Post-Crisis: Texas Housing Laws Could Help All Banks

So I’m glad Texas is making waves about seceding from the United States right now, since it leads nicely into my first ever weekly project here at Rortybomb. I don’t know the specific talking points of the Texas Teabaggers, but if they have a feeling that they did something right while everyone else was doing something wrong during the 2000s, they may have a point.

In 2007, when everyone first started to realize en masse how bad the housing landing was going to be for the country, I remember telling a friend “I bet Texas is going to be a giant crater when this is over.” From my mind, I’ve always associated Texas with the worst boom-and-bust cycles in everything, housing above all. The next day I checked the numbers and realized I was entirely wrong.

Let’s look at some data. Here’s the Case-Shiller numbers for the 20-city US index, Phoenix, Arizona, and Dallas, Texas, seasonally adjusted. (For some reason, Case-Shiller does Dallas instead of Houston. These numbers are 'generalizable' though).

Now Phoenix and Dallas have a lot in common. And so do Texas and Arizona. Yet somehow Texas, which seemed perfectly engineered to replicate the problems of Nevada and Arizona, as well as California and Florida, avoided the fate of the “Sand States.” Home values didn’t jump high then crash; they rose a nice 25% over the decade (it looks small on the chart, but only because it is overshadowed by the boom/bust).

From USA Today, we see Texas is right around the median of housing foreclosures, with a normal 1%; Arizona, Florida, California and Nevada all have 4% and above. When you start digging, you see all kinds of signs that the Texas market is fine - it is the first everyone expects to start going again.

So what gives? I’ve thought about this a lot, and have come to a simple three word conclusion: “No prepayment penalties.” Right there in their state law:

§ 343.205. PREPAYMENT PENALTIES PROHIBITED. A lender may not make a high-cost home loan containing a provision for a prepayment penalty.

And, in general, a consumer’s bill of rights:

No Balloons – a high-cost home loan may not provide for a payment that is more than twice as large as the average of earlier scheduled monthly payments within the first sixty months of the loan.
No Negative Amortization – a high-cost home loan may not provide for a payment schedule that may cause the principal balance to increase.
Borrower’s Payment Ability – the lender may not make high-cost home loans based on the collateral value of the property without regard for the borrower’s repayment ability, including current and expected income, current obligations, employment status, and other financial resources.
No Prepayment Penalty – a high-cost home loan may not contain a provision for a prepayment penalty.
No Charge for Service Not Received – a lender on a high-cost home loan may not charge a borrower for a service or product if the borrower does not receive it.

I think all these are good ideas to be brought back to the federal level. It was not always this way, determined at the state, or in a way friendly to whatever banker and consumers could agree on. As part of a wave of deregulation in the late 1970s and early 1980s, Congress passed AMTPA, which allowed the subprime market to begin to be built. That wave of deregulation was a series of experiments; it is in the nature of experiments to sometimes succeed, and sometimes fail. It is our job to determine which is which among the wreckage, and my argument will be that these prepayment penalties created the worst incentives for banks.

I understand that we don’t want to regulate the previous crisis. The Democratic Party is busy with trying to fix the Recession and the banking crisis, while the Republicans are busy heroically fighting the One World Currency and the FEMA internment camps. During 2007, we heard from candidates Hillary Clinton and Chris Dodd that they would want to ban prepayment penalties. We haven’t heard it from President Obama; I would like to see pressure to do so, while Change is in the air.

So I’ll spend a few days talking about this in detail, from empirics, to financial theory arguments, to a model as to why this happened, hopefully making it accessible to any educated reader. Feel free to skip if you are already bored, and please criticize away, even if you agree with me.

I also want to get away from the duality of thinking of the subprime crisis as evil banks looting homeowners or evil lenders tricking banks. With the genius of prepayment penalties, banks didn’t have to make money by lending loans to credible homeowners - they could form a de facto company with unqualified borrowers to bet on house prices rising. The prepayment penalty was the bank’s equity in this endeavor. Or another way to say it, is that the bank found a way to hire a person to sit in a house they wanted to gamble on; through a subprime loan with a prepayment penalty. More to follow.

Comments

[nukldrager:]

Do buyers of low cost homes have any rights in the loanstar state?

Apr 21 08:35 AM

[Poor Jim:]

One more conservative Texas feature: A bank, by law, cannot loan a homeowner (and I mean a person who has paid for the house in full) more than 50% of its current appraised value.

Apr 21 08:42 AM

[User 306457:]

Texas law also limits refi-s to 80%, thereby preventing borrowers from converting their homes into ATM machines. In CA, 100% plus refi's were rampant and lenders had many customers who religiously refi-ed every year just to cash out.

TX does have a mortgage fraud problem and is usually in the top 10 days for fraud.

Apr 21 09:16 AM

[saifl:]

That is an awesome post...goes to show what happens with a little responsibility...
Thanks,

Apr 21 09:55 AM

[hanumanhojo:]

There are a few other factors causing Texas's better performance:
1. Texas has no state income tax. Instead, it funds its government through property taxes. The high property taxes in Texas results in a large financial drag on home price appreciation...afterall, it is real money that must be paid every year.
2. Many parts of Texas has no zoning (see Houston). So supply can match demand more easily again capping home price appreciation. Texas having lots of land helps too.
3. Texas was ground zero for the S&L crisis. Thus memory of the last regional housing depression is still on the minds of many Texans making us suspicious of housing.

That being said, I have walked many of the newer neighborhoods and from my observation, the housing bubble still did hit us. The NINJA loans were still handed out like candy to many unqualified borrowers so we got pain ahead of us. However, the factors you listed plus the ones I listed has resulted in froth but not a bubble here.

Apr 21 10:47 AM

[Rhett:]

Texas does not suffer fraudsters or phonies lightly. You gotta love Texas! It is different - in a positive way.

Apr 21 10:52 AM

[Allan Frain:]

It was not always like this.

I passed on the San Antonio, TX housing market (and by proxy a job) in 1978 due to pre-payment panalties.

Texas learned the housing-bubble lesson in the 1980's--TWICE.

It is difficult to imagine that the US will have a likewise appropriate reaction in the aftermath of the national housing bubble/crash. Real Estate and Banking interests simply weigh too heavily on Washington.

Bravo, Austin, TX !

Apr 21 11:16 AM

[Tricky:]

Some very good comments to an interesting article -- interesting to me anyway, as a Texan homeowner.

Texas was way behind most of the country for even allowing Home Equity Loans in the first place. I don't know all the details, but generally know they put several controls in place. I might be wrong, but I think you may not even be allowed to do revolving credit on home equity, all have to be installment loans?

Gotta hand it to TX, they had more of an eye on protecting the borrower than most.

Apr 21 11:57 AM

[Keith Goode:]

As someone who's currently considering buying a home here in Austin, TX, I can see firsthand that the house prices haven't been dramatically affected by the nationwide crisis. Thanks for the article. It explains a lot.

Apr 21 12:34 PM

[xmaitlandx:]

You indeed have come to a 'SIMPLE three word conclusion'.
Whether or not this is a valid conclusion would require a little more information...
-What constitutes a 'high cost mortgage? (Did you know for example that a mortgage in Texas is not high cost if it is greater than 1/2 the conforming loan limit?)
-What percentage of mortgages are high cost in Texas?
-What percentage of loans have prepayment penalties?
-Are there other states that also have prohibitions on prepayment penalties? Have these states also outperformed similar states?

There are so many other variables to consider. Your piece comes off as lazy. Was there a dead-line you needed to meet?

Apr 21 12:52 PM

[Jimmy K:]

I like the beach... anything considered waterfront.

Apr 21 02:14 PM

[Jolly_Rancher:]

One additional point, Oil is still a very big part of the Texas economy, so oil in 2088 at $147 and oil in 2009 at $50 is feeding fuel to the Texas economy, limiting home price depreciation.

Apr 21 02:16 PM

[Socialism c...:]

Why the use of the term "Teabaggers", when it is known to be a sexually explicit reference and is quite insulting to the patriotic Americans who showed up at these events??? SHAME ON YOU for defiling an otherwise fine piece of writing.

Apr 21 02:28 PM

[dw57:]

no. nor do the others either. what do you think we have a pro consumer state??


On Apr 21 08:35 AM nukldrager wrote:

> Do buyers of low cost homes have any rights in the loanstar state?

Apr 21 03:49 PM

[dw57:]

Boy did it hit us! It just wasn't as strong here as else where. can't forget that we didn't have the job growth that the states in trouble had. or the growth in incomes either


On Apr 21 10:47 AM hanumanhojo wrote:

> There are a few other factors causing Texas's better performance:
>
> 1. Texas has no state income tax. Instead, it funds its government
> through property taxes. The high property taxes in Texas results
> in a large financial drag on home price appreciation...afterall,
> it is real money that must be paid every year.
> 2. Many parts of Texas has no zoning (see Houston). So supply can
> match demand more easily again capping home price appreciation.
> Texas having lots of land helps too.
> 3. Texas was ground zero for the S&L crisis. Thus memory of
> the last regional housing depression is still on the minds of many
> Texans making us suspicious of housing.
>
> That being said, I have walked many of the newer neighborhoods and
> from my observation, the housing bubble still did hit us. The NINJA
> loans were still handed out like candy to many unqualified borrowers
> so we got pain ahead of us. However, the factors you listed plus
> the ones I listed has resulted in froth but not a bubble here.

Apr 21 03:50 PM

[dw57:]

depends. if your in business, no problem. but if you are not, you have a big problem


On Apr 21 10:52 AM Rhett wrote:

> Texas does not suffer fraudsters or phonies lightly. You gotta love
> Texas! It is different - in a positive way.

Apr 21 03:51 PM

[Lin:]

Rorty,
Good comment. I personally was a victim of a " negative amortsation " loan . i was not aware of this until I sold the Texas home in 1986 minus a huge peice of my equity which went to the mortgage firm . I was NEVER appraised of this ! . Texas real estate taxes are WAY, WAY too high . The entire burden of financing the state gets stuck on the backs of homeowners I have recently read where quite a few folks are re locating to area that have a state income tax , with greatly more reasonable property tax .Folks in apartments Need to fund the state too . They use the roads, services + their kids certainly use the schools . Texas is also VERY dry ! . No rain , no trees , no pastures , A pretty desert -like place to live . Very high property taxes + very High property insurance rates make it a ' place to avoid ' for me .

Apr 21 06:27 PM

[Gary A:]

Of course the big banks looted the middle class. What is the author talking about? Basel 2 guaranteed the looting of the middle class by creating off balance sheet shadow banking that was lapped up by Bush and the congress. To the author, where have you been?

Apr 21 06:32 PM

[texaslandowner:]

Good.


On Apr 21 06:27 PM Lin wrote:

> Rorty,
> Good comment. I personally was a victim of a " negative amortsation
> " loan . i was not aware of this until I sold the Texas home in 1986
> minus a huge peice of my equity which went to the mortgage firm .
> I was NEVER appraised of this ! . Texas real estate taxes are WAY,
> WAY too high . The entire burden of financing the state gets stuck
> on the backs of homeowners I have recently read where quite a few
> folks are re locating to area that have a state income tax , with
> greatly more reasonable property tax .Folks in apartments Need to
> fund the state too . They use the roads, services + their kids certainly
> use the schools . Texas is also VERY dry ! . No rain , no trees ,
> no pastures , A pretty desert -like place to live . Very high property
> taxes + very High property insurance rates make it a ' place to avoid
> ' for me .

Apr 21 07:44 PM

[griff allday:]

Keith, I find your information gathering methods dubious at best. Those that wish to believe often do. Cited just this week in the Austin Chronicle 5/1/2009 :

Where Did Austin's Affordable Housing Go?
www.austinchronicle.co...

You may *think* that housing isn't overvalued in Austin - because zillow.com often does not include historical housing price charts due to the fact that Texas is one of the states where the sales price data is not public information.

On Apr 21 12:34 PM Keith Goode wrote:

> As someone who's currently considering buying a home here in Austin,
> TX, I can see firsthand that the house prices haven't been dramatically
> affected by the nationwide crisis. Thanks for the article. It explains
> a lot.

May 03 02:37 PM