no property rights to community property rights to individual property rights. Except mountains and marshy soils, the remaining 95% of the land is owned by 7% of the global population and the rest 5% of the land owned by next 50% of the global population. At least 40% of the global population does not have any property rights. Irrespective of government incentives, 30% of the population will own land or real estate, because land and home ownership is directly proportional to owner’s social status.
Also, am under the opinion that, in order to protect the interests of the 30% of the elite from the rest of the 70%, and / or to create an incentive system for the rest of the 70% population to integrate into the fabric of the society, and / or to create an easy opportunity for creation and distribution of wealth, and / or to accelerate economic growth and to innovate the building products, materials and appliances, the policy makers created a concept of tax incentives and low interest mortgages.
The questions are as follows:
(1) If we restrain the lender to sell long term mortgages in the market, lender need to have a huge amount of capital resources and loose the risk diversification opportunity. In this highly mobile and volatile economic situation, it is very difficult to predict the risk beyond 7 to 10 years. How can we convince a lender to provide a 20 or 30 or 50 or 70 or 100 year loan and restrict to sell only short term mortgages in the secondary market?
(2) Hypothetically, if we convince the lender to offer a 50 year loan with a restriction to sell only short term mortgage in the secondary market, the existing construction methods and materials won’t last for 40 – 50 years time. Which means the underlying asset will lose value faster than the loan repayment. Also every house contains a substantial amount of plant and equipment like faucets, electrical appliances, windows and HVAC machines etc would depreciate faster than the super structure. How can we handle this situation?
(3)Do we need to build the houses with a solid super structure with high quality plant and equipment, to retain the asset value for long time? Or build houses with low cost materials coupled with dynamic zoning regulations to supply more land to reduce the total cost of the construction and cost of the land respectively?
(4)The proposed changes would increase or reduce the national GDP?