Wednesday, July 23, 2008

Gridlock and the Mortgage Crisis

Michael Heller's new book, The Gridlock Economy, makes a powerful case for the proposition that our economy suffers from "too much ownership." Parlaying into public debate an idea he has expounded in the academic literature, Heller laments the tragedy of the anti-commons. As the first reviewer on the Amazon site linked above notes, the book is very timely for its explanation of the current mortgage crisis---not how we got into it but why it's hard to get out.

Banks loaned money to people who couldn't afford the interest payments because, in a rising housing market, those borrowers could always sell the house---or go further into debt based on home equity loans to service the existing debt. When the bubble burst, the banks and the entities that had bought slices of the loans were left holding the bag. That wouldn't have been a disaster if not for the crucial fact that over the last decade as never before, the right to receive interest payments on mortgage loans was sliced and diced into so many different pieces that workouts became impracticable. In the old days, if Borrower owed 6%/year on a $200,000 loan, but could only afford to make monthly payments equivalent to a 4% loan, Lender could strike a new deal with Borrower if Lender preferred doing so to going into foreclosure. But now, with Lender being a far-flung collection of multiple lenders, the transaction costs of renegotiation are too high to make a workout possible. As a result, foreclosure becomes more likely, and more foreclosures further depress housing prices, making the problem even worse.

To be sure, Gridlock is only one factor at work here. It doesn't explain how we got into this mess, which had more to do with irrational exuberance. Lenders and investors stopped demanding the sort of financial information that a prudent lender or investor should demand. Exactly why that happened is a different story, nicely explained in this episode of This American Life.

Now the hard question: What should we do about the problem of too much ownership? Heller's own prescriptions are mixed: He says that depending on the nature of the resource, we will need different mixes of private ownership, commons, anti-commons, and state ownership. That's quite sensible, and it will be interesting to see how the larger political system responds: Even though the book is not especially ideological, I suspect it will be treated as coming from the left/liberal side of the spectrum. One possible reaction from the right will be simply to ignore or denounce the book. Another would be to try to appropriate its message where it comes out against overregulation, as it does in some choice examples. (These are relevant because they provide a public sector example of the problem of needing permission from too many people or entities, which can be true in an anti-commons or in a system of fragmented regulatory authority, such as building permits).

Perhaps the most interesting reaction might be to note that the real problem, as Heller explains, is not too much ownership per se, but fragmented ownership. One could address that problem either by changing the rules in the direction of commons or state ownership, but one could also go in the direction of concentrated private ownership. It has been a long time since anyone (other than Bill Gates or Steve Ballmer) has sung the praises of monopoly, but if Heller's book gets traction, listen for that tune.

Posted by Mike Dorf

11 comments:

KipEsquire said...

The only reason we have had "too much ownership" of single-family suburban homes is because the federal government has subsidized such ownership ever since the Federal Housing Act's Title II. For those who are keeping score, that's 60 years of loan guarantees, outright subsidies, tax advantages, block grants, restrictions on rental supply (rent control), "government-sponsored entities" and other distortions.

And still we find people who insist that this is, somehow, a "market failure."

Jamison Colburn said...

I've been reading this, too, and wondering whether the right will engage Heller's thesis a little more publicly now. (Buchanan and company at George Mason have actually done a fair bit of engaging in some academic papers -- to their credit.) It has huge implications for natural resources law, especially imperiled species, and I don't think they cut in the usual directions. For example, fragmented regulatory authority has the same outcome as fragmented ownership in some cases, as you point out w/r/t building permits. But this could be a lefty's point, too: fragmented regulatory authority in urban areas may be artificially inflating the demand for greenspace development. Another implication/application (which I've written about some) are connected landscapes as the defined resource. Connected landscapes allow migrations and genetic exchange, natural processes that we are foreclosing at a stunning rate just when we should be helping them. Condemning or exacting conservation easements may be the only way to reassemble the fragments of ownership needed to protect the resource in that case.

egarber said...

To me, the issue relates to the fragmented ownership you mention.

I think in the end, we’re gonna see that one of the major causes (perhaps the primary cause) of this mess relates to what they call the “agency problem”. It used to be that banks issued mortgages and (essentially) held them for relatively long durations. Now, nobody owns the liability for anything – they don’t have any skin in the game. A bank or even a builder (eager to move homes) arranges a loan, and sells it on the CDO market before anything can blow up. The hedge funds think they’re covered, because yet another brand of over-exposed companies sold them “bond insurance” in the form of credit default swaps. Then you have the loan servicing agencies – managing mortgage payments, etc. – who don’t really have an interest in the health of the loans, since their business thrives on processing fees.

My sense is that this basic structure can be repaired, so I’m in the “mend it, don’t end it” mold. For a quick businessweek interview with the supposed “inventor” of this stuff, here's a link:

http://www.businessweek.com/magazine/content/08_27/b4091040380049.htm?campaign_id=rss_topEmailedStories

Neil H. Buchanan said...

I agree with kipesquire that the government ridiculously over-encourages home ownership (though I probably have a different take on rent control). Indeed, my post next Thursday will discuss precisely that issue.

Even so, it is possible for even a "distorted" market to "fail" in the sense that it does not act in the way that one would predict given the legal restrictions. Market failure is not merely failure to reach the unregulated equilibrium but the failure to reach the optimum possible equilibrium, given the legal framework. The implosion of the mortgage market certainly fits that description.

Just a small note re Jamie Colburn's comment: "Buchanan and company at George Mason" refers to James Buchanan. No relation -- genetic or ideological.

signed, Neil Buchanan at George Washington

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