Get Ready for Another Crash of the Economy

Edward J. Dodson

[A response to a lecture by Edward L. Glaeser, Director of the Alfred Taubman Center for State and Local Government and the Rappaport Institute, April 2013 at the Harvard Kennedy School; available on Youtube]

From 1984 to 2005 I worked at Fannie Mae in several different capacities. First, managing a group of review underwriters that did our best to ensure mortgage loan originators were complying with our eligibility requirements and standards. Then, I moved into the Housing & Community Development group as a business manager with responsibilities for market analysis. What the market research confirmed was that land markets were driving property and housing markets. And, what was driving land markets was a combination of factors the most important of which was the concentrated, long-term ownership of land that was consistently under-assessed and subjected to a very very low effective rate of taxation. Thus, as we went through the property market cycles there was in the metropolitan residential markets very little financial pressure on land owners to bring land to the market. And, in fact, the incentive was to do just the opposite.

At Fannie (and Freddie) decisions were made that essentially added fuel to the speculative nature of land markets. Annual loan limits were increased to the point where the GSEs eventually moved heavily into what had once been the "jumbo" market preserved for banks and other institutional investors. As property prices climbed, we kept lowering the minimum down payment requirements, adopted greater flexibility in income and credit standards and partnered with local agencies and foundations willing to provide forgivable second mortgage loans and other forms of assistance.

These measures were needed to maintain transaction volumes, needed to satisfy Wall Street analysts' expectations of double digit earnings growth. The financial strength of households across the U.S. was eroding, as household incomes became more and more concentrated at the top, as household debt skyrocketed and savings disappeared.

Wall Street firms took the market into the high risk area of private label mortgage-backed securities collateralized by minimally and/or fraudulently underwritten sub-prime mortgages. Investors told that these loans had a AAA rating by the bond rating agencies jumped at the higher yields without knowing the default risk was going to be 50 percent or higher in some instances.

Some of us in the trenches saw the crash coming years in advance. Few, if any, decision-makers in our organizations or policymakers in government were interested the message. And, sadly, not even the 2007 crash has resulted in the one measure that can mitigate the coming downturn, which was (is) to prohibit any financial institution that accepts government-insured deposits from extending credit for the purchase of land or acceptance of land as collateral for any borrowing. Requiring the "traditional" 20 percent down payment would be a close second, which would mean that purchases of real estate would be paying cash for the land and financing the cost of the actual house or building. However, these measures are only band-aids on the basic problem.

The only systemic solution is for the public collection of the annual rental value of land, while exempting property improvements from the tax base.