Bailing-out banks won’t fix the US economy. We need to stabilise home prices and standardise the way we value property.
Have we analysed the roots of the current economic crisis or started at the middle? Is it really just the unregulated financial markets and over-liquidity, or have these factors compounded an already broken system? How can we say our securities are “secure” when they are valued incorrectly, are now priced negatively and the bottoming-out point is unknown?
America got into the crisis initially because real estate – and thus the mortgages on it – was valued incorrectly. No one knows the true worth of property in the US. In fact, there is often uncertainty about the actual physical boundaries, as well as other characteristics, of many properties – hence the entire antiquated industry of title insurance.
Think about when you buy a new or used car: no lender requires title insurance. Why not? Because there’s no doubt about the car’s provenance and ownership. US homeowners, though, are required to purchase this insurance to indemnify themselves against loss if the title is defective. Every time a house changes hands, there again are the surveyors out to check the property lines for the umpteenth time so title insurance can be written.
How, then, did today’s crisis unfold? Incorrectly valued mortgages became speculative financial instruments for trading, which makes it possible to drive prices up or down seemingly without limit. And, as they traded downwards, they of course took the price of real estate down with them. Meanwhile, lending banks went over, the precipice of insolvency because the liquidity on which they depend dried up, all because their asset-backed securities have little or no value or even negative value.
Remember, a mortgage is called a “security” because it is secured with a tangible asset. But if its value isn’t real, it can’t really be secure. That’s the starting point for a toxic mix. Throw in excess liquidity (from 2000 to 2006) and housing demand, misvaluations and subprime mortgages to an already overstretched housing and real estate market, and it begins to be deadly unstabilising. Price becomes dependent on speculation, rather than on the actual value of the home and land.
Giving money to the banks is not going to fix this problem. Home values will still be driven by speculation. What we need are deep regulatory changes to the current system that can help establish a secure and true market value of land and real estate and will help stabilise prices for today and the future. That can happen only when the rights on property are recorded in a standardised, transparent and trustworthy manner. Anything short of this is an invitation for more speculation.
The antiquated US system is ridiculously wasteful and does little to provide the full protection of property rights, and title insurance is a poor substitute for the property rights system American property owners need and deserve. The title insurance process is, of course a moneymaking proposition, but that doesn’t change the fact that it is a major culprit in the incorrect valuation of real estate that has brought America and the world to the current crisis. It also slows the transfer of deeds, adds to the expense and thus makes the property market less liquid.
It’s no accident that the root of the crisis is in America. Other countries with sophisticated economies have reliable property rights systems that establish correct mortgage valuation. For example, there is rarely a question about the value of the underlying assets in Canada and Australia, two other countries where mortgages are traded as financial instruments. And the rest of the world hardly knows title insurance. In most countries, public registries keep records of property transfers over time and whether there have been other parties with interest (eg, laying claim to ownership) in a transparent and standardised manner. These registries have the final word, and if they make a genuine error there is a system of remediation.
One key to how things work beyond the US is the public nature of information about property. At the registry, part of that public information includes characteristics of real estate (legal, financial, boundaries, etc) that makes transparent the establishment of a price – that is, the property’s value. There is very little room for speculators to drive the valuation process into the toilet.
As the US government shells out additional hundreds of billions in bank bail-out money, and whatever other hundreds of billions are to come, it needs to make sure some of it is spent on providing citizen property owners and markets with real security over their property – their full money’s worth. It’s time to stop America’s wasteful and risky process. The first step: use some of the bail-out money to establish a regulatory infrastructure for real estate valuation in the form of a nationwide property registry system where titles are well established and transparent to everyone.
If your sinks started to overflow and your pipes were bursting, you’d call a plumber. What if he showed up with towels, threw them on the floor to sop up the water and handed you a bill for $700bn? You’d be flabbergasted.
America needs to fix the plumbing, not just throw towels on the floor. That will take replacing some of the old pipes, like the non-transparent property rights registration process, with ones that will protect property rights at much lower costs today. The US government owes this to its citizens and to the rest of the world who are suffering downstream from the American crisis. Surely it makes sense to invest some of that bailout money to address one of the root problems that has brought all of us to the brink?
It’s time for a structural reform of the system that secures rights on property and real estate – even in the least-secure neighbourhoods – and hence leads to correct valuation. Now is a great opportunity for the new president to make the “ownership society” into something more than a hollow phrase.