Wednesday, June 22, 2005
Home Sweet Home
Mortgage financing is a wonderful thing. The idea is simplicity itself: you take out a loan from a mortgage lender, and use it to buy a house. The house serves as collateral for the loan; this reduces the risk that the lender will be left high and dry if you default, and as a result, he or she (or it) can offer you a dramatically lower rate of interest on your debt.
On the other side of the transaction, the mortgage lender packages several home loans into a single mortgage-backed security or MBS, which can then be sold to an institutional investor (such as a pension fund or university endowment). This MBS offers a rate of return above that of T-bonds, since in theory it's more risky than government debt. In practice, however, the magic of diversification (across many different home-owners and prepayment tranches) means that the MBS investor is shielded from the worst effects of default risk.
So everyone's happy -- the home-owner has borrowed money at a lower rate than would otherwise be possible, the institutional investor has lent money at a higher (risk-adjusted) rate than would otherwise be possible, and the mortgage lender has made a few bucks through securitization fees. If this seems like getting something for nothing, well, that's precisely what it is: when borrowers and lenders are matched efficiently, the system as a whole reaps enormous benefits. And there's no denying that the growth of the mortgage market has been in large part responsible for the dramatic increase in home ownership rates in the US over the last 50 years or so.
Now consider the situation in India. The availability of housing finance has certainly increased in recent years, but it's still not as universal as it is in the US. As a result, the vast majority of wage-earners between the ages of 25 and 40, people with good jobs and steady incomes, who would like nothing better than to own a place of their own, are stuck renting; they have to wait till they've saved a major chunk of the price of the house before they can even consider buying. And on the other side of the ledger, lots of people in their 50s and 60s keep the lion's share of their savings in fixed deposits, in jewellery, even in cash; they would (or should) leap at the chance to earn some extra returns without taking undue risk.
This is an enormous opportunity, just waiting to be seized. Complaints about India's physical infrastructure -- poor roads, unreliable power, dodgy water -- are nothing new, but it seems to me that there are equally big gaps in her financial infrastructure. (Not to mention her legal infrastructure, under which I include clear title to land, efficient dispute resolution, better protection for consumers, less onerous regulations for small businesses, and so on. But as usual, I digress.). Financial intermediation could be the next big thing; the simple mechanism of freeing up dead capital and giving it to those who most need it could, if done right, release a huge amount of prosperity. All you entrepreneurs out there, what are you waiting for?
Further reading: Hernando de Soto's "The Mystery of Capital" is an excellent and thought-provoking study of the immense benefits of having a sound financial infrastructure, especially with respect to property ownership.
Caveat: Mortgage financing is a wonderful thing, but it can also be taken too far. Consider the current state of the housing market in the US. Low long-term interest rates have precipitated a speculative boom in real estate; the availability of cheap financing has prompted significant numbers of people to buy houses they can't really afford, in the expectation that "prices can only go up". Home equity loans and mortgage refis have also helped the US consumer spend ever-increasing sums of money in recent years. How long can it last?
On the other side of the transaction, the mortgage lender packages several home loans into a single mortgage-backed security or MBS, which can then be sold to an institutional investor (such as a pension fund or university endowment). This MBS offers a rate of return above that of T-bonds, since in theory it's more risky than government debt. In practice, however, the magic of diversification (across many different home-owners and prepayment tranches) means that the MBS investor is shielded from the worst effects of default risk.
So everyone's happy -- the home-owner has borrowed money at a lower rate than would otherwise be possible, the institutional investor has lent money at a higher (risk-adjusted) rate than would otherwise be possible, and the mortgage lender has made a few bucks through securitization fees. If this seems like getting something for nothing, well, that's precisely what it is: when borrowers and lenders are matched efficiently, the system as a whole reaps enormous benefits. And there's no denying that the growth of the mortgage market has been in large part responsible for the dramatic increase in home ownership rates in the US over the last 50 years or so.
Now consider the situation in India. The availability of housing finance has certainly increased in recent years, but it's still not as universal as it is in the US. As a result, the vast majority of wage-earners between the ages of 25 and 40, people with good jobs and steady incomes, who would like nothing better than to own a place of their own, are stuck renting; they have to wait till they've saved a major chunk of the price of the house before they can even consider buying. And on the other side of the ledger, lots of people in their 50s and 60s keep the lion's share of their savings in fixed deposits, in jewellery, even in cash; they would (or should) leap at the chance to earn some extra returns without taking undue risk.
This is an enormous opportunity, just waiting to be seized. Complaints about India's physical infrastructure -- poor roads, unreliable power, dodgy water -- are nothing new, but it seems to me that there are equally big gaps in her financial infrastructure. (Not to mention her legal infrastructure, under which I include clear title to land, efficient dispute resolution, better protection for consumers, less onerous regulations for small businesses, and so on. But as usual, I digress.). Financial intermediation could be the next big thing; the simple mechanism of freeing up dead capital and giving it to those who most need it could, if done right, release a huge amount of prosperity. All you entrepreneurs out there, what are you waiting for?
Further reading: Hernando de Soto's "The Mystery of Capital" is an excellent and thought-provoking study of the immense benefits of having a sound financial infrastructure, especially with respect to property ownership.
Caveat: Mortgage financing is a wonderful thing, but it can also be taken too far. Consider the current state of the housing market in the US. Low long-term interest rates have precipitated a speculative boom in real estate; the availability of cheap financing has prompted significant numbers of people to buy houses they can't really afford, in the expectation that "prices can only go up". Home equity loans and mortgage refis have also helped the US consumer spend ever-increasing sums of money in recent years. How long can it last?
