A number of books have been written about the recent real estate crash over the last months. I’ve found Thomas Sowell’s The Housing Boom and Bust to be among the best.
Dr Sowell attributes much of the crisis to the well meaning politicians who misinterpret the meaning behind the data. They assume that any differences in mortgage approval rates between races must be due to racism and calls for correction. Instead of digging through the data to truly understand the origin of these differences, they seek to legislate equality with disastrous results. The Community Reinvestment Act (CRA) at its surface may have seemed to have the best of intentions, to provide affordable housing and improve home ownership rates among minorities. Unfortunately, good intentions didn’t lead to good results.
Let’s first take a step back and look at how the statistics are misunderstood. My undergrad is a BSEE (Bachelor of Science, Electrical Engineering), the number of women in my class and in the engineering school overall was about 15%. Does this need to be ‘fixed’ and if so, how? The immediate fix would be to change the acceptance criteria so all women that apply get admitted, or at least as many as it takes to get to 50/50. You can see how this is nonsense. For the long term, one can present fields of study in an interesting way and let the students decide. Can you change the interest of an entire gender? My data is 25 years old, and I suspect that the percent of women engineers has risen but not to the point of equality. This is a bit of a tangent, the truth behind the statistics, one I’ll bring up again in future posts.
An article in SmartMoney last November titled The Color of Money, spoke about the difference observed in wealth vs income among races, white households having a median net worth of $118,300 in 2004 vs black household’s $11,800. Even after normalizing for income, the wealth accumulation was higher for whites at the same income level as their black or Hispanic counterpart. The article didn’t go into the home ownership implications as it was pretty brief, instead focusing on retirement issues, but this observation sets the stage for some of the conclusions Dr Sowell’s book reaches.
The difference in mortgage approval rates can be viewed two ways, one study showing a denial rate for whites was 11% vs blacks 17%, ‘nearly 60% higher denial rate.’ When we look at the same data and state that the white approval rate was 91% vs blacks 83%, ‘less than a 10% disparity,’ the picture seems a bit different. What the CRA did was to encourage the banks to change the rules of lending, discarding much of what we learned in Mortgage 101. It wasn’t simply that house prices rose too high, as even in in 2005, the median house took just 22% of median income to afford, a number consistent with having housing cost 25% or less of one’s income. It was the introduction of subprime loans including those of the ‘no money down’ variety becoming the norm in many areas. This combined with the various adjustable rate products were the proposed solutions to a problem that didn’t exist. It doesn’t take a math genius to calculate the monthly payments required for an option ARM (paying interest only at a low teaser rate) and a fully amortizing higher rate loan a few years later. These products were the equivalent of financial time bombs.
This book is brief, only 148 pages, but an excellent read. The author, Thomas Sowell, is not a journalist with an agenda to promote, currently a Senior Fellow at the Hoover Institution, Stanford University, he has a respectable resume as a professor and author.