Housing Market Mess – Labor Econ Style?
I’ve felt kind of left out discussing the bailout.
Dr. Michel does research on fiscal policy – particularly taxes – and financial economics, and thus this is right up his alley. Dr. Coats does research on public choice – government spending, pork, attempting to get reelected – again, right up his alley.
And I, at least according to my vita, am but a lowly labor economist.
Labor economists can’t claim to have domain (over other types of economists) about incentives. At its heart, all of economics is really a study of the incentives people have and the constraints they have. However, there are some labor economics issues that are floating around in the background of this financial mess that I think are not getting lip service, at least not on this blog.
I’d wanted to post about the incentives that various players have had in the housing market for a while, hence the post. Then I came across an article, linked here, to a short commentary on the housing market mess written by John Quigley, an economist at UC-Berkeley.
Quigley suggests a large part of what got us into this mess was a really simply problem with labor market incentives – the way the people were compensated. I couldn’t agree more.
Not all people are paid on hourly pay or even salaries – some people’s compensation is structured differently. These different compensation structures give people different incentives. They are done with a reason – to solve one problem – but all forms of compensation schemes have drawbacks.
Back to the housing market mess. You’ll have to go to the link above, and then download the article (there is a download button on the upper right part of the page), but it is free, and only 3 pages long.
Here’s the background, lifted from the article:
The incentive structure that arose for firms in this specialized industry set the stage for the collapse. The incomes and fees generated are all transactions-based, that is, payments are made at the time the transaction is recorded. The originator of the loan, typically a mortgage broker, is paid at the time the contract is signed. Brokerage fees have varied between 0.5 and 3.0 percent. The mortgage lender earns a fee, between 0.5 and 2.5 percent, upon sale of the mortgage. The bond issuer is paid a fee, typically between 0.2 and 1.5 percent, when the bond is issued. On top of this, the rating agency is paid its fee by the bond issuer at the time the security is issued. All these fees are earned and paid in full within six to eight months after the mortgage contract is signed by the borrower.
And now the punchline, at least of the labor econ stuff:
Thus, no party to the mortgage transaction has any economic stake in the performance of the underlying loan. In fact the mortgage broker is paid a larger percentage, termed a “yield spread premium,†if he convinces his clients to accept a higher and more default-prone interest rate. With this structure of incentives, it is not hard to understand why many risky loans were originated, financed, sold, and securitized, especially during the period of rapidly rising house prices from 1999 through 2006.
Read that first sentence again.
Thus, no party to the mortgage transaction has any economic stake in the performance of the underlying loan.
That, folks, is a big problem.
And for the record, Quigley goes on to make some suggestions about how the system could be changed to make things better. Read it!
For my next trick, what labor economics has to do with this whole ACORN voting registration mess…
–CT
October 27th, 2008 at 1:54 pm
I have even a better trick. I will predict what your labor econ/ACORN connection will be about. It will be how when people get paid by how many voters they register, Mickey Mouse and Superman, as well as entire sports team rosters, suddenly get signed up to vote. The question is “why does ACORN continue to pay its workers in this way, even though they have been accused in election after election of fraudulent voter registration?”
-MC