The determinants of capitalization rates: evidence from the US real estate markets

PurposeEstablishing the strength of a novel variable–mortgage debt as a fraction of US gross domestic product (GDP)–on forecasting capitalization rates in both the US office and multifamily sectors.Design/methodology/approachThe authors specifies a vector error correction model (VECM) to the data. VECM are used to address the nonstationarity issues of financial variables while maintaining the information embedded in the levels of the data, as opposed to their differences. The cap rate series used are from Green Street Advisors and represent transaction cap rates which avoids the problem of artificial smoothness found in appraisal-based cap rates.FindingsUsing a VECM specified with the novel variable, unemployment and past cap rates contains enough information to produce more robust forecasts than the traditional variables (return expectations and risk premiums). The method is robust both in and out of sample.Practical implicationsThis has direct implications for governmental policy, offering a path to real estate price stability and growth through mortgage access–functions largely influenced by the Fed and the quasi-federal agencies Fannie Mae and Freddie Mac. It also offers a timely alternative to interest rate-based forecasting models, which are likely to be less useful as interest rates are to be held low for the foreseeable future.Originality/valueThis study offers a new and highly explanatory variable to the literature while being among the only to model either (1) transactional cap rates (versus appraisal) (2) out-of-sample data (versus in-sample) (3) without the use of the traditional variables thought to be integral to cap rate modelling (return expectations and risk premiums).

Bailouts Without End

The Fed’s rescue of Bear Stearns and the Treasury Department’s nationalization of Fannie Mae and Freddie Mac in 2008 provoked widespread criticism. Consequently, the Fed and Treasury were very reluctant to approve further bailouts, and they allowed Lehman Brothers to fail in September 2008. Lehman’s collapse triggered a global panic and a meltdown of financial markets around the world. The Fed and Treasury quickly arranged a bailout of AIG, and Congress approved a $700 billion financial rescue bill. Treasury established the Troubled Asset Relief Program, which injected capital into large universal banks, while the Fed provided trillions of dollars of emergency loans and the FDIC established new guarantee programs for bank debts and deposits. In February 2009, federal regulators pledged to provide any further capital that the nineteen largest U.S. banks needed to survive, thereby cementing the “too big to fail” status of U.S. megabanks. The U.K. and other European nations arranged similar bailouts for their universal banks. Meanwhile, thousands of small banks and small businesses failed, millions of people lost their jobs, and millions of families lost their homes during the Great Recession.

Bank size as a source of competitive advantage of Chinese global systemically important banks

During the financial crisis in 2007–2009 banks all around the world suffered liquidity problems and were a subject to a system stability testing. The problems of large financial institutions, such as Bear Sterns, Fannie Mae or Freddie Mac, drew attention to the issue of financial liquidity more than ever in 2007. After the collapse of Lehman Brothers a question was raised about the stability and system security of the largest institutions in the financial system. Credit institutions recognised as systemically important, are distinguished by the enormous size of assets, which creates the risk of being too big to fail or too important to fail. The extent of links with other institutions on the market through various market segments makes them also too connected to fail.

A Return to Securitization

This chapter discusses the distributional politics of mortgage markets and securitization in the postwar era and explains their transformation in the 1960s as the Federal National Mortgage Association (FNMA/Fannie Mae) was “spun off” from the government and authorized to finance itself by issuing a new kind of government-guaranteed mortgage-backed security. In the second half of the decade, a series of crises marked the end of one era and the beginning of a long transition into a new one marked by scarcity, neoliberalism, and financialization. The end of postwar affluence created a distributional struggle over which social groups would pay for what, and that process played out through the highly contentious and veto-ridden world of budget politics. Housing credit was doubly implicated in these fights, first because it was hit hard and early in market corrections, and second because its credit programs could be used for off-budget accounting. For all that the new approach to securitization reflected a changing relationship between the state and the market, the modern mortgage-backed security continued to reflect the institutional logic of the credit programs: the use of state-promoted financial development and risk redistribution as an alternative to more direct forms of wealth redistribution.

Book Reviews

Sumit Agarwal of National University of Singapore reviews “Last Resort: The Financial Crisis and the Future of Bailouts,” by Eric A. Posner. The Econlit abstract of this book begins: “Argues that, in responding to the financial crisis that began in 2007, the US government violated the law and was able to gain control over AIG, the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac) early in the critical stage of the crisis—but it did so in the public interest.”

Republican Home-Owning

Ten years after failing and being rescued by our federal government, our nation’s principal secondary market makers in home mortgage loans – Fannie Mae and Freddie Mac – remain in federal receivership. The proximate reason for this is that neither Republicans nor Democrats in Congress have been able to find consensus – interparty or intraparty consensus – on what should be done with our home mortgage GSEs post-crisis. The deeper reason is that public – that is to say, citizen – ownership of secondary market makers in home loans is in a certain sense ‘natural’ in any republic, such as our own, where both middle class standing and that standing’s primary indicator – home-owning – are deeply ingrained in the citizenry’s self-ascribed national identity. This truth is yet more compelling when home prices, as they are bound to do anywhere homes are the primary middle class asset, become what I call 'systemically significant' - that is, when they become pervasive determinants both of other prices and of broader macroeconomic wellbeing. I conclude that the only sustainable future for Fannie and Freddie, not to say for the American middle class and our other GSEs (including our student loan GSEs), is to be found in their past. Fannie and Freddie should be forthrightly made citizen-owned once again as Fannie was through our home markets’ healthiest decades.

What, If Anything, Should Replace the QM GSE Patch?

In 2017, approximately 400,000 high debt-to-income mortgages met the definition of the Bureau of Consumer Finance Protection’s Qualified Mortgage rule thanks to an exemption that grants QM status to high-DTI loans guaranteed by Fannie Mae or Freddie Mac. This exemption, referred to as the “GSE patch” is set to expire on January 10, 2021, or when the GSEs exit conservatorship, whichever comes first. This sets up an urgent need to determine what, if anything should replace the patch. This article offers three options to that end: 1) preserve the patch; 2) make QM determination based on overall riskiness, as measured by spread to a mortgage lending benchmark rate; or 3) drop the patch. The authors examine each option and recommend Option 2 because it strikes a healthier balance between expanding access to credit and limiting defaults to reasonable levels. Option 2 would eliminate both the DTI cap and the GSE patch while placing the private sector on a more equal footing with the GSEs.