Reforming the Housing Transaction
Tuesday, November 13, 2012
If policymakers truly want to make things better for home buyers, they should look for ways to streamline and modernize the housing transaction itself.
Editor’s note: this is part two in a series of essays about housing policy. You can see the first essay here.
The process of buying a home in the United States is archaic and expensive. To understand why, you have to remember that one person's wasted expense is another person's income. What to consumers are unnecessary fees are the bread-and-butter of real estate agents, attorneys, and mortgage lenders. And remember that these interest groups make up one of the most successful lobbying coalitions in all of politics.
When the government looks for ways to help home buyers, it usually thinks in terms of subsidies in the mortgage market. However, if policymakers truly want to make things better for home buyers, they should look for ways to streamline and modernize the housing transaction itself. Some suggestions I have include reforming the title process, fostering more competition in real estate sales and mortgage lending, and making the foreclosure process less costly and more streamlined.
The Title Process
Today, title insurance is recommended for every home owner — and is required by nearly every mortgage lender. Title insurance provides protection against a lawsuit claiming an improper change of title somewhere in the history of the property. Part of the problem is that while buyer A and seller B may be acting in good faith, former owner F might claim that he was improperly deprived of ownership by former owner E, who sold to D, who sold to C, who sold to B. Former owner F then brings this claim against buyer A.
For at least 150 years, we have known that this system could be improved. In Australia, Robert Torrens proposed the idea of a central registry for titles. This central registry would be definitive in determining who currently owns a property. If former owner F has a claim that his title was improperly transferred, he takes up his case not with the current owner, but with the registrar (which could be a government entity). If a court rules in favor of F, the registrar pays compensation, but the current owner is unaffected.
If title laws were changed and the recording process was modernized, the cost of buying a home would be reduced by hundreds of dollars.
In the 21st century, we could improve the title process even more by standardizing and computerizing property records. County recording offices are still set up the way they were when property descriptions were of the form “walk 8 paces west of the beech tree,” etc. Today, we have geocoding. In many counties, you have to physically walk into the recorder's office in order to see the property records. Today, those records could be available on the Internet.
If title laws were changed and the recording process was modernized, the cost of buying a home would be reduced by hundreds of dollars. This benefit would not require any taxpayer subsidy. On the contrary, title registration could be a profit-making enterprise, either in the form of a regulated monopoly or managed competition.
Competition in Real Estate Sales
Economists and others have long been troubled by the standard 6 percent commission in real estate sales. While it is true that real estate agents sometimes bargain away part of their commissions, it seems that the market is far from competitive.
Economists question the basic structure of real estate commissions. Why should the commission be 6 percent, regardless of the price of a home? If it takes the same work to sell a $150,000 home in a low-price area as to sell a $400,000 home in a high-price area, why does the agent earn more from the latter sale?
Another concern is that the real estate agent's incentive is to sell a house relatively quickly, rather than for the highest possible price. Freakonomics author Steven Levitt famously showed that, when selling their own houses, real estate agents wait longer in order to obtain higher prices.
To economists, the sensible real estate sales contract would employ what we call marginal commissions. The agent would be compensated a fixed dollar amount (even if the house is not sold) plus a percentage of the sales price over and above a figure that is minimally acceptable to the seller. For example, suppose that I am willing to sell my house for $300,000. I offer to pay an agent $1,000 plus 40 percent of the amount by which the sales price exceeds $300,000. Thus, if it sells for $310,000, the real estate agent gets an additional $4,000.
I am not suggesting that government should dictate the terms of contracts between real estate agents and home sellers. However, the government should not do anything to protect the real estate cartel. I think that if the real estate title process were reformed, as described in the preceding section, then this would take a lot of the mystery out of the real estate settlement process. If the settlement process were less complex and fragile, then buyers and sellers would be more comfortable with using alternatives to standard real estate agents. The combination of straightforward settlement and the ability to search for homes using the Internet would likely cause real estate commissions to be lower and more aligned with the incentives of sellers.
Competition in Mortgage Lending
Many consumers pay mortgage costs that are too high. Phrases like “yield spread premiums” and “junk fees” have been inside jargon for consumer rip-offs.
What to consumers are unnecessary fees are the bread-and-butter of real estate agents, attorneys, and mortgage lenders.
In general, there are two sources for consumer protection. One source is regulation, and one source is competition. They are not mutually exclusive. In my view, however, relying solely on regulation is not a promising approach. Lenders can always find ways to work within the letter of regulation to exploit poorly informed borrowers. (I suggested a better regulatory alternative in “Why We Need Principles-Based Regulation.”)
A competitive mortgage lending process requires two components. First, the borrower's loan application needs to receive bids from multiple lenders. Second, those bids must be firm commitments, not “good-faith estimates.” If I were tasked by the Consumer Financial Protection Bureau with helping consumers obtain better mortgage loans, I would focus on these sorts of process reforms rather than trying to regulate the terms of actual mortgages.
One of the more misguided ideas about housing policy is that consumers benefit by making it difficult for lenders to foreclose on mortgages. In the long run, lenders pass on high foreclosure costs in the form of higher interest rates to all borrowers. Legal provisions designed to restrain banks may help a few otherwise-oppressed home owners, but they have the effect of benefitting housing speculators and other undeserving borrowers. In addition, such provisions lead to houses being trashed or damaged by delinquent borrowers who know they are never going to make their payments current.
We would be better off if the standard foreclosure process were streamlined. If borrowers cannot make their payments current, they should be evicted as soon as they are more than 90 days in arrears.
To address the risk of improper foreclosure, borrowers should have recourse to an appeal board of some sort. These boards could act as mediators between borrowers and lenders in cases where the borrower has a legitimate argument against foreclosure. Most importantly, these boards could insist that borrowers maintain the integrity of the house or forfeit their right of appeal. One of the main reasons that costs of foreclosure are high is that borrowers strip and damage properties before they are evicted. Such losses should be preventable.
Arnold Kling is a member of the Financial Markets Working Group at the Mercatus Center of George Mason University. He writes for econlog, part of the Library of Economics and Liberty.
FURTHER READING: Kling also writes “Who Needs Home Ownership?,” “How to Think about QE3,” and “Many-to-One vs. One-to-Many: An Opinionated Guide to Educational Technology.” Alex Brill says “Housing Finance: For Once, Please Leave It Alone.” Peter J. Wallison discusses “Housing Finance Reform: Should There Be a Government Guarantee?” Edward J. Pinto contributes “Moving the Housing Market Forward: Principles for Returning FHA to Its Traditional Mission.”
Image by Darren Wamboldt / Bergman Group