RE: “6. Banks have repeatedly got into trouble by lending on real estate, with the current crash only the most recent example. Wise policy would insist that banks make mainly “self-liquidating” loans, such as for inventory or accounts receivable, and require that real estate purchasers provide hefty equity.”

This hefty equity, would that not make it more difficult to purchase a house?

my response:

You are correct, and this is one of the penalties of trying to very briefly summarize a book full of sound thinking.

So let’s make up some plausible numbers to look at the problem. Say that in 2006 the minimum cost for a decent house (and lot) in a particular area was $200,000. A person paying, say, 3% down would come up with $6,000, and have to pay, say, $1200/month for mortgage and taxes (we ignore maintenance and utility costs, which actual homeowners know can kill you.) Assume mortgage is fixed rate and there’s no HELOC.

In an alternate universe, everything is the same except the minimum down payment is 20%. How would this affect the cost of housing? Fewer people can come up with $40,000 than with $6,000, so, the demand for housing is somewhat less. Lower demand means lower price, let us say $190,000. Still, the guy who has $6,000 for a downpayment cannot buy the house, she must rent.

Now, suppose our $6,000-down-payment guy loses her job, which paid $3,000/month, and can only find another paying $2,000/month. Not only that, but real estate taxes went up, so the monthly payment goes up from $1200 to $1250. What can she do?

In our universe she is screwn, she has to sell her house, may or may not be able to afford to rent a cheaper place, or move in with friends, or, worst case, becomes homeless. (It doesn’t always take job loss, either; a busted furnace financed on a credit card could do the trick.)

In the alternate universe, her income is down, but she has a $6,000 cushion so she can pay the rent for at least a few months. She has options: Maybe move to a cheaper apartment when the lease expires, or to another city with better job prospects. If there is a widespread economic slowdown, her landlord might reduce the rent in order to keep a tenant.

Of course in the alternate universe she never had the chance to build “equity” in the increasing dollar value of a house and lot, but she also never was exposed to the risk. For most people who can barely afford to buy, the “equity building” in our universe is an illusion anyway. Something always happens.

If your highest priority is to get everyone into an owner-occupied house, then a higher down payment requirement is not helpful. But if your priority is a stable and prosperous economy, where everyone willing and able to work can afford a decent place to live, I think it is good policy.

Maybe, when one gives the book to the Dignitary, one should say “Have your economic advisor take a look at this.”

In March I will be giving a talk at HGS on “Who Stole Prosperity?” Of course I haven’t yet written it, but expect to rely heavily on AtC. Perhaps the result will be something useful.