Income trends and the housing market - Special Issue: Earnings Inequality - Panel Discussion

New England Economic Review, May-June, 1996 by Ann B. Schnare

I was asked to address the impact the mortgage market may be having on income inequality. I find that a difficult hypothesis to address and have decided to turn it around a bit. I will discuss the impact that income trends are having on the housing market and the pressures they are putting on the mortgage industry as well as on the housing programs that serve the poor, such as those run by the Department of Housing and Urban Development (HUD).

Let me begin with a few words on how the effects of earnings inequality have played out in the housing market historically. Enormous and rapid improvements occurred in the homeownership rate after World War II. We went from a nation of renters to a nation of owners. But in the early 1970s, homeownership rates began to decline and continued to do so until last year. Many feared that the American Dream of homeownership was being threatened.

If you look at the numbers, much of the decline in the homeownership rate can be explained by demographic trends, for example, the rise of single-person households. But more important, in my view, are the income trends we have examined today. Younger, middle-class households between 25 and 35 years old, the classic first-time homebuyers, have experienced stagnating or even declining wages. Homeownership rose among younger households without children, both singles and married couples, but it fell significantly for both single and married parents with children. These were also the groups who experienced declining incomes.

Poverty in the Cities

The middle class certainly has been affected, as the stagnation in wages put pressure on homeownership rates, but the big impact has been on the rental market, as both relative and real incomes fell for those at the bottom of the income distribution, the people who traditionally have been renters. As a result, there is a large and growing gap between what it costs to operate an apartment building and the rents households can afford to pay. This has led to two problems, the physical decay we see in urban areas and an increased demand for government subsidies. And HUD has been severely hit by reductions in the resources put into low-income programs, a trend that will only intensify in the future, in my opinion.

These are individual effects, in a way. But the papers we discussed earlier make clear that not only are individuals pulling apart, so are neighborhoods and communities. Increasingly, the poor are concentrated in highly impacted neighborhoods within the city. Most who can get out have been getting out. These changes are having a growing impact in turn on the fiscal health of cities and their ability to pay for essential services. And city fiscal difficulties may in turn intensify some of the negative neighborhood effects that we have discussed today. The problems of urban areas are now linked intrinsically to problems of income distribution. To what extent they are contributing to or causing such problems is a matter for debate, but income distribution problems certainly are affecting the future viability of urban areas.

Implications for the Mortgage Industry

What does this mean for the mortgage industry? Certainly there is a lot of concern about the ability of low- and moderate-income households, especially minorities, to get access to the mortgage market. Following the Boston Fed study, as well as other work on mortgage flows in low-income and minority neighborhoods, the response by the mortgage industry has been fairly dramatic as we reexamined our underwriting criteria to see if we had unnecessary barriers to getting credit to inner-city neighborhoods.

This reexamination has led to a lot of experimentation, which has intensified in recent years. Unfortunately, the initial results are not very comforting. The mortgage industry has seen a real decline in credit quality, due in part to a drop-off in loan origination volumes. Mortgage originators were staffed up, and then they saw the refinancing market go away. Thus, there has been increasing economic pressure to preserve volume as well as political pressure.

At Freddie Mac we have found it important to distinguish between the performance of special programs and that of mainstream programs as they relate to the income of the borrower. In our special programs designed to lift certain underwriting guidelines, the record is not very good. These programs are relatively new, but as the data begin to come in, they are showing significantly higher default and foreclosure rates. These are low-equity loans, where only 2 percent of the money comes from the borrower's equity, and often even this is paid by or borrowed from the bank. Other aspects of risk are typically involved as well; in fact, layering of risk appears to be a significant problem. In my opinion, it is bad public policy to put individuals into houses they cannot afford to support. Some of the biggest abuses of government programs occurred in FHA during the early 1970s, when neighborhoods were blown away by bad underwriting.