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UBC Theses and Dissertations

Financing the market for existing housing : an alternate source of funds Eger, Albert Frederic 1976

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c . \ FINANCING THE MARKET FOR EXISTING HOUSING: AN ALTERNATIVE SOURCE OF FUNDS by ALBERT FREDERIC EGER B . S . F . Un ive rs i t y o f B r i t i s h Columbia 1964 M.B.A. Oregon State Un ivers i ty 1969 A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY in the Facul ty o f . Commerce and Business Adminis t ra t ion We accept th is thes is as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA September, 1976 Albert Frederic Eger, 1976 In present ing th is thes is in p a r t i a l fu l f i lment of the requirements for an advanced degree at the Un ivers i ty of B r i t i s h Columbia, I agree that the L ibrary sha l l make it f ree ly ava i lab le for reference and study. I fur ther agree that permission for extensive copying of th is thes is for scho la r ly purposes may be granted by the Head of my Department or by his representat ives . It is understood that copying or pub l ica t ion of th is thes is fo r f inanc ia l gain sha l l not be allowed without my wri t ten permission. Department of Commerce & Business Administration The Univers i ty of B r i t i s h Columbia 2075 Wesbrook Place Vancouver, Canada V6T 1W5 Date February 3, 1977 to the s p i r i t of running free and mother and dad. Chairman: Professor Stanley W. Hamilton 1 Abst rac t Guttentag demonstrated that the demand fo r mortgages was negat ive ly re la ted to the demand fo r bonds. He reasoned that during periods of i n -creas ing i n t e r e s t r a t e s , that mortgages are rat ioned from the cap i ta l markets more rap id ly thaiii bonds because of short run i n e l a s t i c i t y of business firms and because of the h igh ly e l a s t i c demand of mortgagors. This behaviour of the mortgage market was i d e n t i f i e d as a c o u n t e r c y c l i c a l hypothes is . Because of the lack o f a v a i l a b l e da ta , Guttentag assumed that the mortgage market f o r e x i s t i n g housing reacted in a manner s i m i l a r to the i n s t i t u t i o n a l mortgage market. The c o u n t e r c y c l i c a l hypothesis would suggest that during periods o f ra t ion ing in the c a p i t a l markets, that the p r ice of housing would f a l l in response to lack o f demand. The evidence by Hamilton ind ica tes that the p r ice of housing continued to r i s e in periods of inc reas ing i n t e r e s t r a t e s . This c o n f l i c t of theory and observat ion suggests that the study of housing p r i c e behaviour in r e l a t i o n to the mortgage market f o r e x i s t i n g housing is one worthy of examination. In order to e s t a b l i s h a framework fo r ana lys is o f the e x i s t i n g housing market, a c l a s s i f i c a t i o n system r e l a t i n g sources o f f inanc ing to types of housing market is dev ised . Research to date has centered on the new housing market and the lenders who f inance the mortgages to support that housing market. S p e c i f i -ca t ion of the mortgage market as a consequence has dea l t with two s e c t i o n s , the i n s t i t u t i o n a l lenders and government agencies . Complete s p e c i f i c a t i o n of the mortgage market must inc lude the n o n - i n s t i t u t i o n a l (pr ivate) l enders . A d e s c r i p t i v e ana lys is o f the e x i s t i n g housing market by c l a s s i f i c a t i o n type , not only gives dimension to a market prev ious ly uncharted, but the impact of c y c l i c a l , seasonal and s u b s t i t u t i o n a l e f f e c t s are contrasted by type during periods of changing i n t e r e s t rates and var iances in vacancy r a t e s . A der ived demand and supply model i s developed to determine the e f f e c t o f s u b s t i t u t i o n i i by the components of the mortgage market fo r e x i s t i n g housing on the pr ice of housing. Proper s p e c i f i c a t i o n of the c r e d i t r a t i o n i n g var iab le i s c r u c i a l to the t e s t i n g of the model because of the problem of measuring changes in i n t e r e s t rates in the mortgage market. A spec ia l chapter is devoted to exp la in ing the impact that the s u b s t i t u t i o n of mortgages funds has on the measurement of the mortgage r a t e . Several conclusions are noted. F i r s t , a c l a s s i f i c a t i o n system which s p e c i f i e s the to ta l mortgage market in terms of new and e x i s t i n g housing as well as source and purpose o f f inanc ing has been e s t a b l i s h e d . This c l a s s i f i -cat ion system completes the s p e c i f i c a t i o n of the mortgage and housing markets. Future research can be undertaken from t h i s b a s i s . Second, two segments of the mortgage market fo r e x i s t i n g housing prove to be s i g n i f i c a n t . In t o t a l , the pr iva te vendor f inance and assigned mortgage sectors account fo r more than f i f t y percent of the to ta l mortgage funds fo r f inanc ing new and e x i s t i n g housing. The above markets provide an important source of funds h i ther to unexplored. The lack of exp lora t ion has been due to the f a c t that data on the above type of mortgage must come from a labor in tens ive t i t l e search of i n d i v i d u a l r e s i d e n t i a l proper t ies over a per iod of t ime. T h i r d , dur ing 'per iods of i n c r e a s i n g i n t e r e s t r a t e s , the pr iva te vendor f inanc ing and assigned mortgage sectors of the mortgage market increase absolute ly and r e l a t i v e l y . Consequently these markets s t a b i l i z e the pr ice of housing by prov id ing subst i tu te f inanc ing when mortgages suppl ied by conventional lenders are rat ioned from the mortgage market. This conclus ion i s v a l i d when excess demand condi t ions e x i s t in the housing market. A s i m i l a r conclusion can be i n f e r r e d in the excess housing supply per iod from d e s c r i p t i v e ev idence , although s t a t i s t i c a l v a l i d a t i o n i s not p o s s i b l e . Review of the d e s c r i p t i v e ev idence , ind ica tes that the s u b s t i t u t i o n of the agreement-f o r - s e c t o r occurred t when i n s t i t u t i o n a l funds were s h i f t e d to the ref inance i i i market during the excess supply p e r i o d . Inasmuch as the agreement-for-sa le sec tor remained as the major source of funds, i t can be i n f e r r e d that th is market s t a b i l i z e d housing pr ices during the excess supply per iod in s p i t e of the fac t that i n t e r e s t rates dec l ined during the l a t t e r part of the study p e r i o d . Greater v o l a t i l i t y c o u l d have been expected in housing pr ices in 1961 and 1962 i f the agreement- for -sale sec tor had been absent. F i n a l l y , the s u b s t i t u t i o n of mortgage f inanc ing during, periods of i n -creas ing i n t e r e s t rates could account fo r the reduced amplitude of observed mortgage r a t e s . The narrow amplitude of mortgage rates should not be con-s idered as a s ign of i n e f f i c i e n t mortgage markets. During periods of excess housing demand, the use of the c r e d i t r a t ion ing var iab le r m - r^ proves to be a s t a t i s t i c a l l y s i g n i f i c a n t measure o f r a t i o n i n g in the mortgage markets. In a per iod of excess housing supp ly , th is measure is not adequate. The measure f a i l s to account f o r i n f r a - i n s t i t u t i o n a l s h i f t s in funds in the mortgage market. R.A. Restrepo i v TABLE OF CONTENTS Page CHAPTER I. INTRODUCTION. . . . . 1 1.1 Statement of the Problem . . . . . . 2 1.2 Purpose of Study 3 1.3 Overview 4 II. BACKGROUND LITERATURE SURVEY 7 2 1 2.1 Summary of L i t e r a t u r e Review 8 2.2 Housing and Mortgage S p e c i f i c a t i o n : A National View 9 2.2.1 Counte rcyc l i ca l Hypothesis and Demand Condit ions . . . . 9 2.2.2 Counte rcyc l i ca l Hypothesis and Supply Condi t ions 13 2.3 Regional Housing and Mortgage Market S p e c i f i c a t i o n 17 2.3.1 Mortgage Market Structure 17-2.3.2 Regional Risk Factors . . . 18 III. CLASSIFICATION OF TOTAL MORTGAGE MARKET 23 3.1 C l a s s i f i c a t i o n System of Mortgage Sub-Markets 24 3.2 D e f i n i t i o n s of the Mortgage Market 25 3.2.1 D e f i n i t i o n of Pr iva te Vendor Financing 26 3.2.2 D e f i n i t i o n of Assigned Mortgage Financing 27 IV. HISTORIC PROFILE OF EXTENDED MORTGAGE MARKET ON EXISTING HOUSING IN GREATER VANCOUVER REGIONAL DISTRICT (1954-1963) 30 4.1 Summary . . . . . . 31 4.2 Introduct ion 31 4.2.1 The Data Bases and Period of Study 31 4 .2 .2 Regional Comparison . . . . • 32 4.3 Tota l Extended Mortgage Market . . . 34 4.3.1 C y c l i c a l Nature of the Mortgage Market 37 4.4 Extended Mortgage Market f o r E x i s t i n g Housing 38 4.5 Pr iva te Vendor Financing . . . . . . . . . . . . . . 42 4.5.1 C y c l i c a l Nature . . . . 42 4.5.2 Secular V a r i a t i o n 42 4.5.3 Seasonal Va r i a t ion . . . . . . . . . . . . 44 4 .5 .4 Vacancy in Housing Market 45 4 .5 .5 Re la t ionship to Conventional Lenders 45 4.6 Assigned Mortgage Financing 51 4.6.1 Gyelvirca<I Nature . 51 4.6.2 Secular V a r i a t i o n 53 4.6.3 Seasonal Va r i a t ion 55 4 .6 .4 Conventional Lender Re la t ionship 55 4.7 Conventional Lender Financing 59 V Page CHAPTER V. STABILIZING EFFECT OF PRIVATE VENDOR FINANCING AND ASSIGNED MORTGAGES ON HOUSING PRICES: THE MODEL AND METHODOLOGY 5.1 Introduct ion 68 5.2 Sources of Funds 68 5.2.1 Pr iva te Vendor Financing 68 5.2.2 Assigned Mortgage 70 5.3 Model . , . 71 5.4 Expected Demand Re la t ionsh ips 72 5.4.1 Cred i t Rat ioning 73 5.4.2 Income E f f e c t 77 5.4.3 Rental Market Subs t i tu t ion 78 5.4.4a A l t e r n a t i v e Investment 79 5.5 Expected Supply Re la t ionships 80 5.5.1 Vacancy Rate 80 5.6 Complete Model and Methodology 81 5.6.1 Complete Model 81 5.6.2 Est imat ing Technique 81 5.6.3 Methodology 82 VI. STABILIZING EFFECT OF PRIVATE VENDOR FINANCING AND ASSIGNED MORTGAGES OM HOUSING PRICES: EMPIRICAL RESULTS 6.1 Summary 89 6.2 Introduct ion 90 6.3 Empir ical Resu l ts : Excess Demand in the Housing Market . . . 93 6.3.1 Pr ice Rat ioning Var iab le 93 6.3.2 Rental Market Subs t i tu t ion 95 6.3.3 Income Var iab le 97, 6.3.4 Subst i tu te Investment 98 6.4 Empir ical R e s u l t s : Excess Supply in the Housing Market . . . 100 6.4.1 Mortgage Demand Equations 100 6.4.1.1 Vacancy Rate Var iab le 100 6 .4 .1 .2 I n s t i t u t i o n Ref inancing of Mortgages 104 6.4.2 Mortgage Supply Equations 107 6.4.2.1 A l te rna te Measures and Aggregation 109 6.5 S i g n i f i c a n c e to Hypothesis 109 6.5.1 C r e d i t Rat ioning Var iab le I l l VI I . IMPACT OF PRIVATE VENDOR FINANCING AND ASSIGNMENT OF MORTGAGES ON THE NARROW AMPLITUDE OF MORTGAGE RATES 114 7.1 Summary 115 7.2 Introduct ion 115 7.3 Background L i t e r a t u r e Survey on the Narrow Amplitude of Mortgage Rates 115 7.3.1 P r i c i n g Arguments 115 7.3.2 Commitment Procedure 117 7.3.3 I n s t i t u t i o n a l Factors 118 vi CHAPTER Page r 7.4 Mortgage Rate Amplitude Hypothesis 118 7.5 Test of the Hypothesis 120 7.5.1 Subs t i tu t ion E f f e c t 120 7.6 Impl icat ions f o r Further Research 121 VI I I . IMPLICATIONS FOR FURTHER STUDY 125 8.1 Further Studies and P o l i c y Impl icat ions 126 8.2 Comments on the Use of More Accurate Data 128 v i i LIST OF TABLES TABLE Page 3.1 C l a s s i f i c a t i o n System of Mortgages 25 4.1 Composite Table of Reg iona l , National Housing and Mortgage Market Var iab les 33 4.2 Gross Mortgage Flows by liender.and Transact ion im "the ' : . Greater Vancouver Regional D i s t r i c t (G .V .R .D . ) 36 4.3.1 C o u n t e r c y c l i c a l Components of the Extended Mortgage Market f o r E x i s t i n g Housing 39 4 .3 .2 Assigned Mortgages and Pr iva te Vendor Financing in the Extended Mortgage Market f o r E x i s t i n g Housing 40 4.4 Re la t i ve Ratios o f Sub-Markets wi th in the Extended Mortgage Market on E x i s t i n g Housing 41 4.5 Agreement - for -sa le on E x i s t i n g Housing Re la t ive to Conventional Loans on E x i s t i n g Housing 51 4.6 Assigned Mortgages and Pr iva te Vendor Financing in the Extended Mortgage Market fo r E x i s t i n g Housing 52 4.7 Countercyc l ica l Components of Extended Mortgage Market on E x i s t i n g Housing 60 6.1 D e f i n i t i o n of Dependant Var iab les in Demand and Supply Model 90 6.2 Demand Equations of C y c l i c a l Components in the Mortgage Market f o r E x i s t i n g Housing under Excess Demand Condit ions 92 6.3 E l a s t i c i t i e s of Demand fo r C y c l i c a l Components of Mortgage Market f o r E x i s t i n g Housing 94 6.4 Average Loan to Value Ratio and Average D o l l a r Loan in New and E x i s t i n g Mortgage Market 96 6.5 Demand Equations of C y c l i c a l Components of Mortgage Market f o r E x i s t i n g Housing during Excess Housing Supply 99 6.6 Selected Demand Equations of C y c l i c a l Components of Mortgage Market f o r E x i s t i n g Housing during Excess Housing Supply 102 6.7 Supply Equations of C y c l i c a l Components of Mortgage Market f o r E x i s t i n g Housing Under Excess Supply Condi t ions 108 7.1 Regression of D i f fe rence between Observed Mortgage Rate and Bond Rate ( r m - r^) and Bond Rate (r^) 119 v i i i TABLE Page 7.2 E l a s t i c i t i e s of Demand fo r C y c l i c a l Components of Mortgage Market f o r E x i s t i n g Housing 120 7.3 Average Mortgage Rates by Type of Mortgage 122 ix LIST OF FIGURES Page FIGURE 2.1 Counte rcyc l i ca l Nature of Mortgage Market . 10 2.2 A l l o c a t i o n of Funds between Mortgages and Bonds 11 4.1 GrcGvjoss Quarter ly Flows of Total Extended Mortgage Market 35 4.2 Gross Quarter ly Flows of Pr iva te Vendor Financing and Extended Mortgage Market , 43 4.3 Pr ice of Housing and Ratio of Unoccupied, but Completed Housing to Total Housing Stock 46 4.4 Percent of Pr iva te Vendor Financing to Conventional Lending on E x i s t i n g Housing as well as New and E x i s t i n g Housing 47 4.5 Percent of Pr ivate Vendor Financing Compared to New Conventional Mortgage on New or E x i s t i n g Housing 48 4.6 Percent of Pr ivate Vendor Financing Compared to Total New Mortgages on New or E x i s t i n g Housing • . . . . . . . . . . 49 4.7 Gross Quarter ly Flows of Assigned Mortgage Sector and Extended Mortgage Market on E x i s t i n g Housing 54 4.8 Percent of Total Assigned Mortgage Sector Re la t ive to Conventional Lending on E x i s t i n g Housing as well as New and E x i s t i n g Housing 56 4.9 Percent of Total Assigned Mortgages to New Conventional Lending on-New or E x i s t i n g Housing 57 4.10 Percent of Tota l Assigned Mortgages to Tota l New Mortgages on New or E x i s t i n g Housing , .58 4.11 Percent of New Conventional Mortgages Compared to Extended Mortgage Market in E x i s t i n g Housing Market 61 4.12 Percentoof Refinanced Mortgages Compared to Extended Mortgage Market in E x i s t i n g Housing Market 63 5.1.1 S i m p l i f i e d System of Flow of Funds . . . 69-5.1.2 Complete System of Flow of Funds 69 5.2 E f f e c t of an Increase in Interest Rates on Mortgage Lending 71 5.3 Marginal Return to Capi ta l Schedule , 75 5.4 •" Observed PPHeeaa-ridQQaanitJy i im PReriidds eof LExeess DDemarid f>arid Excess Supply 8 3 X FIGURE Page 6.1 Percent of Pr iva te Vendor Financing Compared to New Conventional Mortgage on New or E x i s t i n g Housing 106 Appendices Appendix I Data Source and Der ivat ion II C o r r e l a t i o n C o e f f i c i e n t s • ACKNOWLEDGEMENTS An idea is born. A d i s s e r t a t i o n is completed. Between these events l i e a long tangled path for which many persons deserve c r e d i t . I would l i k e to thank the chairman of my d i s s e r t a t i o n committee, Professor Stanley W. Hamilton fo r h is ins igh ts into the funct ion ing of the housing and mortgage markets. Without these bases, t h i s d i s s e r t a t i o n would not have been p o s s i b l e . Professor Micheal A. Goldberg provided generous encouragement as well as time f o r d i s -c u s s i o n . His a b i l i t y to synthesize concepts is g r a t e f u l l y acknowledged. Professor Robert W. White proved extremely helpful in making suggestions with respect to procedures and problem d e f i n i t i o n . His a b i l i t y to s i m p l i f y a problem on more than one o c c a s i o n , provided the necessary impetus to cont inue. Professors Craig H. Davis and Carl E. Sarndal provided a id during the prel iminary dra f t of the d i s s e r t a t i o n . The i r comments on the f i n a l d ra f t have improved the f i n a l copy. F inanc ia l support received from the B r i t i s h Columbia Real Estate Council as well as The Canada Council i s hereby acknowledged. This support i s a most necessary component of the d i s s e r t a t i o n . As a graduate student at the Un ive rs i t y of B r i t i s h Columbia, I was for tunate to meet Professors Micheal J . Brennan and Eduardo S. Schwartz. The former with his strong moral support and the l a t t e r with his f r i e n d s h i p borne during the period of graudate study w i l l long be remembered. F i n a l l y , the memory of Professor Fred G. Pennance w i l l stay a l i v e as I continue to t rave l the marketplace fo r hypotheses. 1 CHAPTER I INTRODUCTION 1.1 STATEMENT OF THE PROBLEM 1.2 PURPOSE OF THE STUDY 1.3 OVERVIEW 2 1 .1 STATEMENT OF THE PROBLEM Guttentag^ demonstrated that the demand for mortgages was negat ive ly re la ted to the demand fo r bonds. He reasoned that during periods o f inc reas ing i n t e r e s t r a t e s , that mortgages are rat ioned from the cap i ta l markets more rap id ly than bonds because o f . s h o r t run i n e l a s t i c i t y o f business f i r m s . . During periods of decreasing i n t e r e s t r a t e s , when business demand can be expected to d e c l i n e , he hypothesized that mortgage demand .would i n c r e a s e , because of the h igh ly e l a s t i c demand exh ib i ted by mortgagors. Mortgage demand i s considered to react in a c o u n t e r c y c l i c a l manner in comparison to the bond market, because of the res idua l nature of the mortgage market. Because of the lack o f a v a i l a b l e data., the behaviour of the mortgage market f o r existrimg housing was assumed by Guttentag, to react in a s i m i l a r manner to that of the i n s t i t u t i o n a l mortgage 2 market. The c o u n t e r c y c l i c a l hypothesis would suggest that during periods of ra t ion ing in the c a p i t a l markets, that the p r ice o f housing would f a l l in response to the 3 lack of demand. Evidence by Hamilton ind ica tes that the p r i c e of housing con-t inued to r i s e during periods o f inc reas ing i n t e r e s t r a t e s . This c o n f l i c t of theory and.observat ion suggests that the study of housing pr ices behaviour in r e l a t i o n to the mortgage market fo r e x i s t i n g housing i s one worthy o f examination. The subject matter is important not only because i t f i l l s a void in the housing-mortgage l i t e r a t u r e , but because the need today (1976) to supply add i t iona l c a p i t a l to the mortgage f inance area is c r u c i a l . For the f i r s t time in contemporary h i s t o r y , the mortgage funds suppl ied to the market have exceeded ( a b s o l u t e l y ) 4 5 the requirements of the bond market. Such demands are expected to continue and the need to meet th is demand e f f i c i e n t l y w i l l be the centre of future p o l i t i c a l -3 i n s t i t u t i o n a l dilemmas. Hence the subject matter is not only t imely from a t contemporary need viewpoint , but i t i s unique to the housing-mortgage market l i t e r a t u r e . 1.2 PURPOSE OF STUDY The purpose of th is d i s s e r t a t i o n w i l l be to model the mortgage lending r e l a t i o n s h i p within the market for e x i s t i n g housing and note the e f f e c t on the p r ice of housing. Such a study w i l l necessi ta te examination of c a p i t a l markets which are r e g i o n a l , as wel as n a t i o n a l , and in add i t ion the study w i l l examine the regional nature of the housing markets. Research to date has centered on the new housing market and the ro le of lenders who f inance the mortgages to support th is market.^ The s p e c i f i c a t i o n of th is mortgage market has dea l t with two sources of funds, the (pr ivate) i n -s t i t u t i o n a l lenders and government agencies. However, complete s p e c i f i c a t i o n of the complete mortgage market must inc lude the (pr ivate) n o n - i n s t i t u t i o n a l l enders . The f i r s t step in the development of the model then , i s to spec i fy a l l subsets of the to ta l mortgage market. V i r t u a l l y no r e s e a r c h 7 has been d i rec ted to descr ib ing the react ion of the e x i s t i n g housing market to changes in vacancy rates and changes in i n t e r e s t r a t e s . Because of the lack of recorded research in mortgage market f o r e x i s t i n g housing, i t is necessary to e s t a b l i s h basic dimensions, v a r i a t i o n and poss ib le s u b s t i t u t i o n e f fec ts in the market f o r e x i s t i n g housing. A second step in the development of the model then requires a d e s c r i p t i o n of the components of the mortgage market fo r e x i s t i n g housing to the above f o r c e s . The der ived demand and supply model developed to model the flow of mortgage Q funds in the market f o r e x i s t i n g housing is patterned a f t e r that of Muth and Clauret ie.9 The e f f e c t on housing pr ices due to s u b s t i t u t i o n in the above market i s noted. Proper s p e c i f i c a t i o n of the c r e d i t r a t ion ing v a r i a b l e i s 4 c r u c i a l to the t e s t i n g of the model because.of the problem of measuring changes in i n t e r e s t rates in the mortgage market. P r ice r a t i o n i n g in th is d i s s e r t a t i o n re fers to the ra t ion ing by p r i c e , i . e . , the mortgage i n t e r e s t r a t e ; whereas non-p r i c e ra t ion ing re fers to r a t i o n i n g by p r ice and non-pr ice factors such as l o a n -to -va lue , r a t ios . A spec ia l purpose of th is d i s s e r t a t i o n w i l l be to note the impact on the measurement.of the mortgage rate by funds flow in the market fo r e x i s t i n g housing. 1.3 OVERVIEW The organizat ion of th is d i s s e r t a t i o n , fo l lows d i r e c t l y from the purposes j u s t o u t l i n e d . The s t y l e of the d i s s e r t a t i o n has been adapted to r e f l e c t the nature of the problem presented. Chapter II provides a survey of the background l i t e r a t u r e . Chapter III develops a c l a s s i f i c a t i o n system which de l ineates subsets of the mortgage market fo r both new and e x i s t i n g housing. From th is c l a s s i f i c a t i o n system, a d e s c r i p t i v e exp lora t ion of the dimension, v a r i a b i l i t y and s u b s t i t u t a b i l i t y o f gross mortgage flows in the market fo r exist ingl ihousing is made poss ib le in Chapter IV. The der ived demand and supply model f o r mortgage f inanc ing in the market f o r e x i s t i n g housing developed in Chapter V incorporates the observed r e l a t i o n -ships of Chapter IV in to the model. The model is tested e m p i r i c a l l y in two types of housing markets in Chapter VI. Excess demand periods in the housing market are denoted as periods in which housing pr ices i n c r e a s e d ; whereas the excess supply periods are denoted by decreasing housing p r i c e s . Chapter VII notes the impact that the sources of funds o f the market f o r e x i s t i n g housing have on the narrow amplitude of mortgage r a t e s . In Chapter VIII p o l i c y imp l ica t ions and fu r ther avenues of study are o u t l i n e d . 5 Footnote References - Chapter I 1. J . Guttentag. "The Short Cycle in Res ident ia l C o n s t r u c t i o n , " American  Economic Review, June 1961, pp. 275-98. 2. Authors who have suggested that the t o t a l mortgage market reacts in a comparable manner to the new housing market inc lude : (a) R.C. F a i r . "D isequ i l ib r ium in Housing Models," Journal of F inance, A p r i l 1972, pp. 207.-230. (b) R .C. F a i r and D.M. J a f f e e . "Methods of Est imat ion fo r Markets in D i s e q u i l i b r i u m , " Econometr ica, V o l . 40, No. 3, May 1972, pp. 497-514. (c) Guttentag, op. c i t . , p. 276. (d) D. Huang. "The Hort-Run Flows of Nonfarm Res ident ia l Mortgage C r e d i t , " Econometrica, A p r i l 1966, pp. 433-59. •'3.;. S.W. Hamilton. "Housing Pr ice Index Paper," Unpublished paper, (Vancouver: U n i v e r s i t y of B r i t i s h Columbia, 1974), pp. 1-33. 4. J . Evans. "The Res ident ia l Mortgage Market in Canada: Market St ructure and I n s t i t u t i o n a l Behaviour ," Unpublished paper, (Vancouver: Un ive rs i t y of B r i t i s h Columbia, 1974), p. 19. 5. This phenomena in context is not s u r p r i s i n g given that now (1976) a large number of required re f inanc ing of the f i v e year c a l l s introduced by lenders in the l a t e 1960's has occur red . Second, the p r i c e of housing has increased r a p i d l y in the past f i v e years so as to require greater amounts of c a p i t a l fo r re f inanc ing and i n i t i a l mortgaging. 6. Authors who have dea l t with the new housing market i n c l u d e : (a) W. A l b e r t s . "Business C y c l e s , Res ident ia l Construct ion Cycles and the Mortgage Market," The Journal of P o l i t i c a l Economy, June 1962, pp. 263-81. (b) T .M . C l a u r e t i e . " Interest Rates, The Business Demand for Funds and the Res ident ia l Mortgage Market: A S e c t o r i a l Econometric Study," Journal  of F inance, Dec. 1973, pp. 1313-1326. (c) M. Evans. "Investment in Res ident ia l C o n s t r u c t i o n , " Macroeconomic A c t i v i t y , (New York: Harper and Row, 1969), Ch. 7. <(i'dy • Jt ' -Gu'Mentag. "Cred i t A v a i l a b i l i t y , In terest Rates and Monetary P o l i c y , " Southern Economic J o u r n a l , 1960, pp. 219-28. (e) L . B . Smith. "A Model of Canadian Housing and Mortgage Market," Journal 6 of P o l i t i c a l Economy, September - October 1969, pp. 795-816. (f) L . B . Smith and G.R. Sparks. "The Interest S e n s i t i v i t y of Canadian Mortgage Flows," The Canadian Journal of Economics, V o l . 3, August 1970, pp. 407-21. 7. Studies and estimates of the s i z e of the e x i s t i n g housing markets can be found i n : (a) A . F . Eger. "Lending Patterns of F inanc ia l I ns t i tu t ions of Greater Vancouver Regional D i s t r i c t , " Prel iminary working paper, (Vancouver: Un ive rs i t y of B r i t i s h Columbia, 1974). (b) R.M. F i s h e r . "Monetary P o l i c y " : Its r e l a t i o n to Mortgage Lending and Land Economics," Land Economics, V o l . 45, November 1969, pp. 418-24. (c) J . Poapst. Resident ia l Mortgage Market'. Working paper prepared by the Royal Commission of Banking and Finance Ottawa, 1962. 8. R. Muth. "The Demand for Non-Farm Housing," in the Demand fo r Durable  Goods, ed. by A. Harberger. (Chicago: The Un ivers i ty of Chicago Press , T960T, pp. 29-56. 9. C l a u r e t i e , op. c i t . , p. 22. 7 CHAPTER II  BACKGROUND LITERATURE SURVEY 2.1 SUMMARY OF LITERATURE REVIEW 2.2 HOUSING AND MORTGAGE MARKET SPECIFICATION: A NATIONAL VIEW 2.2.1 Countercyc l ica l Hypothesis and Demand Condit ions 2.2 .1.1 Business Demand I n e l a s t i c i t y 2.2 .1 .2 Stable Demographic Condit ions 2.2.2 Countercyc l ica l Hypothesis and Supply Condit ions 2.2.2 .1 I n s t i t u t i o n a l Mortgage Lending Behaviour 2 .2 .2 .2 I n s t i t u t i o n a l Construct ion Lending Behaviour 2 .2 .2 .3 Non- Ins t i tu t iona l Lending Behaviour 2 .2 .2 .4 E x i s t i n g Housing Market Response 2.3 HOUSING AMD MORTGAGE MARKET SPECIFICATION: A REGIONAL VIEW 2.3.1 Mortgage Market Structure 2.3.2 Regional Risk Factors 8 2.1 SUMMARY OF LITERATURE REVIEW Review of the l i t e r a t u r e ind icates that conclusions regarding mortgage and housing cyc les depend upon the s p e c i f i c a t i o n of the mortgage market in terms of types of lenders ( i n s t i t u t i o n a l or n o n - i n s t i t u t i o n a l ) as well as by leve l of aggregation ( n a t i o n a l , r e g i o n a l , or l o c a l ) . The concept of a c o u n t e r c y c l i c a l response by the mortgage market (Guttentag hypothesis) depends on the mortgage market being s p e c i f i e d as i n s t i t u t i o n a l as well as being based on n a t i o n a l l y aggregated data . If regional d i f f e rences e x i s t and i f the pr iva te n o n - i n s t i t u t i o n a l sector i s s u f f i c i e n t l y l a r g e , as a review of the Canadian mortgage data i n d i c a t e s , then the response of the housing market may d i f f e r from that recorded on a nat ional i n s t i t u t i o n a l b a s i s . V i r t u a l l y no research has been undertaken simply descr ib ing the magnitude of regional markets for e x i s t i n g housing, nor t h e i r r e a c t i o n . A secondary focus of th is review examines the lending r o l e of the banks and near-banks during periods of increas ing i n t e r e s t r a t e s . Whereas the counter-c y c l i c a l response i s based on a l l i n s t i t u t i o n a l l enders , the Gurley-Shaw hypothesis in fe rs that near-banks, who are not regulated by monetary a u t h o r i t i e s may lend in a pattern incons is ten t with that of the banks; S i g n i f i c a n t l y d i f f e r e n t lending patterns of the near-banks were not evidenced in a review of the re -corded experiences in Canada and the United S ta tes . The near-banks can be el iminated as a poss ib le reason why the e x i s t i n g housing market does not react, in a manner s i m i l a r to the new housing market. As demand for the mortgages i s a derived demand, the l i t e r a t u r e review a lso focuses on requirements from the demand s ide that condi t ions the housing market to react on a c o u n t e r c y c l i c a l b a s i s . Stable growth in popu la t ion , m igra t ion , and income are the necessary p re requ is i t es for such a response. 9 2 . 2 HOUSING AND MORTGAGE SPECIFICATION: A NATIONAL VIEW The l i t e r a t u r e survey on the c y c l i c a l behaviour of the mortgage markets begins at a nat ional l e v e l . Condit ions necessary f o r the c o u n t e r c y c l i c a l phenomena of the mortgage market are reviewed. A regional overview completes the survey. In approaching the review in t h i s manner, the e f f e c t of aggregation may be i s o l a t e d . 2 . 2 . 1 Countercyc l ica l Hypothesis and Demand Condit ions Guttentag^ es tab l ished the hypothesis that mortgage c r e d i t issued by i n s t i t u t i o n a l lender (banks, l i f e insurance companies and t r u s t s ) i s a r e s i d u a l . Guttentag assumed a f ixed supply of funds to be a l l o c a t e d between mortgages and 2 bonds. He reasoned that because of economies of sca le , business demand was f i r s t s a t i s f i e d , then mortgagors obtained what was l e f t . Guttentag then concluded that mortgage borrowing was c o u n t e r c y c l i c a l to business lend ing . He based his conclus ion on the fac t that : "movements in the net increment to mortgage debt and to corporate s e c u r i t i e s ( inc lud ing e q u i t i e s ) o u t s t a n d i n g . . . are v i r t u a l l y mirror images of each other . We can r e j e c t out of hand the p o s s i b i l i t y that demands fo r investable funds by corporat ions and by mortgage borrowers are subject to independent in f luences which happen to be opposite in t h e i r e f f e c t s . The chart suggests instead an organic in terconnect ion between the processes of f i n a n c i a l corporat ions through s e c u r i t y issues and f inanc ing home purchases through the crea t ion of mortgage debt."3 The strong negative r e l a t i o n s h i p between the flows of new mortgages and corporate bond issues formed the basis of the c o u n t e r c y c l i c a l theory. As i n t e r e s t rates i n c r e a s e d , mortgage lending decreased. Mortgage lending was sa id to be c o u n t e r c y c l i c a l because of the above r e l a t i o n s h i p . Evans^ presented the r e l a t i o n s h i p between mortgage investment and the business cyc le (Graph 2 .1) more d e f i n i t i v e l y . 10 C T o t a l c r e d i t a v a i l a b l e s G.N.P. reference cycle Business investment demand Mortgage investment increasing //A decreasing ''/// | / / i n t e r e ' s t rates y l i n t e r e s t rates I ' / . , Time Graph 2 1 C o u n t e r c y c l i c a l n a t u r e o f mortgage i n v e s t m e n t r e l a t i v e t o a Gross N a t i o n a l P r o d u c t r e f e r e n c e c y c l e and b u s i n e s s c y c l e . 2 . 2 . 1 . 1 B u s i n e s s Demand I n e l a s t i c i t y The f i x e d s u p p l y o f funds was assumed by G u t t e n t a g t o be a l l o c a t e d between mortgages and b o n d s . Demand f o r mortgages was assumed t o be h i g h l y e l a s t i c t o changes i n i n t e r e s t r a t e s , whereas demand f o r bonds was assumed t o be i n e l a s t i c . B u s i n e s s demand was deemed t o be i n s e n s i t i v e t o i n c r e a s e d b o r r o w i n g c o s t s because of r e l a t i v e l y m i n o r p r o p o r t i o n o f b o r r o w i n g t o t o t a l c o s t s , t h e s h o r t term n a t u r e o f t h e b o r r o w i n g and l a s t l y the a b i l i t y o f b u s i n e s s t o f r e q u e n t l y pass the c o s t s on t o the consumer. S p a r k s 0 i l l u s t r a t e d the same c o n c e p t i n h i s i n v e s t i g a t i o n o f p o s t - w a r i n t e r m e d i a r i e s as can be seen i n Graph 2 . 2 . A r i s e i n income c a u s e s both s c h e d u l e s t o s h i f t upward from (1) t o ( 2 ) . The g r e a t e r e f f e c t i s f e l t on c o r p o r a t e demand. The r e s u l t i s a s h i f t away from mortgages t o the bond m a r k e t . n (2) (1 ) Credit te rms ( 2 ) (I) Total Supply Corporate bonds Mortgage funds Graph 2.2 A l l o c a t i o n of Funds between Mortgages and Bonds. A l b e r t s 6 i n d i r e c t l y explained the c o u n t e r c y c l i c a l phenomenon by observing mortgage f lows . He noted that there was a high cross e l a s t i c i t y of demand f o r mortgages with respect to y i e l d s on competing investments on the part of l enders . A l b e r t s ' evidence r e l i e d on several data s e r i e s : the percentage of i n s t i t u t i o n a l inf lows invested in home mortgages; FHA a p p l i c a t i o n s and appra isa l requests and new commitments by l i f e insurance companies. I n s t i t u t i o n a l f l o w s , a p p l i c a t i o n s and commitments rose in r e l a t i o n to an i n c r e a s i n g mortgage to bond y i e l d . These r e s u l t s provided the basis f o r A l b e r t s ' t h e s i s of a c o u n t e r c y c l i c a l mortgage market. C l a u r e t i e 7 using an econometric approach noted the e f f e c t of business demand on the a l l o c a t i o n of mortgage funds. He measured business demand by the d i f f e r e n c e between re ta ined earnings and expected expenditures in the near fu ture of non-f i n a n c i a l bus inesses . He noted t h i s business demand may not be i n e l a s t i c f o r reasons suggested by Sparks , but ra ther from the r e s u l t of using committed l i n e s of c r e d i t over a per iod of t ime. C l a u r e t i e suggested that i f business demand was committed to funding a pro jec t (both on a short and long term f inanc ing bas is ) then the business sec tor would appear less s e n s i t i v e to increases in i n t e r e s t 12 r a t e s . Th is l a t e r evidence would appear not to change the behaviour observed e a r l i e r by Sparks and Guttentag, but rather suggests a d i f f e r e n t reason as to the i n e l a s t i c i t y of business demand. It should be noted that these observat ions as to the c o u n t e r c y c l i c a l nature of the mortgage market were observed in a mortgage market subject to deposi t rate c e i l i n g s . R e s t r i c t i o n s on savings and loan companies as well as mutual savings banks to lend only on r e s i d e n t i a l property could have caused the c o u n t e r c y c l i c a l nature noted by Guttentag. Subsequent research by o g Smi th 0 and Brady , reveal c o n f l i c t i n g r e s u l t s as to the e f f e c t of the i n t e r e s t rate c e i l i n g s . 2 .2 .1 .2 Stable Demographic Condit ions The i n e l a s t i c i t y of business demand assumes that the mortgage demand schedule f o r funds i s s t a b l e . A l b e r t s ^ noted that the demand schedule for funds was r e l a t i v e l y s tab le over the course of each recess ion and recovery . It i s commonly accepted that demand var iab les such as marr iages, household formation (and in the case of regional models, migrat ion) change r e l a t i v e l y s lowly . Often these va r iab les have no e f f e c t from a regress ion viewpoint . In f a c t during the post-war decades i t has become common p r a c t i c e to ignore the demand f a c t o r s and simply r e l y on the supply r e s p o n s e . ^ 12 However, there i s , a grave danger in t h i s type of approach. Swan for example, in his review of the home-building exper ience, r e l i e d s i g n i f i c a n t l y on a trend l i n e to obtain a remarkably p r e d i c t i v e se r ies of housing s t a r t s which, ex p o s t , he was able to apply in p red ic t ing the 1966 c r e d i t crunch. A p p l i c a t i o n of the same regress ion to a subsequent recess ion (1969) required a mechanical adjustment to the s e r i e s before s u f f i c i e n t p r e d i c t a b i l i t y r w o u l d occur . Demand cannot always be assumed to be e l a s t i c . ^ 3 13 2.2.2 Counte rcyc l i ca l Hypothesis and Supply Condit ions 2.2.2.1 I n s t i t u t i o n a l Mortgage Lending Behaviour In reviewing the supply c o n d i t i o n s , i t should be noted that the c o u n t e r c y c l i c a l hypothesis impl ies that f i n a n c i a l i n s t i t u t i o n s react in a manner s i m i l a r to increas ing i n t e r e s t r a t e s . The Gur ley -Shaw^ hypothesis re jec ts t h i s assumption. The Gurley-Shaw hypothesis was developed as an explanat ion of the ine f fec t i veness of monetary p o l i c y administered through the banking system. The Gurley-Shaw hypothesis i s important to the c o u n t e r c y c l i c a l argument because of the impact that t h i s hypothesis may have on the mortgage market fo r e x i s t i n g housing f inanced by conventional lenders . The Gurley-Shaw hypothesis breaks the i n s t i t u t i o n a l lenders into two groups, the banks and the near-banks. This hypothesis states that when c r e d i t i s r e s t r i c t e d by the monetary a u t h o r i t i e s , the impact of th is r e s t r i c t i o n i s f e l t f i r s t by the banks. The reduced l i q u i d i t y of the banks manifests i t s e l f in a reduct ion of lending by the banks, p a r t i c u l a r l y in t h e i r marginal a reas . Mortgage lending is a marginal lending area fo r the banks. Because of t h e i r s i z e however, the impact on the mortgage supply is s i g n i f i c a n t and i n t e r e s t rates on mortgages increase . The near-banks, Gurley-Shaw hypothesize , react d i f f e r e n t l y . Because they are not a d i r e c t part of the c r e d i t r e s t r i c t i o n process , t h e i r l i q u i d i t y is not reduced. As mortgage and bond rates increase ( a b s o l u t e l y ) , the near-banks are able to ra ise t h e i r deposi t rates to a t t r a c t funds. They issue debentures fo r • cash and use the funds to f inance mortgages and bond investments. If the deposi ts are long term debentures, then the near-banks have a secure source of funds on which to make new mortgage loans. Hence i t i s poss ib le that near-banks can be issu ing new mortgages in periods of increas ing i n t e r e s t rates when the banks are forced to withdraw. The imp l i ca t ion here is that the c o u n t e r c y c l i c a l nature of the 14 mortgage market is e i t h e r reduced in amplitude or s h i f t e d from a s t r i c t counter-c y c l i c a l pattern because of the lending patterns of the near-banks. Evidence suggests that the impact of the Gurley-Shaw hypothesis is minimal in the s t r i c t context of the f i n a n c i a l i n s t i t u t i o n a l s e t t i n g . Boorman and P e t e r s o n ^ argue that because near-banks are faced with a borrow-short , lend- long d e c i s i o n , s i g n i f i c a n t s h i f t s in savings must occur before a mortgage manager w i l l commit funds. Before these s h i f t s can become s i g n i f i c a n t , the mortgagor is pr iced out of the market because of i n e l a s t i c business demand. Hence the expected s h i f t to mortgages never occurs . E x p l i c i t examination of conventional ( i n s t i t u t i o n a l ) mortgage lending patterns in a Canadian regional i n s t i t u t i o n a l mortgage subs-tan t ia tes Boorman and Peterson. In the Greater Vancouver Regional D i s t r i c t , ( G . V . R . D . ) , during the 1957 per iod of c r e d i t r e s t r a i n t , near-banks evidenced 1 g reduct ion in lending comparable to that of the banks. Hence i t can be expected that the near-banks w i l l lend in a manner comparable to the banks, although the magnitude of the change may vary because of the nature of the i n s t i t u t i o n J 7 2.2 .2 .2 I n s t i t u t i o n a l Construct ion Lending Behaviour A re la ted i s s u e , which involves the near-banks and banks, because of t h e i r lending preferences concerns the supply of short term const ruc t ion c r e d i t . Klaman wr i t ing in the la te f i f t i e s , noted: " . . . desp i te the interdependent r e l a t i o n s h i p between const ruc t ion and permanent f i n a n c i n g , the supp l ie rs of each type of c r e d i t operate in f i n a n c i a l markets with d i f f e r e n t c h a r a c t e r i s t i c s . The d i s p a r i t y can lead to lack of short - term const ruc t ion f inanc ing even when permanent take-out commitments have been negot ia ted . . Such a s i t u a t i o n usua l ly occurs during periods of heavy demands f o r short - term commercial bank c r e d i t . " 1 8 F i s h e r 1 ^ , however, noted that genera l ly short term f inanc ing was a v a i l a b l e with long term f i n a n c i n g . However the concept is not to be dismissed l i g h t l y . As i s so often the c a s e , i t i s some unique under ly ing supply f a c t o r , be i t the lack of 15 short term f inanc ing or whatever, that constra ins the c o u n t e r c y c l i c a l r e a c t i o n . Knowledge of the s p e c i f i c cons t ra in t is important. Unique f a c t o r s ^ may r e s t r i c t the c o u n t e r c y c l i c a l response on s p e c i f i c o c c a s i o n s , rather than c o n t i n u a l l y over several c y c l e s . 2 .2 .2 .3 Non- Inst i tu t iona l Lending Behaviour Guttentag's c o u n t e r c y c l i c a l hypothesis impl ies ( i m p l i c i t l y ) that non-i n s t i t u t i o n a l sources of funds in the mortgage market react in a manner s i m i l a r to that of the i n s t i t u t i o n s . Reference to the n o n - i n s t i t u t i o n a l sources of funds in the l i t e r a t u r e i s fragmentary. In a Canadian context , Poapst in his report to the Royal Commission on Banking and Finance in 1962 ind icated (on a gross flow basis ) that the n o n - i n s t i t u t i o n a l source of funds for the to ta l mortgage market was 47% of the t o t a l . ^ The Ontario Realty Mortgage Loans R e p o r t s ^ from 1970 to 1972 inc lus ive ,show the personal s e c t o r . p r o v i d i n g 56.7, 49 .0 , and 43.8 percent of the to ta l p r o v i n c i a l conventional sector and 42 .1 , 33 .9 , and 31.7 percent of to ta l p r o v i n c i a l N.H.A. s e c t o r . While the f igures are not comparable, they do ind ica te that a large volume of mortgages are f inanced outs ide the i n s t i t u t i o n a l s e c t o r . Given that there is l im i ted data in th is important s e c t o r , estimates of the reac t ion of housing pr ices to changing i n t e r e s t rates remain very much in doubt. Hence movement of th is large uncharted market, which could be contrary to that commonly assumed, could provide c lues as to reasons why the p r i c e of housing continued to r i s e during periods of ra t ion ing in the c a p i t a l markets. 2 .2 .2 .4 E x i s t i n g Housing Market Response A second i m p l i c i t assumption i s found in Guttentag's theory. Guttentag assumed that : "the e x i s t i n g mortgage a c t i v i t y . . . moves in the same d i r e c t i o n as new r e s i d e n t i a l const ruct ion 16 In th is area as in the preceding s e c t i o n , l i t t l e concrete evidence ex is ts as to the movement of the mortgage market of e x i s t i n g housing. E i ther Guttentag's assumptions must be accepted or fragmentary evidence must be r e l i e d upon. H u a n g ^ ; C l a u r e t i e ^ and Jaffee^6 a l l dea l t with the to ta l mortgage market in t h e i r models which pred ic t mortgage flows from a var ie ty of aggregated bases. The impact of a mortgage market on e x i s t i n g housing being p o s t i v e l y cor re la ted to i n t e r e s t rates was not explored. The p o s s i b i l i t y then of a c y c l i c a l mortgage market reac t ing on a contrary basis to the c o u n t e r c y c l i c a l hypothesis was not cons idered . The e x i s t i n g market is assumed to move in the manner Guttentag suggested. D i rec t recogni t ion of the e x i s t i n g housing market (on a regional basis) was noted by Hamil ton, Mao et a l . ^ 7 These authors introduced the concept of turnover^ 8 and re la ted i t to the business c y c l e . Here e x p l i c i t recogni t ion was given to two d e f i n i t e housing markets, i . e . , the new and the o l d . 3 The above paper marks the f i r s t e x p l i c i t attempt to incorporate the response of two d i s t i n c t , ye t •3(1 re la ted markets. Schaaf i n d i r e c t l y examined the concept of regional housing turnover in his examination of changes in housing pr ices in both new and e x i s t i n g housing. Schaaf 's a t tent ion was devoted to p r i c e change and only a general idea of turnover in the e x i s t i n g housing market is obta ined. Fragmentary evidence is fur ther given by F i s h e r 3 1 (on an aggregated nat ional b a s i s ) . F isher report ing over the period 1960 - 1966 noted that the r a t i o of e x i s t i n g housing to to ta l housing ranged from 65 percent in 1960 to a maximum of 72% in 1962 and 1965. More casual references can be found in Winger who estimated that : "20 - 25 percent of the demand fo r mortgage funds (are deemed) to come from the demand fo r funds in the e x i s t i n g housing market."32 In f a c t F i s h e r ' s f i g u r e s , ind ica te Winger's estimates to be i n c o r r e c t . Reference could have been made to P o a p s t 3 3 , Schaaf 3 ^ who give somewhat more accurate est imates. 17 However the obvious point here is that the area of the e x i s t i n g housing market is so poorly developed, that general statements of magnitude, based on s p e c i f i c contexts are of l i t t l e va lue . No framework e x i s t s which would provide for a basis of ana lys is of the mortgage market fo r e x i s t i n g h o u s i n g . 3 5 2.3 REGIONAL HOUSING AND MORTGAGE MARKET SPECIFICATION Much of the background research included in th is review has resu l ted from n a t i o n a l l y aggregated data . Emphasis on a regional housing market is important because p r i o r reasoning suggests that reg iona l v a r i a t i o n could account fo r a r e j e c t i o n of the c o u n t e r c y c l i c a l hypothesis suggested by Guttentag. Limited evidence supports the notion that regional mortgage markets do act d i f f e r e n t l y depending on t h e i r i n s t i t u t i o n a l predominance or the perceived r i s k by lenders of one region compared to another. 2.3.1 Mortgage Market St ructure D i l b e c k 3 ^ examined mortgage s t r u c t u r e . He reviewed the case of loca l const ruct ion responses to changes in nat ional mortgage c r e d i t r a t i o n i n g . He was able to substant ia te his hypothesis that areas suppl ied by nat ional mortgage c r e d i t had greater v a r i a t i o n in housing const ruct ion than those areas suppl ied mainly by a loca l or r e g i o n a l l y based mortgage markets. Gi11es and C u r t i s 3 7 fu r ther examined the s t ructure of loca l mortgage markets and the e f f e c t of govern-ment housing and f inance on regional areas. They concluded that a l l regions do not share equal ly in F .H.A. and V .A . mortgages because of market s t r u c t u r e . "People . . . l i v i n g in areas dominated by savings and loan assoc ia t ions w i l l not be able to obtain F .H.A. insured loans as e a s i l y as people l i v i n g in areas where the bulk of lending is done by banks."38 From the above, i t can noted that the s t ruc ture of regional mortgage markets is important to both the const ruct ion cyc le and the mortgage market. 18 2.3.2 Regional Risk Factors Study of the v a r i a t i o n in regional mortgage markets has been i n i t i a t e d . For example Brady 3 ^ examined c y c l i c a l v a r i a t i o n of regional mortgage markets and found that regional imbalances pers is ted in the housing cyc le of 1956 and 1957. He i n f e r r e d the need fo r fur ther research by concluding that : " th is study has not attempted to evaluate a l l of the important f a c t o r s which go into the ana lys is o f r e g i o n a l housing cyc les and cannot be considered a complete s t u d y . ^ Regional imbalances were analyzed by S c h a a f ^ who noted that reg ional d i f f e rences in r e s i d e n t i a l mortgage market i n t e r e s t r a t e s , rather than being the r e s u l t of an imperfect mortgage market may r e s u l t from higher lending r i s k s in one region than another. W i n g e r ^ concluded along a s i m i l a r ve in and suggested that regional growth d i s p a r i t i e s can occur because of varying degrees of r i s k in d i f f e r e n t reg ions . Hence not only market s t r u c t u r e , but varying degrees of r i s k give the regional markets unique reac t ion to changing i n t e r e s t rates in the c a p i t a l markets. Winger's remarks are appropr ia te as they set the stage fo r the development of a c l a s s i f i c a t i o n system of mortgages based on varying degrees of r i s k as s h a l l be descr ibed in Chapter III. 19 Footnote References - Chapter II 1. Guttentag, "The Short Cycle in Resident ia l C o n s t r u c t i o n , " pp. 275-98. 2. A .R . Winger. "An Economic Analyses of Mortgages During Periods of Monetary Res t ra in t : C h a r a c t e r i s t i c s and A c q u i s i t i o n s by Lenders," in Ways to  Moderate F luctuat ions in Housing Const ruc t ion . Board of Governors. Federal Reserve System, 1972, pp. 456-487. 3. Guttentag, "The Short Cycle in Resident ia l C o n s t r u c t i o n , " p. 279. 4. M. Evans. "Investment in Res ident ia l C o n s t r u c t i o n , " p. 189. 5. G. Sparks. "Economic Ana lys is of the Role of F inanc ia l Intermediaries in the Post-war Resident ia l C y c l e , " Determinants of Investment Behaviour, (New York: Columbia Un ivers i ty Press , 1967), pp. 301-332. 6. A l b e r t s , "Business C y c l e s , Res ident ia l Construct ion Cycles and the Mortgage Market," pp. 263-281. 7. C l a u r e t i e , " Interest Rates, The Business Demand fo r Funds and the Res ident ia l Mortgage Market," pp. 1313-1325. 8. L . B . Smith. "On the Economic Impl icat ions on the Y i e l d C e i l i n g on Government Insured Mortgages," The Canadian Journal of Economics, V o l . 33, August 1967, pp. 420-431. 9. E . Brady. "A Sectoral Econometric Study of the Postwar Res ident ia l Housing Market," The Journal of P o l i t i c a l Economy, A p r i l 1967, pp. 147-58. 10. W. A l b e r t s . "Business C y c l e s , Resident ia l Construct ion Cycles and the Mortgage Market," pp. 263-281. 11. Huang, "The Short Run Flows of Non-farm Resident ia l Mortgage C r e d i t s , " pp. 433-59. 12. C. Swan. "Homebuilding: A Review of the Exper ience," Brookings Papers on  Economic A c t i v i t y . Brookings I n s t i t u t e . 1970, pp. 49-76. 13. S. M a i s e l . "The Rela t ionship of Resident ia l Financing and Expenditures on Resident ia l Cons t ruc t ion , " Conference on Savings and Res ident ia l F inanc ing . Proceedings of U.S. Savings and Loan League. Chicago. 1965, p. 71. 14. J . G . Gurley and D. Shaw. Money in a Theory of F inance. Brookings I n s t i t u t i o n 1960. Washington, D.C. Also see L i f e Insurance Companies F i n a n c i a l I ns t i tu t ions Commission of Money and C r e d i t . (New York: Prent ice H a l l , 1964), pp. 233-243. 15. J . T . Boorman and M.0. Peterson. " I n s t a b i l i t y of Savings Flows and Mortgage Lending by F inancia l In termediar ies ," Southern Economic J o u r n a l . 1973-74, pp. 297-312. 20 16. Eger, "Lending Patterns of F inanc ia l I n s t i t u t i o n s . " 17. L . B . Smith. The Postwar Canadian Housing and Res ident ia l Mortgage Markets. (Toronto: . U n i v e r s i t y y o f T o r o n t o P r e s s , 1974), p. 111. Smith notes: : "considerable v a r i a b i l i t y ex is ts in the i n t e r e s t s e n s i t i v i t y of the investment dec is ions of these i n s t i t u t i o n s , with chartered banks and l i f e ( insurance) companies being most s e n s i t i v e , t r u s t companies next , and mortgage loan companies l e a s t s e n s i t i v e . . . The ranking of these i n s t i t u t i o n s in terms of i n t e r e s t ra te responsiveness is not s u r p r i s i n g s ince i t i s cons is tent with the t r a d i t i o n a l view that i n s t i t u t i o n s w i l l be more responsive to varying economic c o n d i t i o n s , the f reer they are from l e g a l , l i q u i d i t y and t r a d i t i o n a l investment c o n s t r a i n t s . " 18. S . B . Klaman. 'The Postwar Resident ia l Mortgage Market." (Pr inceton: Pr inceton Un ivers i ty P r e s s , 1961), p. 177. 19. R. F i s h e r . " A v a i l a b i l i t y of Construct ion Cred i t fo r Housing," in Ways to  Moderate F luctuat ions in Housing Construct ion Board of Governors, Federal Reserve System, 1972, pp. 127-135. 20. These fac tors can be expanded beyond the i n s t i t u t i o n a l monetary sphere as s i m i l a r comments may be noted with respect to l a b o r , mater ia l and serv iced land inputs . Smith, The Postwar Canadian Housing, p. 41 comments on these supply f a c t o r s . 21. Poapst, Resident ia l Mortgage Market, p. 165. Data was based on 1960 aggregate fo r Canada. Source of data was C M . H . C . S t a t i s t i c s and Caisses Populaires submission to Royal Commission on Banking and Finance 1962. 22. Realty Mortgage Loans Newly Registered in Ontario 1969-72. Ontario S t a t i s t i c a l Centre. Economic and S t a t i s t i c a l Services D i v i s i o n . Department of Treasury and Economics, Toronto 1974. 23. Guttentag, "The Short Cycle in Res ident ia l C o n s t r u c t i o n , " p. 276. 24. D. Huang. "The Short Run Flows of Non-farm Resident ia l Mortgage C r e d i t , " pp. 433-59. 25. C l a u r e t i e , " Interest Rates, The Business Demand fo r Funds and the Res ident ia l Mortgage Market: A S e c t o r i a l Econometric, ;;Study," Journal of F inance, Dec. 1973, pp. 1313-1326. 26. R.C. Fa i r and D.M. J a f f e e . "Methods of Est imation for Markets in D i s -e q u i l i b r i u m , " Econometrica V o l . 40 No. 3. May 1972. pp. 497-514. 27. S.W. Hamilton and J . T . Mao, et a l . "Turnover Rates in Metropol i tan Vancouver," Unpublished paper. (Vancouver: Un ive rs i t y of B r i t i s h Columbia, 1971), pp. 1-31. 21 28. Turnover d e f i n i t i o n was der ived as f o l l o w s : T = cT N •+ T e (1 - c) where: T^ = turnover rate of new housing T g = turnover rate of e x i s t i n g housing c = completions in year t as a percent of housing stock at end of year t . 29. Recognit ion of these two markets goes back to bas ic research ind ica ted by: (a) E.M. F isher and R.M. F i s h e r . Urban Real Es ta te . (New York: Henry Holt C o . , 1954), p. 210. :(b) v J . S . Duesenberry. Business Cycles and Economic Growth. (New York: McGraw-Hi l l , 1958), pp. 135-165. Duesenberry.notes the dependence of new house const ruc t ion on the e x i s t i n g stock in his d i s c u s s i o n of business c y c l e s . However, no empir ica l research has been d i r e c t e d to the e x i s t i n g housing market. 30. A . H . Schaaf. "E f fec t of Federal Mortgage Interest Rate P o l i c y and Supply of FHA-VA C r e d i t , " Review of Economics and S t a t i s t i c s , XL, November 1958. pp. 384-89. 31. F i s h e r , "Monetary P o l i c y " , p. 421. 32. A .R . Winger. "Regional Growth D i s p a r i t i e s and the Mortgage Market," Journal  of F inance. 1969, pp. 659-662. 33. J . Poapst. Res ident ia l Mortgage Market, Chapter 3. 34. A . H . Schaaf. "Pr ice Behaviour in E x i s t i n g House Markets 1961-1966," Appraisal J o u r n a l , V o l . 37 (Apr i l 1969), pp. 289-95. 35. In an area re la ted to the study of e x i s t i n g housing and mortgage markets several authors examine the use of mortgage debt fo r non-real purposes. The most s i g n i f i c a n t cont r ibu t ions to t h i s area of study can be found i n : (a) A . I . Sommers and S .H . Rhine. The New Dimension in Mortgage Debt. Technical Paper No. 15. (New York: National Conference Board, 1972), pp. 7-20. (b) B.A. Gelb. Mortgage Debt fo r Non-Real Estate Purposes. Research Report No. 548, (Ottawa: National Conference Board, 1972), pp. 1-83. (c) A . H . Mel tzer . "Credi t A v a i l a b i l i t y and Economic Dec is ions : Some Evidence from the Mortgage and Housing Market," Journal of Finance 1974, pp. 763-777. 36. H. D i lbeck . "Responses of Local Res ident ia l Construct ion to changes in 22 National Cred i t Condit ion 1953-59," Journal of Bus iness , V o l . 37, 1964, pp. 295-308. 37. J . G i l l e s and C. C u r t i s . "The Structure of Local Mortgage Markets and Government Housing Finance Programs," Journal of F inance, September 1955, pp. 363-375. 38. I b i d , p. 375. 39. E. Brady. "Regional Cycles of Res ident ia l Construct ion and the Interregional Mortgage Market. 1954-59," Land Economics, February 1963, pp. 15-30. 40. I b i d , p. 30. 41. A . H . Schaaf. "Regional Di f ferences in Mortgage Financing C o s t s , " Journal  of F inance, V o l . 21, March 1966, pp. 85-94. 42. A .R . Winger. "Regional Growth D i s p a r i t i e s and the Mortgage Market," pp. 659-662. 23 CHAPTER III  CLASSIFICATION OF TOTAL MORTGAGE MARKET CLASSIFICATION OF SUB-MARKETS DEFINITIONS OF MORTGAGE MARKET 3.2.1 D e f i n i t i o n of Pr iva te Vendor Financing 3.2.2 D e f i n i t i o n of Assigned Mortgage Financing 24 3.1 CLASSIFICATION SYSTEM OF MORTGAGE SUB-MARKETS The l i t e r a t u r e review has revealed that s p e c i f i c a t i o n of the mortgage market has been in terms of conventional lenders and the r o l e they play in the new housing market. C l a s s i f i c a t i o n , consequently has r e f l e c t e d th is s p e c i f i c a t i o n . 1 This chapter provides a c l a s s i f i c a t i o n system for the study of the e x i s t i n g mortgage market. A c l a s s i f i c a t i o n system must r e f l e c t c h a r a c t e r i s t i c s unique to the species s t u d i e d . In analyzing the e x i s t i n g mortgage market the c l a s s i f i c a t i o n system i s developed on the basis of sources and uses of funds a v a i l a b l e for mortgage f i n a n c i n g . This basis of f inanc ing i s then re la ted to the age of the housing s t r u c t u r e . This c l a s s i f i c a t i o n system i s unique and i t r e f l e c t s an 2 attempt to e s t a b l i s h a basis from which fur ther research might be launched. The c l a s s i f i c a t i o n system r e f l e c t s the r i s k - r e t u r n r e l a t i o n s h i p evidenced in the term s t ructure of mortgages. This ser ies i l l u s t r a t e s fo r example, that new mortgages on new housing are in a d i f f e r e n t r i s k - r e t u r n c l a s s as the i n t e r e s t r a t e , loan - to -va lue and amort izat ion periods are less c o s t l y than ref inanced mortgages, f inanced by the same conventional lenders . These l a t t e r mortgages are genera l ly used for renovation and non-real estate p u r p o s e s . 4 Second, the source of funds provided by pr iva te vendor f inanc ing and assigned mortgages i s e x p l i c i t l y recognized. This type of lender then is re la ted to source of funds and age of dwe l l ing . The c l a s s i f i c a t i o n system r e f l e c t s the use of funds. Mortgages which r e f l e c t sa les and non-sales motivat ion are i s o l a t e d and c l a s s i f i e d . A non-sales mot ivat ion is one which does not inc lude a t i t l e t r a n s f e r . An example of use of funds in a non- t ransfer case would occur should the mortgagor use the money to renovate a home, re f inance a mortgage or purchase a c a r . A sa le of property on the other hand, r e s u l t s in a t r a n s f e r of t i t l e . This sales c l a s s i f i c a t i o n may involve the 25 use of assigned mortgages, conventional lender or p r iva te vendor f i n a n c i n g . Age of dwel l ing is important. Housing one year old is considered new housing and housing greater than one year is i d e n t i f i e d as e x i s t i n g housing. This pattern fo l lows recognized r i s k - r e t u r n patterns noted above. Table 3.1 i l l u s t r a t e s the type of market and sources of funds for each market. C l a s s i f i c a t i o n Number 1 2 3 4 5 6 Type of Market New mortgages on new housing New mortgages on new housing New mortgages on e x i s t i n g housing New mortgages on e x i s t i n g housing:; Refinanced mortgages on e x i s t i n g housing Assumed mortgages on e x i s t i n g houses Source of Funds Conventional lenders C.M.H.C. loans Conventional lenders ( i ) ( i i ) Pr ivate vendor f inanc ing Conventional lenders (.ii i Mortgage debt held by previous mortgagor ( iv Table 3.1 C l a s s i f i c a t i o n system of mortgages by type of d w e l l i n g , type of f inanc ing and source of funds. Explanat ion of d e f i n i t i o n s are as f o l l o w s : ( i ) Conventional lenders include N.H.A. insured mortgages, ( i i ) During period of s tudy, ne i ther N.H.A. or C .M.H.C. loans were a v a i l a b l e on e x i s t i n g housing, ( i i i ) Non-sales mot ivated, i . e . , re f inance mortgages, ( i v ) Includes both p r iva te under f i n a n c i n g , conventional and govern ment lenders as a p o s s i b l e source of o r i g i n a l funding. 3.2 DEFINITIONS OF THE MORTGAGE MARKET D e f i n i t i o n s have been developed in keeping with concepts commonly re fe r red to in the l i t e r a t u r e as much as p o s s i b l e . The fo l lowing d e f i n i t i o n s w i l l be used 26 in descr ib ing the mortgage markets throughout the remainder of th is d i s s e r t a t i o n . . 1. Total mortgage market is equal to new mortgages on new and e x i s t i n g housing (source of funds i s both conventional lender and government) as well as ref inanced mortgages (source of funds is conventional lenders) plus pr ivate vendor f i n a n c i n g . 2. Mortgage market f o r e x i s t i n g housing includes a l l poss ib le f inanc ing on e x i s t i n g housing, i . e . , new and ref inanced mortgages as well as pr iva te vendor f i n a n c i n g . 3. New housing mortgage market includes a l l new mortgages on new housing (funds from conventional lenders and government). 4. Pr ivate vendor f inanc ing a l t e r n a t e l y is c a l l e d the agreement- for -sa le market. 5. Tota l extended mortgage market i s equal to the to ta l mortgage market plus assigned mortgages on e x i s t i n g housing. 6. Extended mortgage market on e x i s t i n g housing is equal to the mortgage market fo r e x i s t i n g housing plus assigned mortgages on e x i s t i n g housing. 3.2.1 D e f i n i t i o n of Pr ivate Vendor Financing Pr ivate vendor f inanc ing or an agreement- for -sa le is s i m i l a r to a mortgage in terms of purpose. An agreement- for -sa le provides fo r a mechanism of exchange in the t rans fe r of real property . Pr ivate vendor f inanc ing i s best i l l u s t r a t e d by a comparison with mortgage t r a n s a c t i o n . Three pa r t i c ipan ts are ac t ive in a normal mortgage t ransact ion invo lv ing a sa le of property . The mortgagee (conventional lender) provides the f inanc ing fo r the mortgagor (borrower) who in turn uses the f inanc ing to purchase real property from a vendor. Transfer of t i t l e from vendor to mortgagor completes 27 the t ransac t ion and the mortgagee places a l i e n against the t i t l e on the property now in the hands of the mortgagor. The vendor i s involved only u n t i l the conveyancing is complete. Pr ivate vendor f inanc ing involves two p a r t i c i p a n t s . The vendor i s a lso the mortgagee. The vendor accepts an agreement- for -sa le in which the mortgagor promises to pay the vendor ( i . e . , the mortgagee) monthly payments fo r a given amort izat ion per iod . The vendor in th is case acts as a t rustee fo r the l i f e of the agreement. Conveyancing of the t i t l e to the mortgagor i s f i n a l i z e d with complete payment of the agreement - for -sa le . Other than t i t l e t r a n s f e r , legal d i f f e rences between a mortgage and an agreement - for -sa le are i n s i g n i f i c a n t in o p r a c t i s e . There are several synonyms for the term pr iva te vendor f inanc ing such as r i g h t to purchase, land or property contracts as well as land or property sa le c o n t r a c t s . 3.2.2 D e f i n i t i o n of Assigned Mortgage Financing A mortgagor may t rans fe r a mortgage to a new mortgagor upon sa le of real property . Genera l ly t h i s t r a n s f e r occurs i f the p r i n c i p a l outstanding on the e x i s t i n g mortgage is large r e l a t i v e to purchase p r i c e and/or i f market i n t e r e s t rates have increased from date of o r i g i n of the assigned mortgage. In th is case , the mortgage l i f e of the e x i s t i n g mortgage would not be terminated at s a l e , but would continue to be repaid by the new mortgagor u n t i l terminat ion of expected amort izat ion or next sa le of the property . The new mortgagor w i l l assume (or take over) the terms of the old mortgagor. No change of lending condi t ions occur . The new mortgagor w i l l covenant to repay the mortgage to the mortgagee as d id g the o r i g i n a l mortgagor. Hence an assignment i s a t r a n s f e r of a mortgage payment o b l i g a t i o n from one mortgagor to another. 28 Footnote References - Chapter III 1. Various disaggregat ion systems can be found in the l i t e r a t u r e : (a) The new housing market has been disaggregated on a basis of s i n g l e and mul t ip le housing s t a r t s . See L . B . Smith, "A B i - S e c t o r a l Housing Market Model ," Canadian Journal of Economics. 1969, pp. 557-569, as well as L . B . Smith and G. Sparks " S p e c i f i c a t i o n and Est imation of F inanc ia l Stock Adjustment Models, with Specia l Reference to L i f e Insurance Company Mortgage Investment," Internat ional Economic Review, February 1971, pp. 14-26. (b) Ana lys is by type of conventional lender i s most prominent and i s found f o r example in L .B . Smith "F inanc ia l Intermediary Behaviour in the Post-war Canadian Mortgage Market," Quarter ly Journal of Economics. V o l . 81, August 1971. pp. 493-514 and E. Brady, "A Sectoral Econometric Study of the Postwar Resident ia l Housing Market," The Journal of P o l i t i c a l  Economy, A p r i l 1967, pp. 147-58. (c) Huang, "The Short Run Flows of Non-Farm Resident ia l Mortgage C r e d i t , " represents those who examine the new housing market on a basis of guarantor . Huang analyzes both the F .H .A . and V . A . mortgages. (d) C l a u r e t i e , " Interest Rates and the Business Demand fo r Funds " and Fa i r and J a f f e e , "Methods of Est imation for .Markets in D i s e q u i l i b r i u m , " are among those authors who analyze the to ta l mortgage market as an e n t i t y . Although no mention is made of the f a c t , by d e f i n i t i o n t h e i r mortgage market ana lys is must inc lude mortgage on new housing and e x i s t i n g housing, with re f inanc ing included in the l a t t e r case . No such breakdown is ev ident . This system was or ig ina ted by P. White, formerly Dean of Commerce and Dr. S. Hamilton, Act ing Dean and Associa te P r o f e s s o r , Urban Land D i v i s i o n , Un ivers i ty of B .C . The i r concepts have been expanded upon by the author in e s t a b l i s h i n g the c r i t e r i a fo r the market d e f i n i t i o n s def ined in t h i s chapter . 3. A . F . Eger. "Mortgage Term S t r u c t u r e , " Pre l iminary Working Paper, (Vancouver: Un ive rs i t y of B r i t i s h Columbia, 1974), pp. 1-20. 4. The present f i v e year c a l l as we know i t today (1976) was not an in tegra l part of the mortgage lending at the time of study. 5. See sec t ion 3.2.1 f o r d e f i n i t i o n . 6. A . I . Sommers and S . H . Rhine. The New Dimension of Mortgage Debt, pp. 7-20 as well as lGe;l'b„ Mortgage Debt f o r Non-Real Estate Purposes, study the use of mortgage debt fo r non-real estate purposes. 29 7. Adjustments are made to year end data to r e f l e c t delays in Land Registry system. A mortgage fo r example, may be reg is te red against a property in December and t i t l e t r a n s f e r would not occur u n t i l the fo l lowing quar ter . This property would be c l a s s i f i e d as of December, in t h i s study. 8. D. BabaTos. "Study of Agreement - for -Sa le ," Unpublished Masters T h e s i s , (Vancouver: U n i v e r s i t y of B .C . • 1972), p. 10. 9. The fo l lowing quotat ion ind ica tes that the o r i g i n a l personal l i a b i l i t y of the mortgagor is not terminated with an assignment of a mortgage. "The t rans fe r by the mortgagor of his equity of redemption to a t ransferee does not r e l i e v e the mortgagor of his personal l i a b i l i t y to the mortgagee of his personal l i a b i l i t y to the mortgagee on his o r i g i n a l covenant to repay the debt. Thus the mortgagor may be l i a b l e on his covenant many years a f t e r he has sold his i n t e r e s t and a f t e r he had completely d isassoc ia ted himself with the mortgage property . The mortgagor is the primary debtor of the loan and i t does not matter than the t ransferee has covenanted to assume or to repay the mortgage or even that the t ransferee has contracted d i r e c t l y with the mortgagee to pay the debt , under an assumption agreement." Source of quotat ion can be found in Agent 's L icens ing Course, (Vancouver: Extension D i v i s i o n , Facul ty of Commerce, 1975), p. 67. 30 CHAPTER IV HISTORIC PROFILE OF EXTENDED MORTGAGE MARKET ON EXISTING HOUSING IN GREATER  VANCOUVER REGIONAL DISTRICT (1954 - 1963) 4.1 SUMMARY 4.2 INTRODUCTION 4.2.1 Data Base and Period of Study 4.2.2 Regional Comparison 4.3 TOTAL EXTENDED MORTGAGE MARKET 4.3.1 C y c l i c a l Nature of the Mortgage Market 4.4 EXTENDED MORTGAGE MARKET FOR EXISTING HOUSING 4.5 PRIVATE VENDOR FINANCING (AGREEMENT-FOR-SALE) 4.5.1 C y c l i c a l Nature 4.5 .2 Secular Va r i a t ion 4.5.3 Seasonal Va r i a t ion 4 .5 .4 Vacancy in Housing Market 4 .5 .5 Re la t ionsh ip to Conventional Lenders 4.6 ASSIGNED MORTGAGE FINANCING 4.6.1 C y c l i c a l Nature 4.6 .2 Secular V a r i a t i o n 4.6.3 Seasonal V a r i a t i o n 1 4.6 .4 Conventional Lender Rela t ionships 4.7 CONVENTIONAL LENDER FINANCING 31 4.1 SUMMARY This chapter is noteworthy for several reasons. F i r s t , dimensions are provided fo r the mortgage market on e x i s t i n g housing for the f i r s t t ime. These dimensions, as noted in the l i t e r a t u r e review have been vague or non-ex is tent . The agreement- for-sale and the assigned mortgage s e c t o r , i n d i v i d u a l l y are larger than the convent iona l ly f inanced mortgage sector on new houses or on e x i s t i n g houses. Second, the agreement- for -sale and assigned mortgage sector react in a c y c l i c a l manner. As i n t e r e s t rates i n c r e a s e , increas ing proport ions of the above sectors are used as sources of funds fo r housing s a l e s . C y c l i c a l s u b s t i t u t i o n s occur . T h i r d , the agreement- for -sale s e c t o r , during the period under study, dec l ined from 25% of extended mortgage market on e x i s t i n g housing to 20%. This dec l ine w i l l probably continue to the extent that non-pr ivate sources of f inanc ing are made ava i l ab le to households. The assigned mortgage sector appears to have remained r e l a t i v e l y constant at 27% of the extended mortgage market on e x i s t i n g housing. Fourth , seasonal demand is strongest in the second and t h i r d quarters in both the agreement- for-sale sector and assigned mortgage s e c t o r . F i n a l l y , s u b s t i t u t i o n between the assigned mortgage sector and the re f inance sector occurs when i n t e r e s t rates remain s t a t i c or decrease. 4.2 INTRODUCTION This chapter provides a disaggregated d e s c r i p t i o n of the mortgage market of the Greater Vancouver Regional D i s t r i c t (G.V.R.D. ) during the period 1954-1963. The disaggregat ion of the mortgage market by c l a s s i f i c a t i o n type not only reveals the absolute and r e l a t i v e changes within the G .V .R .D . mortgage market, but i l l u s t r a t e s seasona l , c y c l i c a l and mortgage sector s u b s t i t u t a b i l i t y . 4.2.1 The Data Bases and Period of Study In order to observe the lending patterns of the n o n - i n s t i t u t i o n a l l e n d e r s , 32 i t was necessary to search ind iv idua l c e r t i f i c a t e s of t i t l e of s i n g l e fami ly residences in the Greater Vancouver Regional D i s t r i c t . The land r e g i s t r y system in B r i t i s h Columbia i s a c e n t r a l i z e d one in that a l l c e r t i f i c a t e s of inde feas ib le t i t l e are kept in the regional r e g i s t r y o f f i c e s . Obtaining data fo r sampling i s f a c i l i t a t e d by th is central r e g i s t r y system.^ The data was c o l l e c t e d from the Vancouver and New Westminster Land Registry O f f i ces by a random number search of c e r t i f i c a t e s of t i t l e . Because growth patterns of the region v a r i e d , a proport ional random number search was undertaken which accounted for the three major growth patterns found in the r e g i o n . In to ta l 7,500 c e r t i f i c a t e s of t i t l e were observed. This sample represents 2.8% p of a l l s i n g l e family housing. Sample s i z e meets the requirements f o r to ta l est imation based on a housing turnover of every 10 years for a l l s i n g l e fami ly res idences . The base year of 1954 was se lec ted fo r two reasons. F i r s t , th is year marks turning point in the h is to ry of Canadian mortgage markets. Major r e v i s i o n to the National Housing Act occurred. Insured mortgages were introduced by the government and in addi t ion the banks were allowed to mortgage new housing. These l e g i s l a t i v e changes establ ished the framework fo r contemporary mortgage market behaviour a f t e r that t ime. Second, data se r ies to complete the demand and supply model were not ava i l ab le in quar ter ly ser ies p r i o r to 1954. Hence 1954 was se lec ted as a base year f o r these two reasons. 4.2.2 Regional Comparison Table 4.1 i s a composite of several var iab les which sets out the absolute and r e l a t i v e leve ls of income ( G . N . P . ) , housing s t a r t s , mortgage l e n d i n g , average period of s ing le fami ly residence ownership, and a p r i c e index of s i n g l e fami ly res idences . To the extent that data were a v a i l a b l e , comparisons are made on a regional Gross National Product oer Capital B.C. Canada Relative Hnuslno Starts .Conventional Mortgage Lending Average period of Single Family residence owner-G.V.R.D. Canada Relative &.V.R.D7 Canada G.V.R.D. Canada Relative Housing Price Index (Based on 1949 • $ $ B.U/Lanaaa Current $000 Real $000 $000 e.V.R.D./ Canada ship 1n G.V.R.D. (years) 1954 1,973 1.627 1.21 6,868 113,527 .061 44,439 30,860 788,856 5.63 8.267 1.44 1955 2.095 1.728 1.21 8,468 138,276 .061 ' 56.764 34,195 1,056,760 5.37 8.407 1.66 1955 2,303 1,902 1.21 8,403 127,311 .066 69,112 38.183 856,583 8.07 7.307 1.81 1957 2,304 1.923 1.21 7,539 122,340 .062 61,401 29.951 666,781 9.21 8.708 2.05 1553 2.244 1.928 1.21 12,299 164.632 .074 106,427 51 ,663 1,017.313 10.46 7.757 2.06 1959 2.376 1.998 1.16 9,510 141,345 .067 78,174 35,859 867.189 9.01 8.628 2.18 1960 2.381 2.019 1.19 4,675 108,858 .043 53,997 23,174 770,092 7.01 11.908 2.33 . 19€t 2.475 2.170 1.18 5,588 125,577 .045 70,634 33,006 1,085.943 6.50 12.987 2.14 1JE2 2.623 2.2?0 1.15 • 7.387 130,095 .056 90,095 38,834 1 ,220,533 7.38 11.368 2.32 1S63 2.760 2.430 f 1.14 8,941 148,624 .060 82,613 35.609 1,467,479 5.63 12.340 2.32 Table 4.1 Composite table of regional and national housing and rortcagg market variables. Sources of data for appropriate years are as follows: Gross National and Provincial Product 1s the B.C. Economic Review Department of Economic Development, Victoria, B.C. Provincial housing starts collected from records at Central Mortgage and Housing Corporation Regional Office, Vancouver, B.C. National Housing starts ar.d conventional irortgage lending dollar amounts are taken from Housing Statistics, Central Mortgage and Housing Corporation. Price index and average period of single family residence ownership were provided by Cr. S.W. Hamilton, in study of Turnover Rates for Metropolitan Vancouver 1949-1963. Un-published paper University of B.C. Vancouver, 1971. AH data is in current terms except as noted. to CO 34 b a s i s . The table is most e a s i l y understood by example. Examine housing s t a r t s , conventional lending patterns and b a s i c . G . N . P . . data in 1958. The Gross P r o v i n c i a l Product has dropped, housing s t a r t s have advanced dramat ica l ly in the wake o f the r e c e s s i o n . The high ( r e l a t i v e ) r a t i o of conventional lending in the G .V .R .D . (compared to Canada) is accounted fo r by three f a c t o r s . F i rs t»new housing s t a r t s are at a h i s t o r i c high (7.4% G.V .R .D . compared to Canada). Second, the e x i s t i n g housing market experienced a decrease in the average per iod ownership o f s i n g l e family residences (from 8.7 years to 7.8 y e a r s ) . This increase in turnover i s coupled with a t h i r d f a c t o r , that of higher r e l a t i v e incomes ( G . P . P . per cap i ta compared to G.N.P . per c a p i t a ) . Highereincome t rans la tes in to greater personal income f o r housing: and greater demand f o r mortgage d o l l a r s . The s u r p r i s i n g feature o f the tab le is to be found in the p r ice o f housing. There are three recessionary periods during the study p e r i o d . -Only once during these three recessions d id the. p r i c e of housing drop. Hence the composite appears to represent an expected react ion o f housing and mortgage markets to changes in i n t e r e s t r a t e s , with the exception of the housing p r i c e index. This exception i s worth noting as i t . fo rms an under ly ing reason f o r the examination of the mortgage subsets found in the remainder o f the study. 4.3 TOTAL EXTENDED MORTGAGE MARKET The to ta l extended mortgage market may be considered a subset of the c a p i t a l market in the same sense . tha t the more commonly s tudied conventional mortgage market and the bond markets are considered subsets o f the cap i ta l market. Inasmuch as the conventional mortgage market and the bond market compete fo r funds wi th in the c a p i t a l market, i t can be expected that s u b s t i t u t i o n and competi t ion f o r funds w i l l occur wi th in the to ta l extended mortgage market. This s e c t i o n examines funds flow wi th in the to ta l extended mortgage market. LEGEND Total Extended Mortgage Market Extended Mortgage Market for Existing Housing New Mortgages on New Housing (Conventional Lenders) New Mortgages on New Housing (Non-conventional Lenders) •z. o ecu o -T55T •T553" '///////////'///'/// " ' • /INCREASING INTEREST RATES' y / / / A '1959 Y E A R S T5BF T55B~ — • tech ~T5DT f5BT "T55T DECREASING "TSBT INTEREST RATES TS52" Graph 4.1 Gross Quarterly flows M954-1963) of the total extended mortgage market, extended mortgage. on l ^ s l i m housing as well as tne mortgage "lows of newhojjsjilq supp I \ ed by convention d ^ S i e n t l o n ^ ' l e n d e r s . Difference betwee, fleSTofW and exist n g m o r t g a g e markets represents new housing mortgage flow. Data for G.V.R.D. 1s price adjusted. Credit rationing periods shown for contrast. y////\ —T5E3" Financing Single Family Housing in the Greater Vancouver Regional D i s t r i c t 1954-1963 (Millions of $) Conventional Lenders Government and Other Agreements for Sale Assigned Mortgages New Existing Existing Total New Existing Existing Total New Existing E x i s t i n g Total Agree- New Assigned Assigned Agree- Total Housing Hous ing Housing Conventional Housing Housing Housing Government Housing Housing Housing ment For Housing Mortgages on ment for Sale on Assign-Col. (1) (Sales; (No Sales) (Sales) (No Sales) and Other (Sales) (No Sales) Sale Existing Housing Existing Housing ments year Col. (21 Col. (3) Cc!. ft) Col. (5) Col. (6) Col. (7) Col. (8) Col. (9) Col.(10) 19.65 Col. (11) N.A. Col. (12) 19.65 Col. (13) Col. (14) Col. (15) Col. (16) 1954 32.64 7.86 3.94 44.43 2.89 5.29 5.31 13.49 N.A. N.A. 7.01 18.31 25.32 1955 45.81 11.01 12.43 6S.13 3.72 4.46 6.80 14.98 N.A. 23.15 N.A. 23.15 N.A. 6.33 18.70 25.03 1956 39.96 15.92 13.21 69.12 3.75 • 10.08 7.54 21.37 N.A. 32.26 N.A. 32.26 N.A. 11.10 29.34 40.44 1957 35.73 " '14.25 11.42 61.29 3.93 10.46 7.66 22.05 N.A. 34.13 N.A. 34.13 N.A. 9.02 33.28 42.30 1958 70.86 20.84 14.71 106.43 15.95 6.74 11.76 34.45 N.A. 29.15 N.A. 29.15 N.A. 10.45 32.07 42.52 1959 41.67 20.32 16.19 78.18 22.92 7.63 15.28 45.83 N.A. 34.60 N.A. 34.60 N.A. 11.32 37.24 48.56 1960 14.78 22.28 16.92 59. Qo 12.04 11.84 9.52 33.40 N.A. 26.38 N.A. 26.38 N.A. 7.28 45.10 .52.38 1961 17.78 20.24 20.24 57.85 7.28 8.55 11.36 27.19 N.A. 30.08 N.A. 30.08 N.A. 3.62 35.37 38.99 1962 37.73 32.68 19.69 90.09 4.37 . 9.10 16.24 29.71 N.A. 27.69 N.A. 27.69 N.A. 9.46 41.89 51.35 1963 29.90 28.93 23.79 82.61 3.58 11.90 17.46 32.88 N.A. 35.78 N.A. 35.78 N.A. 6.15 36.85 43.00 Total Financing on Single Family Housing (Excluding Assignments) New Housing Existing Housing (Sales) (Col. 2+ Existing Housing (No Sales) (Col. 3+7+ Year 5+9-17) 6+10=18) 11 = 19) 1954 35.53 32.80 9 .25 1955 49.53 38.62 19 .23 1956 43.71 58.26 20 .75 1957 39.66 58.84 19 .08 1958 86.81 56.73 26 .47 1959 64.59 62.55 31 .47 1960 26.82 • 60.50 26 .44 1961 25.06 58.87 31 .60 1962 42.10 69.47 35 .93 1963 33.48 76.61 41 .19 Total Excludes . Assignments 3' (Col. 17+18+ 19-20) 77.58 107.38 122.72 117.58 170.01 158.61 113.76 115.53 147.50 151.28 Total Financing on Single Family Housing (Including Assignments) New Housing (Col. 17+ 13-21) 35.53 49.53 43.71 39.66 86.81 64.59 26.82 25.06 42.10 33.48 Existing Housing (Sales) (Col. 18+ 14-22) 39.81 44.95 69.36 67.86 67.18 73.87 67.78 62.48 • 78.93 82.76 Existing Housing (No Sales) (Col. 19+15-23)  27.56 37.93 50.09 52.36 58.54 68.71 71.54 66.97 77.82 78.04 Total New (Includes Housing Assignments) (Col. 20+16- (Col. 17/ 24) 20=25) Relative Proportions of Financing on Single Family Housing (Excluding Assignments) Existing Existing Housing Housing (Sales) (No Sales) (Col. 18/ (Col. 19/20-20-26) 27)  102.90 132.41 163.16 159.88 212.53 207.17 166.14 154.51 198.85 194.28 45.80* 46.13% 35.62% 33.73% 51.06% 40.72% 23.58% 21.69% 28.54% 22.13% 42.29% 35.96% 47.47% 50.04% 33.37% 39.44% 53.18% 50.96% 47.10% 50.64% 11.91% 17.91% 16.91% 16.23% 15.57% 19.84% 23.24% 27.35% 24.36% 27.23% Relative Proportions of Financing on Single Family Housing (Including Assignments) New Housing (Col. 21/ 24=28) 34.53% 37.41% 26.79% 24.81% 40.85% 31.18% 16.14% 16.22% 21.17% 17.23% Existing Housing - (Sales) (Col. 22/24= 29)  38.69% 33.95% 42.51% 42.44% 31.61% 35.66% 40.80% 40.44% 39.69% 42.60% Existing Housing (No Sales) (Col. 23/24= 30) 26.78% 28.64% • 30.70% 32.75% 27.54% 33.16% 43.06% . 43.34% 39.14% 40.17% Table 4.2. Gross mortgage flows in the Greater Vancouver Regional D i s t r i c t by type of lender and type of transaction on new and existing housing. Relative proportions are shown i n columns 25 to 30. a) Column 20 i s the total mortgage market; column 24 i s equal to the total extended mortgage market. Both are defined i n Section 3.2. 37 Graph 4 . 1 , Tables 4.1 and 4.2 i l l u s t r a t e several important dimensions of the G . V . R . D . mortgage market. From Table 4.1 i t can be noted that G .V .R .D . lending by conventional lenders represented 7.43 percent of the Canadian t o t a l . Th is per-centage ranged from 5.37 percent (1955) to 10.46 percent in (1958). Graph 4.1 presents a breakdown of conventional lending patterns by i l l u s t r a t i n g the gross quar te r ly flow of the new conventional mortgages on new housing, new government mortgages on new housing as well as the tota l extended mortgage market and the extended mortgage market on e x i s t i n g housing. Table 4.2 presents a d isaggregat ion of the to ta l extended mortgage market. Mortgage f inanc ing is presented by typeeof lender , type of t ransac t ion on new and e x i s t i n g s i n g l e family housing. Table 4.2 ind ica tes the importance o f mortgage markets other than the new mortgages on new housing. In 1958 for example, the new mortgage on new housing represented 41 percent of the to ta l extended mortgage market; whereas in 1960, new mortgages on new housing represented only 16 percent of the to ta l extended mortgage market. The new mortgage f igures include both conventional and government l end ing . Contrast the s i z e of the new mortgage-pew housing market with the mortgages in the e x i s t i n g housing market. The polar cases are again presented. In 1958, t h i s l a t t e r market represented 59 percent of the tota l extended mortgage markets. By 1960 th is proport ion had r i s e n to 84 percent . Hence as noted in ifehe in t roduct ion of t h i s chapter , examination of the e x i s t i n g mortgage market and the r o l e i t plays in c r e d i t ra t ion ing and housing pr ices is of paramount concern because of the dominance of th is market in the to ta l extended mortgage market. 4.3.1 C y c l i c a l Nature of the Mortgage Market Graph 4.1 and Table 4.2 not only i l l u s t r a t e the s i z e and proport ions of the major subsets of the to ta l extended mortgage market, but reveal the c o u n t e r c y c l i c a l nature of the new housing mortgage market as evidenced e a r l i e r by Evans arid Guttentag. 38 For example, in the recession of 1958, new housing const ruct ion responded s t rongly to d e c l i n i n g i n t e r e s t r a t e s . Comparatively however, the to ta l extended e x i s t i n g mortgage market does not respond in the manner ( c o u n t e r c y c l i c a l ) impl ied by Guttentag f o r example: , "The most important a c t i v i t y not c o v e r e d . . . i s the mortgaging of e x i s t i n g houses, which i s inc luded only in the mortgage recording s e r i e s . This a c t i v i t y genera l ly accounts f o r more than h a l f of the to ta l volume of mortgage record ings . Never the less , there i s a presumption that the volume of r e s i d e n t i a l const ruc t ion a c t i v i t y and the volume of mortgage  a c t i v i t y w i l l move in same d i r e c t i o n . " 4 . 5 Gnaph 4.1 does not reveal the expected c o u n t e r c y c l i c a l trend assumed by Guttentag. It i s d i f f i c u l t to determine any s p e c i f i c pa t te rn . At th is point i t i s noted that the to ta l extended mortgage market fol lows a p a t t e r n , which i s ne i ther c y c l i c a l nor c o u n t e r c y c l i c a l . Reasons f o r th is behaviour are now explored . 4.4 EXTENDED MORTGAGE MARKET FOR EXISTING HOUSING Tables 4.3.1 and 4.3.2 reveal the reason fo r the strange phenomena above. The extended mortgage market on e x i s t i n g housing is a composite of four major sub-markets. These sub-markets ( i d e n t i f i e d in Chapter III and .now examine in d e t a i l in th is chapter) are as f o l l o w s : new mortgages on e x i s t i n g housing; ref inanced mortgages on e x i s t i n g houses (Table 4.3.1) as well as new mortgages on e x i s t i n g houses (pr iva te vendor f inanced) and assigned mortgages on e x i s t i n g housing (Table 4 . 3 . 2 ) . The l a t t e r two sub-markets are termed c y c l i c a l because o f t h e i r p o s i t i v e c o r r e l a t i o n to changes in i n t e r e s t r a t e s . Examination of Tables 4.3.1 and 4.3 .2 reveal that the s i z e o f each o f these sub-markets is s i g n i f i c a n t , i . e . , each is approximately 20% of the extended mortgage market. Each of the subsmarkets could by themselves in f luence the housing and mortgage markets because o f th is s i g n i f i c a n t s i z e . As noted from Table 4.3.1 (columns 5, 6 and 11, 12) , new mortgages on e x i s t i n g housing account f o r 18 to 25 percent of the extended mortgage market on e x i s t i n g housing; whereas re f inanced 39 i : — — Year M Exi ortgages on sting Housing Refinanced Mortgages on Exist ing Housing (non-sales) F1nanc by Conven Lende ing t ional r Financing by Non-convent-ional Lender Total Financing by Conventional Lender Financing by Non-convent-ional Lender Total % EMMEH % TMM % EMMEH % TMM % EMMEH TMM % EMMEH % TMM % EMMEH % TMM % EMMEH % TMM Col .1 Co l . 2 Co l . 3 Col .4 Col .5 C o l , 6 Co l . 7 Co l . 8 Col .9 Col.10 c o i.n Col.1 1954 .11 .08 .08 .05 • 19 .13 .06 .04 .08 .05 .14 .09. 1955 .13 .09 .05 .03 .18 .12 ,15 .07 .08 .05 ,23 .15 1956 .14 .10 .08 .06 .22 .16 .11 .08 .06 .05 .17 .13. 1957 .12 .08 .09 .07 .21 .15 .10 .07 .06 .05 .16 .12 1958 .17 .10 .05 .03 .22 .13 .12 .06 .09 .06 .21 .12 1959 .17 .09 .05 .04 .22 .13 .11 .08 .11 .07 .22 .15 1960 .16 .14 .08 .07 .24 .21 .12 .11 .07 .05 .19 .16 1961 .15 .13 .07 .06 .22 .19 .15 .13 .09 .07 .24 .20 1962 .21 .16 .06 .05 .27 .21 .13 .10 .10 .08 .23 .18 1963 .18 .15 .07 .06 .25 .21 .16 .13 .11 .08 .27 .21 Table 4.3.1 Countercyclical components of the extended mortgage market  on exist ing housing. These components are financed by conventional and government lenders. Series is based on 1954-1963 monthly data for G.V.R.D. Total extended mortgage market represented by T.M.M.; whereas extended mortgage market on existing housing represented by E.M.M.E.H. 40 Year Ass igned mortgages on e x i s t i n g housing New Agreement - fo r -sa le on e x i s t i n g housinc O r i g i n a l F inanc ing by Convent ional Lender O r i g i n a l F inanc ing by Agreements-f o r - s a l e T o t a l Tota l EMMEH % TMM % EMMEH % TMM % EMMEH % TMM % EMMEH % TMM C o l . 1 C o l . 2 C o l . 3 C o l . 4 C o l . 5 C o l . 6 C o l . 7 C o l . 8 1954 .27 .17 .10 .07 .37 .24 .29 .19 1955 .22 .14 .08 .05 .30 .19 .28 ? 17 1956 .25 .18 .09 .07 .34 .25 .27 .19 1957 .28 .21 .07 .05 .35 .26 .28 .21 j 1958 .26 .15 .08 .05 .34 .20 .23 .13 1959 .26 .18 .08 .05 .34 .23 .24 .16 } 1960 .33 .28 .05 .04 .38 .32 .19 .16 [ 1961 .27 .23 .03 .02 .30 .25 .23 i .20 ] 1962 .27 .21 .06 .05 .33 .26 .18 .13 1963 .23 .19 .04 .03 .27 .22 .22 .18 •i . 3 . 2 Assigned mortgages and p r i v a t e vendor f i n a n c i n g found i n the extended mortgage market f o r e x i s t i n g hous ing . These sec to rs are i d e n t i f i e d as c y c l i c a l components because o f p o s i t i v e c o r r e l a t i o n to changes in i n t e r e s t r a t e s . The data f o r the G . V . R . D . i s based on y e a r l y aggregat ion o f monthly d a t a . Per iod of a n a l y s i s i s 1954-1963. Tota l extended mortgage market represented by T . M . M . ; whereas extended mortgage market on e x i s t i n g housing represented by E . M . M . E . H . 41 mortgages on e x i s t i n g housing account fo r 14% to .27% of the same e x i s t i n g housing market. Table 4 .3 .2 (columns 5, 6 and 7, 8) represents the c y c l i c a l components which react p o s i t i v e l y to increase in i n t e r e s t r a t e s . The l a r g e s t o f the sub-markets are the assigned mortgages on e x i s t i n g housing , as 27% to 38% of the to ta l extended mortgage market f o r e x i s t i n g housing, (or equ iva len t ly 22% to 32% of the total -mortgage -market) are funds suppl ied by th is assigned s e c t o r . The pr iva te vendor f inanc ing sec tor a c c o u n t s . f o r 18%.to 29% of the extended mortgage market on e x i s t i n g housing or 13% to 21% of the to ta l extended mortgage market. Table 4.3.1 and 4.3.2 have revealed large sub-markets 7 in the e x i s t i n g housing market which may act as f inanc ing subst i tu tes f o r each other . These sub-markets are comparable in s i z e to the new housing mortgage market. Each of these sub-markets i s explored in tu rn . Assigned mortgages New Mortgages on Refinanced mortgages on e x i s t i n g housing e x i s t i n g housing on e x i s t i n g housing O r i g i n a l f inanc ing Financing by non- Financing by non-by agreement-for- conventional lender conventional lender • Year sa le r e l a t i v e to r e l a t i v e to r e l a t i v e to con-o r i g i n a l f inanc ing conventional vent ional lender by conventional lender lender C o l . 1 C o l . 2 C o l . 3 1954 .37 .66 1.33 1955 .34 .40 .54 1956 .38 .63 .57 1957 .27 .73 .67 1958 .33 .32 .80 1959 .30 .38 .95 1960 .16 .53 .55 1961 .10 .43 .56 1962 .22 .42 .56 1963 .16 .41 .73 Table 4.4 Re la t ive ra t ios of the sub-markets wi th in extended mortgage market on e x i s t i n g housing. The ra t ios are based on monthly d a t a , aggregated by year fo r the Greater Vancouver Regional D i s t r i c t 1954-1963. 42 4.5 PRIVATE VENDOR ^ FINANCING 4.5.1 C y c l i c a l Nature Table 4 .3 .2 presents a concise summary of the react ion of the c y c l i c a l com-ponents to increas ing i n t e r e s t r a t e s . Pr iva te vendor f inanc ing var ies d i r e c t l y with changes in i n t e r e s t r a t e . During the major c r e d i t r a t ion ing periods from 1954 to 1963, the pr iva te vendor f inanc ing market reacted by increas ing pro-por t iona te ly as conventional funds were rat ioned out of the mortgage market. The recessionary periods of 1954, 1958 show the pr iva te vendor f inanc ing to be at a proport ional peak, as can be noted from column 7 and 8, Table 4 . 3 . 2 . The general statement that the pr iva te vendor f inance market i s cyclical, ,however^must be modif ied to r e f l e c t s e c u l a r , seasonal v a r i a t i o n (Graph 4.3.1) as well as the d i r e c t r e l a t i o n s h i p to the housing market. 4 .5.2 Secular Var ia t ion Table 4.3.2 and Graph 4.2 reveal that there has been a general dec l ine in the use of p r iva te vendor f inanc ing from 1954 to 1963. Peaks of 29% and 28% ( r e l a t i v e to the extended mortgage market on e x i s t i n g housing) represent a high in market penet ra t ion . P r i o r to 1958, the pr iva te vendor market maintained at l e a s t 27% of the ex is t inghhousing mortgage market. A f t e r that t ime, the r e l a t i v e proport ion continues to s h r i n k . The reduct ion would appear to be s i g n i f i c a n t as an average leve l of 20% by 1963 becomes the r u l e . Reasons fo r th is r e l a t i v e reduct ion are not r e a d i l y apparent. In 1954 the reorganizat ion of the National Housing Act co inc ided with a reduct ion of i n t e r e s t r a t e s . Only a s l i g h t l y d i s c e r n i b l e reduct ion o f p r iva te vendor f inance is apparent o on a r e l a t i v e b a s i s . A more dramatic e f f e c t i s evidenced by the withdrawal of the Canadian banks from the new housing market by quarter 3 1959. This withdrawal should have resu l ted in an increase in pr iva te lender f inanc ing in the existiling housing market, as i t could be expected that the other conventional lenders would se rv ice the demand fo r mortgages in new housing a f t e r the banks 1 withdrawal . This increase in pr iva te lender f inanc ing d id not o c c u r , because the other conventional 44 lenders d id not fund mortgages in the new housing because of the high inventory 9 in new housing fo r the per iod 1959 and 1960. It i s concluded .that p r iva te vendor f inanc ing represents a reduced percentage (20%) because o f inc reas ing dominance of the other conventional lenders in the e x i s t i n g housing market. 4 .5 .3 Seasonal Var ia t ion The seasonal pattern of the pr iva te vendor f inanc ing i l l u s t r a t e s , three c h a r a c t e r i s t i c s worth n o t i n g . F i r s t Graph 4.2 shows that in general the second and t h i r d quarters are periods of highest demand. The second or t h i r d quarter flow can be as much as 115%, greater than the f i r s t quarter (witness 1955-3 compared to 1955-1). An average v a r i a t i o n is c l o s e r to 50% (see 1957-3 r e l a t i v e to 1957-1 or 1958-3 r e l a t i v e to 1958-1). However, th is ru le of having second and/or t h i r d quarter p r iva te vendor f inanc ing greater than the f i r s t and fourth quarter i s v a r i a n t . For example, when periods of c r e d i t r a t ion ing (1959-2).and.(1962-4) co inc ide with a f i r s t or fourth quar ter low, then the pattern does not h o l d , simply because the f i r s t and fourth quarter demand in the pr iva te sec tor o f fse ts the lack of funds from con-vent ional l enders . When the c r e d i t r a t i o n i n g ceases , the pr iva te market loses the r e l a t i v e importance in the f i r s t and fourth quar te rs . T h i r d , not a l l f i r s t and fourth quarter periods react the same way to i n -creas ing i n t e r e s t r a t e s , because of factors other than c r e d i t r a t i o n i n g . Con-s i d e r a t i o n must a lso be given to the demand^supply r e l a t i o n s h i p s in the housing market. Graph 4.2 ind ica tes that the pr iva te market f a i l e d to respond to the inc reas ing s ta te of monetary s t r ingency in 1959-1 to 1960-1. Poss ib le reasons are explained bel'ow. 4 .5 .4 Vacancy in Housing Market The lack of p o s i t i v e c o r r e l a t i o n to increased i n t e r e s t rates in quarter 1 1959 to quarter 1 I960 can be i n f e r r e d from Graph 4 . 3 . Housing const ruct ion aided 45 in the recovery of the Canadian economy from the recession of quarter 2,1957 to quarter 2,1958. Construct ion s t a r t s increased from 7,539 in 1957 to 12,299 in 1958. The r a t i o of unoccupied but completed housing t o . t o t a l s t o c k , i n c r e a s e d to a high of .3% compared to an average of .1%. Housing supply exceeded demand. In such a c l a s s i c c a s e , the expected pr ice drop soon fol lowed in 1960-1961. Table 4.1 records the average housing pr ices from 1954 to 1963. Evidence from the experience of the recession of 1959-1960, is that the p r iva te vendor f inance market cannot be expected, to react c h a r a c t e r i s t i c a l l y i f housing supply exceeds demand. I f demand i s l a c k i n g , then the agreement-for-sa le market may not respond i n periods o f inc reas ing c r e d i t r a t i o n i n g . The pr iva te vendor f inanc ing may only respond to increas ing i n t e r e s t rates i f the housing market has a low or normal vacancy r a t e , ^ 4 .5 .5 Re la t ionsh ip to Conventional Lenders Graph 4.4 to 4.6 presentsthe p lo t ted ra t ios of p r iva te vendor f inance sec tor compared to conventional l end ing . Graph 4.4 and 4.5 each p l o t the ra t ios fo r both new and e x i s t i n g housing. Graph. 4.4 however inc ludes Refinanced mortgages; whereas Graph 4.5 excludes the re f inanc ing component. Graph 4,6 inc ludes non-conventional mortgages in the p l o t s . These graphs are important f o r several reasons. Consider the r e l a t i v e magnitude of the agreement- for -sa le market. From Graph 4.4 fo r example, i t can be noted that the agreement- for -sa le markets represents 97% of a l l conventional lending on e x i s t i n g 46 2.8 2.6 2.4 -2.2 . 2.0 J 1.8 J 1.6 " M 1.2 1.0 Jl Rat io of unoccupied, but completed / • housing to t o t a l housing stock \ (Rat io x 10) ^ / | / ^ k ' \ A / / X * I 1/ \ / / / / / I, .1/ / / Housing p r i c e l e v e l (1949 = 1 . 0 0 ) \ \ V A / / 1954 1956 • i t 1 1958 1960 Years 1962 1964 G r a p h 4 , 4 P r i ce l eve l of housing and r a t i o o f unoccupied, but completed housing to t o t a l housing stock in Greater Vancouver Regional D i s t r i c t 1954-1963. LU LEGEND Private Vendor Financing conventional Mortgage on Existing Housing Private Vendor Financing Conventional Mortgages on New and Existing Housing "t55fT 155T 1959 YEARS " tar 1 w " t o " " t o - 1964 "T936 ///////////////S///' " /INCREASING INTEREST RATES / / / / , //// ,,,,,, /</,,,/ W/////A DECREASING INTEREST RATES t5Bt 35B" 553" Graph 4.4 Percent of private vendor financing sector relative to al l conventional lending on existing housing as well as percent of private vendor financing sector compared to all conventional lending on new and existing housing. Data base for G.V.R.D. covers time period of 1954-1963 and represents gross mortgage flows. 5k UJ a. LEGEND Private Vendor Financing New Conventional Mortgages on Existing Housing Private Vendor Financing Mew Conventional Mortgages on New Housing " t e ~ " t e - OT " t e -YEARS " t e - " t e " " t e " " t e " , / / / / / / / / / / / / / / / / / / / * ' ' /INCREASING INTEREST RATES ' / / s / /" ' / ' / ' / i / / A ''/////////, DECREASING INTEREST RATES te " T W "1964 " t e " 3BT Graph 4.5 Percent of private vendor financing sector in comparison to (nwT conventional lending on new houses as well as on new conventional lending'on existing housing. Series covers period 1954-1963 for G.V.R.D. and represents gross mortgage flows. Chances in interest rate indicated by bar graph. Graph 4.6 Pprr.pnt. nf nrivat.P ypndnr financing compared to total frnnyoptinnal anrl nnn-cnnvent.ional 1 new mortgages on existing housing as well as on new housing. Period analyzed is from 1954-1963 for G.V.R.D. and represents gross mortgage flows. Interest rate change shown for comparison. 50 housing - with appropr iate increases to 187%, 202% and 137% during c r e d i t r a t ion ing p e r i o d s . ^ Conventional lending inc ludes lending on e x i s t i n g housing both f o r sa les and non-sales ( re f inancing) purposes. Graph 4.5 removes the e f f e c t of re f inanc ing by conventional lenders . The r e s u l t as may be expected i s an increase in importance of the agreement- for -sa le s e c t o r . Compared to e x i s t i n g housing an average re f inanc ing r a t i o of 231% p r i o r to 1958 e x i s t s and subsequent to 1958 a r a t i o of 137%. The importance of the agreement- for -sa le sector as a subs t i tu te f inance mechanism is shown in Table 4 .5 . Even at the lowest annual r a t i o the p r iva te lender f inance market represents 85% of the conventional lenders market in e x i s t i n g -housing; whereas there are several peaks in excess of 200%. , c Graph 4.6 represents a f i n a l look at the dimensions of the agreement- for -sa le sector as non-conventional sources of f inanc ing are included with the conventional l end ing . The e f f e c t i s to dampen the r a t i o s recorded in Graph 4.5 as to some extent the non-conventional sources of f inanc ing are c y c l i c a l . Agreement- for -sa le r a t i o s ( r e l a t i v e to the e x i s t i n g and new housing market) of 142% and 63% p r i o r to 1958 are recorded. Comparable post-1958 r a t i o s are 95% and 97%. The increased r a t i o of agreement- for -sa le r e l a t i v e to new housing f inanc ing is due to the 50% d e c l i n e in housing s t a r t s (1960, 1961 r e l a t i v e to 1959). The d e c l i n e of the agreement - for -sa le sector noted e a r l i e r in sect ion 4.4 .2 continues to be evident from the agreement - for -sa le to e x i s t i n g housing f inanc ing r a t i o . Is there any seasonal s u b s t i t u t i o n of the agreement fo r sa le sector due to lack of funds by conventional lenders? The fourth quarter in p a r t i c u l a r could show an increase ( r e l a t i v e l y ) in pr iva te vendor f inanc ing i f conventional lenders had completed t h e i r mortgage p o r t f o l i o lending ( for that year) by that t ime. Graph 4.2 (absolute d o l l a r amounts) and Graph 4.5 ( r e l a t i v e ) do not show any s i g n i f i c a n t increase in p r iva te agreement f inanc ing during the four th quarter of each year 51 Year New Mortgage on E x i s t i n g Housing Agreements f o r s a l e r e l a t i v e to f i n a n c i n g by convent ional lenders % 1954 251 1955 209 1956 202 1957 239 1958 139 1959 170 1960 119 1961 149 1962 85 1963 123 Table 4.5 Agreement f o r s a l e on e x i s t i n g housing r e l a t i v e to convent ional  loans on e x i s t i n g housing f o r the G . V . R . D . 1954 - 1963. (compared wi th the preceding t h i r d q u a r t e r ) . T h i s could i n d i c a t e that l a c k o f funds by convent ional lenders i n the four th quar ter of each year only occurs on an i r r e g u l a r b a s i s . 4.6 ASSIGNED MORTGAGE FINANCING 4.6.1 C y c l i c a l Nature Table 4.6 (reproduced from 4.3.2) presents a conc ise summary of the r e a c t i o n o f the p r i va te vendor and assigned mortgage sec to rs to i n c r e a s i n g i n t e r e s t 52 Year Assigned mortgages e x i s t i n g housing on New Agreement - for -sa le on e x i s t i n g housing O r i g i n a l Financing by Conventional Lender O r i g i n a l Financing by Agreements-f o r - s a l e Tota l Tota l EMMEH % TMM % EMMEH % TMM % EMMEH TMM % EMMEH TMM C o l . 1 C o l . 2 Col . . 3 C o l . 4 C o l . 5 C o l . 6 C o l . 7 C o l . 8 1 1954 .27 .17 .10 .07 .37 .24 .29 .19 ! 1955 .22 .14 .08 .05 .30 .19 .28 .17 1956 .25 .18 .09 .07 .34 .25 .27 .19 1957 .28 .21 .07 .05 .35 .26 .28 .21 1958 .26 .15 .08 .05 .34 .20 .23 .13 1959 .26 .18 .08 .05 .34 . .23 .24 .16 1960 .33 .28 .05 .04 .38 .32 .19 .16 1961 .27 .23 .03 .02 .30 .25 .23 • 20 1962 •27 .21 .06 .05 .33 .26 .18 .13 1963 .23 .19 .04 ' .03 .27 .22 .22 .18 Table 4.6 Assigned mortgages and pr iva te vendor f inanc ing found in the extended mortgage market f o r e x i s t i n g housing. These sectors are i d e n t i f i e d as c y c l i c a l components because of the p o s i t i v e to changes in i n t e r e s t r a t e s . The data f o r the G .V .R .D . is based on y e a r l y aggregation of monthly data . Period of a n a l y s i s i s 1954-1963. Tota l extended mortgage market r e -presented by T . M . M . ; whereas extended mortgage market on e x i s t i n g housing represented by E .M.M.E .H . 53 r a t e s . On an annualized b a s i s , i t can be noted that assigned mortgage f inanc ing var ies d i r e c t l y with changes in i n t e r e s t r a t e s . During the major c r e d i t r a t ion ing periods from 1954 to 1963, the assigned mortgage f inanc ing market reacted by increas ing propor t ionate ly (see columns 5 and 6) to increases in i n t e r e s t r a t e s . However, cont rast ing the agreement- for -sale s e c t o r , the assigned sector rose to an a l l time high during 1960; whereas the agreement- for -sale sector decreased due to excess housing supply during that p e r i o d . 1 3 The quar ter ly flows are shown in Graph 4.7 together with extended mortgage market on e x i s t i n g housing. The quar ter ly flow pattern matches that ind icated b y t h e annual f igures in that during c r e d i t r e s t r a i n t periods the amount of assigned f inanc ing inc reases . At th is point i t i s appropriate to ind ica te the s i g n i f i c a n c e of assigned agreements- for -sa le compared with the assigned mortgage. Table 4.4 ind icated that the assigned agreements- for -sa le and r e l a t i v e to the assigned mortgages ranged from 10% (1961) to 38% (1956) with a 10 year average of 26%. Noting that the percentage of assigned agreements- for -sa le dropped o f f dramat ica l ly in 1960, 1961 ( r e f l e c t i n g uncerta inty by potent ia l vendors) , there is l i t t l e evidence to suggest that the assigned agreements- for -sa le vary s i g n i f i c a n t l y from the react ion of the assigned mortgage s e c t o r . Observation of the combined assigned mortgage sector i s s u f f i c i e n t , as can be noted in Graph 4 .7 . 4.6.2 Secular Var ia t ion Unlike the agreement- for -sa le sector no s i g n i f i c a n t decrease in the assignment sector i s noted over t ime. This r e s u l t i s in accordance with the type of mortgage issued during the period under study. The standard mortgage was one with 20 to 25 year amort izat ion and genera l ly no r e s t r i c t i o n s were placed on the mortgagor f o r assignment purposes. Hence, the use of the assigned mortgage as a source of funds Graph 4.7 Gross Quarterly flows of the assigned mortgage sector and the extended mortgage market on existing housing. Denominator 1s of two forms and shows alI assigned mortgages (as well as assigned mortgages) originally financed by non-agreement for sale sector). Changes in interest rate indicated by bar graph. 55 during th is period could be expected to cont inue. 4 .6.3 Seasonal Var ia t ion Graph 4.7 exh ib i ts s i m i l a r seasonal v a r i a t i o n s as was found in the agreement-f o r - s a l e market. Strong second and t h i r d quarter demand tends to be the r u l e . This observat ion i s in keeping with the strong seasonal demand experienced in the Canadian mortgage markets and r e f l e c t s seasonal turnover pat terns . 4 .6.4 Conventional Lender Rela t ionship Graph 4 . 7 , 4.8 and 4.9 p a r a l l e l those presented in the agreement- for -sale sec to r . Graph 4.8 represents the r e l a t i o n s h i p of the assigned sector to the conventional lenders (a l l lending p o s s i b i l i t i e s ) ; Graph 4.9 i l l u s t r a t e s the assigned sector r e l a t i v e to the new and e x i s t i n g housing sector f inanced by conventional lenders . Graph 4.10 reveals the assigned mortgage markets r e l a t i v e to the new and e x i s t i n g sector regardless of use of f i n a n c i n g . F i r s t , the magnitude of these markets i s examined. From Graph 4 .8 , i t can be noted that the assigned mortgage market represents an average of 61% of a l l lending (new and e x i s t i n g housing) by the conventional lenders . This average appears to be increas ing as the pre-1958 average i s 53% and the post-1958 average 14 r a t i o i s 69%. Remaining with Graph 4 .8 , comparison of the assigned sector to conventional lending on e x i s t i n g housing (sales and re f inanc ing) reveals a pre-1958 average r a t i o of 158%, with a decrease a f te r that time to 113%. The dec l ine occurs because of a temporary s u b s t i t u t i o n of re f inanc ing for the assigned mortgage sector rather than permanent reduct ion of the assigned s e c t o r . During the years of 1961 to 1963, mortgage rates remained s t a t i c , hence in the sa le of a house, mortgagors preferred re f inanc ing to ass ignment . 1 ^ It can be concluded that the r a t i o of assigned mortgages to conventional mortgages on e x i s t i n g housing i n -creases as i n t e r e s t rates r i s e , with the exception of the s u b s t i t u t i o n n o t e d . ^ LEGEND Total Assigned Mortgages Conventional Mortgages on Existing Housing r Total Asslqned Mortqaqes Conventional Mortgages on New and Existing Housing TW YERRS T 9 b l T W 1 9 6 4 TW //////////// /////y>/ ' < l/INCREASING INTEREST RATES' T W W / / / / / A ' I960 DECREASING INTEREST RATES T5SF T W 3B5 Graph 4.8 Percent of total assigned mortgages sector relative to a l l conventional lending nn existing housing as well as percent of total assigned mortgages financing sector compared to a l l conventional lending on new and existing housing. Data base for G.V.R.D. covers time period of 1954-1963 and represents gross mortgage flows. Graph 4.9 Percent of total assigned mortgages sector 1n comparison to fnew) conventional lending on new nouses as well as on new conventional lending on existing housing. Series covers period 1954-1963 for G.V.R.D. and represents gross mortgage flows. Changes in interest rate indicated by bar graph. o Ti UJ, C C ™ U J a. LEGEND Total Assigned Mortgages Total New Mortgages on Exist ing Housing Total Assigned Mortgages Total New Mortgages on New Housing " t e " " t e - " t e " " t e r -YEARS " t e " " t e " " t e " " t e " 1 5 3 T V/. " t e " ///////////. /INCREASING INTEREST RATES / s t //// '\ te "T355 %%%% DECREASING INTEREST RATES " t e " " t e " V///A te" T96TJ Graph 4.10 Percent of total assigned mortgages compared to total fconventional and nnn-conyentional) new mortgage on existing housing as well as on new housing. Period analyzed is from 1954-1963 for G.V.R.D. and represents gross mortgage flows. Interest rate change shown for comparison. 59 The dramatic importance of the assigned sector as a source of funds i s found in Graph 4 .9 . The assigned sector ( r e l a t i v e to conventional lending on e x i s t i n g 17 housing) i s two and a h a l f times greater than the conventional lending s e c t o r . The importance of th is assigned mortgage sector i s revealed by the above per-1 o . centage and those in Graph 4.10. Graph 4.10 ind ica tes that the assigned sector on average is 162% r e l a t i v e to a l l types of mortgage lending on e x i s t i n g housing and 113% r e l a t i v e to a l l types of mortgage lending on new housing. The i n c l u s i o n of the non-conventional lenders tends to smooth out the ser ies compared to Graph 4.9 (conventional lenders o n l y ) . T h i s same phenomena occurred during examination of the pr iva te vendor f i n a n c i n g . 4.7 CONVENTIONAL LENDER FINANCING This chapter c loses with a b r i e f look at the c o u n t e r c y c l i c a l components of the e x i s t i n g mortgage market. Table 4.7 (a d u p l i c a t i o n of Table 4.3.1) i n -d i c a t e s , ^on an annual b a s i s ) , that new mortgages on e x i s t i n g housing accounted fo r from 18% (1955) to 27% (1962) of the extended mortgage market on e x i s t i n g housing. Conventional lenders themselves accounted f o r 13% (1955) to 21% (1962) of the same market. Graph 4.11 reveals a quar ter ly s e r i e s with proport ions in excess of 40% of extended mortgage market occurr ing during decreasing i n t e r e s t r a t e s . The non-conventional lender (accounted for by d i f f e r e n c e between two s e r i e s ) , react in t h e i r own c y c l i c a l manner (column 3, Table 4.7) by increas ing propor t ionate ly from 5% (periods of c r e d i t ease) to 8 or 9% (periods of c r e d i t r e s t r a i n t ) . These non-conventional lenders tend to be s m a l l , as noted; but in f a c t another c y c l i c a l proport ion of the e x i s t i n g mortgage market could be s t u d i e d . Table 4.7 (colmns 11 and 12) shows the re f inance (non-sale) mortgage market to range from 14% (1955) to 27% (1963) of the extended mortgage market on e x i s t i n g \ \ 60 ' 1S54 1955 1956 1957 1958 1959 1950 1961 1962 1963 Mortgages on Ex i s t i ng ..JjgjjjirKi Fi nancing by Convcntiona Lender % EMMEH % TMM Col.1 C o l . 2 .11 .13 .14 .12 .17 ,17 .16 .15 ..21 .18 .08 .09 .10 .08 .10 .09 .14 .13 .16 15 Financing by Non-convent-ional Lender % EMMEH Col .3 .08 .05 .08 -.09 .05 .05 .08 .07 .06 .07 % TMM Col .4 .05 .03 .06 .07 .03 .04 .07 .06 .05 .06 Total % EMMEH Col .5 .19 .18 . .22 .21 .22 .22 .24' .22 .27 .25 % TMM Refinanced Mortgages on Ex is t ing Hou s ir jcj.Jnon-sales) C o l . 6 .13 .12 .16 .15 .13 .13 .21 .19 .21 .21 Financing by . Conventional Lender % EMMEH Col .7 .06 .15 .11 .10 .12 .11 .12 .15 .13 .16 % TMM Col .8 ,04 .07 .08 .07 .06 .08 .11 .13 .10 .13 Financing by Non-convent-ional Lender % EMMEI Col .9 .08 .08 .06 .06 .09 .11 .07 .09 .10 .11 % TMM Col .10 .05 .05 .05 .05 .06 .07 .05 .07 .08 .08 Total EMMEH % TMM c o i . n .14 ..23 .17 .16 .21 .22 .19 .24 .23 .27 Col .1 .09 .15 .13 .12 .12" .15 .16 .20 .18 .21 Take! 4.7 Countercyc l ica l components of the extended mortgage market on ex i s t i ng housing. Series is based on 1954-1963 monthly data for G.V.R.D. Total extended mortgage market represented by T.M.M. ; whereas extended mortgage market on ex is t ing housing represented by E.M.M.E.H. o " L U 0 . LEGEND Total New Mortgages on Existing Housing Extended Mortgage Market on Existing Housing New Conventional Mortgages on Existing Housing Extended Mortgage Market on Existing Housing T W " t e " " t e " " t e " " t e " '1959 YEARS T W " t e " " t e " T96T 1964 ,///// / ////// /////S/ ' '' > l/INCREASING INTEREST RATES " t e - 1 W/////A DECREASING INTEREST RATES te " t e - " t e " / / / / / / T W W YEARS 553" GRAPH 4.n Percent new conventional mortgages on existing housing compared to extended mortgage mdiaj on existing housing as well as percent total new (conventional and non-conventional) mortgages on existing housing relative to extended mortgage market on existing housing. Data base represents gross mortgage flows for G.V.R.D. for 1954-1963. Interest rate change shown by bar graph. 62 housing. F luctuat ions appear comparable to the new mortgages on e x i s t i n g housing market. Quarter ly data from Graph 4.12, contrasted to graph 4 .11, shows comparable proport ionate peaks in 1955 and 1963 ( i . e . , in excess of 40% the extended mortgage market on e x i s t i n g housing) . In 1957 quarter 3, a decrease in the proport ion of re f inanc ing occurs . This d i f f e r e n c e could be due to the emphasis placed on new housing const ruct ion (rather than re f inanc ing) at that t ime. The non-conventional re f inance element (column 9) plays an important r o l e again as i t ranges from 6% (1956) to 11% (1963). I n t e r e s t i n g l y , a high (9% to 11%) r a t i o i s maintained in the years 1961 to 1963. It would appear that there i s a d i r e c t r e l a t i o n s h i p between the increase in the re f inanc ing of the years 1961 to 1963 and the d e c l i n e (see sec t ion 4.4.5) in the assigned mortgage sector of the same p e r i o d . ^ During t h i s p e r i o d , s u b s t i t u t i o n between assigned mortgages and ref inanced mortgages would appear to e x i s t in that as l i t t l e or no change i s recorded in the mortgage r a t e , re f inanc ing i s pre fer red to assigned mortgages by the mortgagors. U J LEGEND Total Refinanced Mortgages on Ex is t ing Housing Extended Mortgage Market on Ex is t ing Housing Refinanced Mortgages (conventional lenders) on Ex is t ing Housing Extended Mortgage Market on Ex is t ing Housing | 1554" T 5 5 5 " T 5 5 F " T 5 5 T "T55F T 5 B F T 5 B T "•1964 '1959 YEARS T3BF T S B T T554" ~T555~ T 5 5 S ///////////////S/s;'' > /INCREASING INTEREST RATES') T 5 5 5 W/////A DECREASING INTEREST RATES T5Bt " T5BT T5BT T55F" 5 H T GRAPH 4.12 Percent ref inanced mortgages on e x i s t i n g housing (convent ional ly financed) crimnarpd to extended mortgage market on ex is t ing housing. Total r e -financed mortgages (conventional and non-conventional ly f inanced) also shown r e l a t i v e to extended mortgage market on e x i s t i n g housing. Difference between ser ies represents non-conventional ly ref inanced mortgages r e l a t i v e to the extended mortgage market on ex is t ing housing. Data base represents gross mortgage flows f o r G.V.R.D. f o r 1954-1963. Changes 1n Interest rate indicated by bar graph. 0 64 Footnote References - Chapter IV 1. The land r e g i s t r y system in B r i t i s h Columbia is a modif ied Torrens System. This system was f i r s t derived by an A u s t r a l i a n c i v i l servant and was made law in modif ied form in B r i t i s h Columbia by the Land Registry Act ( R . S . B . C . 1960, Chapter 208). Under the A c t , the Province is d iv ided geographica l ly into seven areas fo r admin is t ra t ion purposes. The p r i n c i p l e element introduced in the Act provides that a l l instruments in real property must be r e g i s t e r e d . The purpose of the system is to save persons dea l ing with reg is te red propert ies from the t rouble of going behind the r e g i s t e r in order to protect themselves of the v a l i d i t y of the t i t l e . From a research v iewpoint , such a system provides an accurate h is tory of property t r a n s f e r as well as the mortgage f inanc ing re la ted to that t r a n s f e r . Further information may be gained be r e f e r r i n g to the (a) S.W. Hamilton. " T i t l e Reg is t ra t ion in B r i t i s h Columbia," in Real Estate  Trends in Metropol i tan Vancouver, (Vancouver: Real Estate Board of Greater Vancouver, 1971). (b) J . E . Smyth and D.A. Soberman. The Law and Business Adminis t ra t ion in  Canada, (Toronto: P r e n t i c e - H a l l , 1968), p. 463. 2. S. Richmond. S t a t i s t i c a l A n a l y s i s , (New York: Ronald P r e s s , 1964), pp. 224-225. 3. Evans, op. c i t . , p. 189, as well as Guttentag, "The Short Cycle in Resident ia l C o n s t r u c t i o n , " pp. 275-98, r e f e r to the c o u n t e r c y c l i c a l hypothesis . 4. I b i d , p. 274. Under l in ing is that of the author. 5. Reference to the concept of the c o u n t e r c y c l i c a l theory can be found in Chapter 2 . 1 . 2 . 1 . 6. Comparable r a t i o s of conventional lending on new mortgages on e x i s t i n g housing ( r e l a t i v e to to ta l extended mortgage market are 12% and 21%. Refinance r a t i o s are 9% to 20%. 7. Tables 4.3.1 and 4.3.2 are i l l u s t r a t e d beyond the explanat ion noted above. The reader w i l l note that a f r i n g e market e x i s t s , corresponding to the la rger sub-market. Explanation of these f r i n g e markets i s footnoted in order to maintain c o n t i n u i t y , not as a means of reducing the importance of these f r i n g e markets. For example, Table 4.3.1 i l l u s t r a t e s that in add i t ion to the conventional lenders f inanc ing e x i s t i n g housing, a smal ler f r inge market, government and p r i v a t e , a lso performs the same f u n c t i o n . The same phenomena repeats in Table 4 . 3 . 2 , although t e c h n i c a l l y speaking in 4.3.2 an assigned agreement-f o r - s a l e market compliments the la rger assigned mortgage market. 65 Table 4.4 i l l u s t r a t e s the r e l a t i v e importance of these non-convent ional ly funded sub-markets. Reference can a lso be found in sect ion 4.5.5 and 4 .6 .4 . 8. Canadian banks withdrew due to maximum lending rate r e s t r i c t i o n s under the Bank A c t . 9. Measurement of the d i f f e rence between new and e x i s t i n g housing in th is study was based on the age of mortgage. With a large stock of completed and un-occupied housing in 1960, 1961, a new house on the market fo r greater than one year , could be c l a s s i f i e d as an e x i s t i n g house, when in f a c t the house was treated as a new bu i ld ing from a l ender 's v iewpoint . This would account f o r the increase in e x i s t i n g lending by non-bank conventional lenders in the e x i s t i n g housing market in 1960, 1961 on ly . 10. No abrupt s h i f t in long run demand can be noted. Populat ion f igures i n d i c a t e no basic populat ion s h i f t at th is t ime. Populat ion f igures can be found in Dabestani , A. A Model of I n t e r - P r o v i n c i a l Migrat ion between B.C. and other- Canadian Prov inces . Master 's T h e s i s , (Vancouver: Un ive rs i t y of B . C . , 1975), p. 12 11. If the conventional lending on new houses is included the r e l a t i v e magnitude of the pr ivate vendor f inanc ing drops to an average of 44% of a l l conventional lend ing . The range of th is r a t i o i s from 23% (1958 quarter 2) to 70% (1961 quarter 3 ) . 12. The contrast to the new housing market f inanced by conventional lenders is a lso brought out by Graph 4 .6 . On average p r i o r to 1958, 71% of the convent iona l ly f inanced market is absorbed by the agreement- for -sa le market. The average f igure a f t e r that date i s 137%. 13. The reasons fo r th is d i f f e r e n t react ion could be due to the fo l lowing f a c t o r s . During th is p e r i o d , fo rec losures on high r a t i o mortgaged homes were at an a l l time high. Hence in these and del inquent mortgage c a s e s , sa le of e x i s t i n g housing with large e x i s t i n g mortgages could have been the r u l e , with l i t t l e or no add i t iona l funds r e q u i r e d . This could account f o r the large percentage of assigned mortgages. Agreements- for -sa le on the other hand, decreased because of lack of confidence in the economy. 14. The increase of th is l a t t e r r a t i o is due to an decrease in new housing s t a r t s rather than an increase in assigned mortgages. The 60% leve l would appear constant . 15. See sect ion 4.6 fo r a b r i e f explanation of why s u b s t i t u t i o n of re f inanc ing fo r assignment occurs . For a more in-depth study r e f e r to Eger, A . F . " P r o b a b i l i t y of Mortgage Repayment," Unpublished working paper. (Vancouver: Un ivers i ty of B r i t i s h Columbia, 1975), pp. 1-25. 16. In Quarter 3 of 1955, the r a t i o of assigned mortgages to conventional lending drops dramat ica l ly . This react ion can be expected as mortgage rates decl ined in that y e a r . However, by the fourth quarter assigned mortgages increased threefo ld over the t h i r d quar ter . Interest ra te change does not cause t h i s r e a c t i o n ; nor is there a change in s i z e of assigned mortgage. Coupled with th is unexplained fourth quarter i n c r e a s e , i s a seasonal d e c l i n e of con-vent ional lenders . 66 17. In comparison the assigned sector r e l a t i v e to the convent iona l ly f inanced new housing market i s 149%. The assigned sector represents a source of funds greater than the housing convent iona l ly f inanced new housing market. 18. At time of wr i t ing (1976) the s i g n i f i c a n c e of the assigned sector in Canada i s probably less than in the period under study because of the predominance of today of f i v e year c a l l s on mortgages. These f i v e year c a l l s probably reduce the s i z e of assigned s e c t o r . In the United States however, the v a r i a b l e rate mortgage i s not as widespread and the assigned mortgage sector probably p a r a l l e l s that ind ica ted by t h i s study. 19. A s t a r t i n g point fo r fur ther research would be to combine a l l the non-convent iona l , non-government lenders by type of housing and determine the c y c l i c a l e f f e c t s . At t h i s p o i n t , i n d i c a t i o n s are that such a combination would merely change the absolute magnitude of the c y c l i c a l components, the bas ic c y c l e of the assigned mortgages and pr iva te agreements would be maintained. 20. Th is would account fo r the dec l ine of assigned mortgages in 1961-1963 as mortgage i n t e r e s t rates d id not increase s i g n i f i c a n t l y . It i s more f e a s i b l e f o r a mortgagor to obtain a new mortgage (on e x i s t i n g housing) with a longer amort izat ion per iod and hence smal ler downpayment, than take-over an assigned mortgage with shorter amort izat ion per iod and consequently higher downpayment. Hence the markets are re la ted in the manner descr ibed . 67 CHAPTER V STABILIZING EFFECT OF PRIVATE VENDOR FINANCING AND ASSIGNED MORTGAGES ON HOUSING PRICES: THE MODEL AND METHODOLOGY 5.1 INTRODUCTION 5.2 SOURCE OF FUNDS 5.2.1 P r iva te Vendor Financing 5.2.2 Assigned Mortgage Financing 5.3 MODEL 564 DEMAND EQUATION 5.4.1 Cred i t Rationing 5.4.2 Income E f f e c t 5.4.3 Rental Market Subs t i tu t ion 5.4.4 A l te rna te Investment 5.5 SUPPLY EQUATION 5.5.1 Vacancy Rate 5.6 COMPLETE MODEL AND METHODOLOGY 5.6.1 Complete Model 5.6.2 Est imating Technique 5.6.3 Methodology 68 5.1 INTRODUCTION In th is chapter , a der ived demand and supply model is developed fo r the market for e x i s t i n g housing which is f inanced by the assigned mortgage mortgage sector or by pr ivate vendor f i n a n c i n g . A flow of funds model is f i r s t adopted to account for the above two sources of f inanc ing in the mortgage market. In addi t ion to s p e c i f y i n g the demand and supply equations of the model, use of est imat ing techniques and problems of measurement in markets in d i s e q u i l i b r i u m are reviewed. Housing pr ices do not enter the model d i r e c t l y ; however, they do d i c t a t e the periods during which the equation are est imated. The empir ica l r e s u l t s and c o n c l u s i o n s , are found in Chapter VI. The word c y c l i c a l i s used i n t e r m i t t e n t l y throughout Chapters V and VI. This word is used to descr ibe the react ion of the pr iva te vendor f inance and assigned mortgage sectors to changes in i n t e r e s t r a t e s . A p o s i t i v e c o r r e l a t i o n between each of the above two markets and changes in i n t e r e s t rates has been i d e n t i f i e d in Chapter IV. 5.2 SOURCES OF FUNDS 5.2.1 Pr iva te Vendor Financing The existence of the pr iva te vendor f inance market does not change any macro-economic r e l a t i o n s h i p s of savings and investment. However, i t does change the perception of the flow of funds within the f i n a n c i a l system. Figure 5.1.1 i l l u s t r a t e s the t r a d i t i o n a l l y accepted flow of funds model 1 in which bus iness , household and government sectors are involved in the borrowing and lending process of the f i n a n c i a l system. A complete flow of funds model which incorporates d i r e c t exchange of real assets fo r f i n a n c i a l assets by the household sector i s shown in Figure 5 .1 .2 . The s ingu la r d i f f e r e n c e with the complete flow of funds Govern-ment an 4 Foreign Nonfinancial Business House-hold Direct Financing Conventional Lenders Indirect Financing Gross Savings frotj Government and Foreign, Business and the Household Sectors  Figure 5.1.1 S i m p l i f i e d system of flow of funds Govern-ment and | Foreign Direct (Financing F i n a n c i a l Assets Intra Household! Transfer Nonfinancial Business House-hold Conventional Lenders Indirect Financing Di r e c t Financing| Real . Assets Gross Savings fron| Government and Foreign, BusinessJ and the Household Sectors  Figure 5.1.2 Complete flow of funds showing d i r e c t financing with f i n a n c i a l and r e a l assets by household sector 70 from the t r a d i t i o n a l flow of funds is that in the l a t t e r case , households are deemed not to be able to borrow d i r e c t l y from a savings u n i t . Hence, in order to obtain a mortgage, a household must borrow i n d i r e c t l y through a f i n a n c i a l intermediary. The t r a d i t i o n a l view is incomplete as has been extens ive ly reviewed in Chapter IV. The conventional lenders are not the only sources of funds in the market for e x i s t i n g housing. The pr ivate vendor f inance sector i s a s i g n i f i c a n t proport ion of the to ta l mortgage market which increases in r e l a t i v e s i z e as i n t e r e s t ra tes increase . 5.2.2 Assigned Mortgages While the pr iva te vendor f inance sector is an e x p l i c i t source of funds, the source of funds a v a i l a b l e in prev ious ly mortgages contracted (ex is t ing mortgages) involves a t r a n s f e r between households. The f a c t that a mortgagor can assign his mortgage creates a conceptual change in the flow of funds model unl ike that of the pr iva te vendor f inance s e c t o r . The assigned mortgage t rans fe rs debt ob l iga t ions from one part of the household sector to another as opposed to the c rea t ion of new debt o b l i g a t i o n s in the case of the pr iva te vendor f inance s e c t o r . Th is t r a n s f e r of mortgage debt has impl ica t ions because of the t iming of the t r a n s f e r . A s s i g n -ment of mortgages can be expected to increase as the d i f f e r e n c e between the assigned mortgage rate and the current conventional mortgage rates inc rease . The c y c l i c a l nature of the assigned sector was noted in Chapter IV,as well as the f a c t that the assigned sector is the la rges t component of the extended mortgage market in e x i s t i n g housing. Figure 5 .1 .2 represents both the e x p l i c i t source of funds of the p r iva te vendor f inance sector and the in terna l t r a n s f e r of funds of the assigned mortgage market with the recogni t ion of d i r e c t borrowings, d i r e c t lending and assignment of mortgages within the household s e c t o r . 71 5.3 MODEL The hypothesis of th is chapter is s t ra ight forward . The s u b s t i t u t i o n e f f e c t of the pr iva te vendor f inanc ing market and the assigned mortgage market s t a b i l i z e s the p r i c e of housing. Due^toothe s u b s t i t u t i o n of the c y c l i c a l components*ofithe t o t a l extended mortgage market, e f f e c t i v e demand fo r housing continues in s p i t e of c o u n t e r c y c l i c a l nature of the conventional mortgage market. Because the c y c l i c a l components provide subst i tu te f inanc ing to the underly ing demand components, the p r ice of housing w i l l not f a l l . Given that the conventional lenders were the only source of funds in the mortgage market, then as ra t ion ing occurs , fewer housing sales could be expected as borrowers would be rat ioned out of the mortgage market. In periods of c r e d i t r a t i o n i n g , market p r ices of houses could be expected to drop as the p r i c e of housing r e f l e c t s higher nlnterjest r a t e s . A l t e r n a t i v e l y in periods of decreasing i n t e r e s t r a t e s , the c r e d i t terms are r e f l e c t e d in increased market pr ices of housing and pr ices of housing can be expected to increase . However, the conventional lenders are not the only source of funds in the market for e x i s t i n g housing. The c y c l i c a l components provide a source of funds which enables housing t rans fe r to continue in s p i t e of the ra t ion ing by conventional lenders . Figure 5.2 ind ica tes the concept g r a p h i c a l l y . Mortgage rates Q 2 Q 3 QT Quantity of mortgages Figure 5.2 E f f e c t of an .i;rrore'a:sre -tn Itn'teresi: Irfft-es 'on ^ortjga^e -Tending. 72 The e f f e c t of an increase in i n t e r e s t rates from r-| to r 2 , decreases quant i ty demanded from Q-j to Q2, i f no s u b s t i t u t i o n e x i s t s in source of f i n a n c i n g . As s u b s t i t u t i o n occurs , then the e f f e c t of an increase in i n t e r e s t rates is to cause a reduct ion in demand from Q-| to Q3. Market rate of i n t e r e s t e q u i l i b r a t e s at r^. In the case of assigned mortgage f i n a n c i n g , the p r ice increases with c r e d i t ra t ion ing because the mortgagor i s obta in ing a house at a mortgage ra te less than the market. The reduced mortgage rates are c a p i t a l i z e d in the increased p r i c e of house. In the case of p r iva te vendor f i n a n c i n g , p r i c e increases with c r e d i t r a t ion ing because of the increase in f inanc ing a v a i l a b l e for housing.^ The e f f e c t of both sub-markets i s to s t a b i l i z e the observed pr ice l e v e l . 5.4 EXPECTED DEMAND RELATIONSHIPS Q D C = f ( r , R, Y, S) Q n ^ = quant i ty of pr iva te vendor and/orrsa^sti!g'ne;drmQi^ Measured in current d o l l a r s per q u a r t e r . 3 r = a measure of c r e d i t r a t i o n i n g . Measured as the d i f f e r e n c e between the mortgage and ebomd fcate' on ta qiiaawt^pliytbai ys b$s is .4 ' -Y = average income per c a p i t a . Measured quar te r ly in current d o l l a r s as a r a t i o of income to p r ice of housing.5 R = a measure of rent and housing p r i c e s . Measured quar te r ly in current d o l l a r s as a r a t i o of rent and housing p r i c e s .6 S = a measure of return of a l t e r n a t i v e forms of investment. Measured quar te r ly in current d o l l a r s . 1 Expected p a r t i a l de r iva t i ves are : 9Q D C / 9r -< 0 9QD^ / 9R > 0 9Q D C / 9Y < 0 3 Q D C / 3S < 0 Appendix I descr ibes sources and der iva t ion of data . 73 5.4.1 Cred i t Rationing The s e l e c t i o n of an independent var iab le to measure c r e d i t ra t ion ing f inds the l i t e r a t u r e d iv ided in to two major theore t ica l f i e l d s . The lack of adjustment of the mortgage rate to i n t e r e s t rate change in the c a p i ta l market has fostered the concept that non-pr ice rationingiTPttafchertfch^ c r e d i t . These non-pr ice terms include loan- to -va lue ra t ios and debt serv ice r a t i o s es tab l ished by the lending i n s t i t u t i o n s . The fo l lowing studies are but a sample of the l i t e r a t u r e which attempts to deal with the problem of non-pr ice r a t i o n i n g . Guttentag^ for example assumed that i n s t i t u t i o n s ra t ion by a l t e r i n g the maturi ty of the loan , rather than adjust ing the i n t e r e s t rate i t s e l f . Ja f fee questioned th is argument. He queried the adjustment of both rate and maturi ty of l o a n , instead of a s i n g l e adjustment of mortgage r a t e . Freimer and G o r d o n ^ emphasized optimal loan s i ze at a given i n t e r e s t rate in t h e i r study of non-pr ice ra t i oni ng. ''nTihfseltfa'utho'rs^ tha t : "a banker chooses some i n t e r e s t rate and makes loan at th is rate only i f the s i z e i s less than or equal to the optimal loan."11. The Freimer and Gordon model however, does not continue to explore the e l a s t i c i t y of quant i ty of bank loans demanded at lower i n t e r e s t ra tes . The question of an optimal loan rate is l e f t unanswered. Another non-pr ice avenue is explored by Kane and Mai lkel who argue that banks give preference to customers with long run p r o f i t potent ia l when c a p i t a l i s ra t ioned . Rather than charge higher i n t e r e s t rates to c l e a r the market, a bank w i l l examine long run deposi t a t t rac t iveness and loaning c a p a b i l i t y of a customer. However, t h e i r argument would appear to ignore the p o s s i b i l i t y that a non-prime customer could bid funds away from a prime customer of a bank. J a f f e e ^ argued that legal lending l i m i t s , considerat ions of goodwill and 74 s o c i a l moves make i t inadv isable to charge widely d i f f e r e n t rates to customers of d i f f e r e n t r i s k c l a s s in a nat ional banking system. A rate s t ruc ture based on a small number of r i s k c l a s s e s , makes adminis t ra t ion of the market f e a s i b l e . This rate s t ructure leads to a s luggish and jerky adjustment of the market r a t e s . In g e n e r a l , the non-pr ice ra t ion ing arguments have been d i s c o u n t e d J 4 J a f f e e ' s arguments approach a p r ice ra t ion ing hypothesis . M u t h ^ argued that p r i c e ra t ion ing occurs in the mortgage market. The Muth hypothesis expects a reduced mortgage rate compared to the bond r a t e , during periods of c r e d i t r a t i o n i n g s , but f o r d i f f e r e n t reasons than rated above. Muth considered two c lasses of borrowers. "both of which have the same marginal return to cap i ta l schedule (MR), but d i f f e r e n t marginal cost of c a p i t a l schedules because of d i f f e rences in the r i s k i n e s s of t h e i r optimal loan c o n t r a c t s " . . . C lass 1 borrowers w i l l each borrow an amount equal to C-[ . . . Class 2 borrowers . . . f i n d borrowing too expensive . . . and no loans w i l l be made."16 Figure 5.3 represents the amount of a c l a s s 1 borrower w i l l demand; whereas a c l a s s 2 borrower w i l l f i nd borrowing too expensive and.no loans w i l l be made to that c l a s s . Muth reasoned that i f the pure rate of i n t e r e s t f e l l , then the marginal cost of c a p i t a l schedule of a l l borrowers would f a l l . Class 1 borrowers would be induced to make greater c a p i t a l expenditure than they would had the pure rate of i n t e r e s t not f a l l e n . Class 2 borrowers would f ind that t h e i r marginal return schedules would have s h i f t e d from MC2 to MCg^• They would be able to obtain loans that would not have been poss ib le at the higher rate of i n t e r e s t . 7 5 % PER YEAR F i g u r e 5 . 3 M a r g i n a l r e t u r n t o c a p i t a l s c h e d u l e and m a r g i n a l c o s t o f c a p i t a l s c h e d u l e f o r two r i s k c l a s s e s o f b o r r o w e r . C l a s s 1 b o r r o w e r s a r e r e p r e s e n t e d by MC-j; c l a s s 2 b o r r o w e r s a r e r e p r e s e n t e d by MC2. The c l a s s 2 b o r r o w e r s would f i n d t h a t t h e i r g r o s s d e b t s e r v i c e r a t i o now met t h e l e n d e r ' s r e q u i r e m e n t s . The e n t r a n c e o f i n c r e a s e d numbers o f c l a s s 2 b o r r o w e r s i n t h e mortgage market would p r e v e n t t h e mortgage r a t e from d e c r e a s i n g i n an a m p l i t u d e c o m p a r a b l e t o t h e bond r a t e . An a d d i t i o n a l p o i n t i s c r u c i a l t o M u t h ' s e x p l a n a t i o n . Muth noted i n h i s c o n c l u s i o n t h a t : 76 "lenders as a group stand ready to make any kind of loans at an i n t e r e s t rate s u f f i c i e n t l y great to compensate them fo r the admin is t ra t ive costs and r i s k that the loan e n t a i l s . " 1 7 Muth appears to have underestimated the importance of t h i s l a t t e r po in t . The conventional lenders react to the increased r i s k of the c l a s s 2 borrowers by demanding i n t e r e s t rates commensurate with the increased r i s k . A c lass 2 borrower with a 33 percent gross debt serv ice r a t i o would be charged a higher rate of i n t e r e s t than would a c lass 1 borrower with a 27 percent gross debt serv ice r a t i o . A dual e f f e c t e x i s t s . The react ion of the lenders to the increased r i s k of c l a s s 2 borrowers in add i t ion to increased demand, tends to cause a lack of s e n s i t i v i t y in the mortgage rate during i n t e r e s t rate changes in cap i t a l markets. The lack of s e n s i t i v i t y of mortgage rates as noted in the above arguments fo r pr ice ra t ion ing d i c t a t e that the c r e d i t ra t ion ing var iab le be measured by a proxy. A measure commonly used to ind ica te change in i n t e r e s t rates in the c a p i t a l markets is the d i f fe rence between the mortgage rate and the bond ra te . This measure has been used by Smith and S p a r k s . ^ The theory behind the use of t h i s measurement device is that the bond rate can be expected to react more qu ick ly to changing c r e d i t condi t ions than the mortgage rate because of bond rate i n e l a s t i c i t y . ^ The arguments of the lack of s e n s i t i v i t y of the mortgage rate (r r n) as presented above by the p r ice ra t ion ing arguments may a lso be added to Muth and J a f f e e ' s hypotheses. The r e s u l t in to ta l i s that the d i f f e r e n c e between the monfgage' anidtfeond rate (r - r^) decreases as i n t e r e s t rates r i s e . A negative c o r r e l a t i o n r e s u l t s between r m - r^ and bond rates (r^) . The r m - r^ proxy has been tested in nat ional models. Use of th is va r iab le impl ies that regional housing markets w i l l respond to nat ional c r e d i t c o n d i t i o n s . If f o r example, excess demand e x i s t s in the housing market and mortgage rates 77 decrease, then the response by the housing market may not occur . The c r e d i t r a t i o n i n g v a r i a b l e depends on the regional housing market ac t ing in conjunct ion with the nat ional mortgage markets. 5.4.2 Income E f f e c t The choice of a va r iab le to r e f l e c t the impact of income on the demand fo r housing can take several forms. Freidman^O emphasized permanent income; M u t h ^ measured current income and p r i c e ; E v a n s ^ investment funct ion in p o housing depended upon current income; whereas Hymans and Shapiro emphasized a two quarter change in income lagged one quarter in t h e i r housing s t a r t s f u n c t i o n . The choice of the r a t i o of current income r e l a t i v e to the p r i c e of housing r e f l e c t s a s tab le consumer p r i c e index as well as the bas ic r e l a t i o n s h i p between p r i c e of housing and income as des i red by the conventional l enders . Th is r a t i o (or more commonly the r e c i p r o c a l ) i s often used as a measure of what a potent ia l purchaser should consider as an upper l i m i t in purchasing a house. The income to p r ice r a t i o can be expected to be negat ive ly re la ted to the demand fo r e i ther assigned mortgages or agreement - for -sa le . Income leve l i s considered to be a co inc ident i n d i c a t o r with respect to the business c y c l e . In periods of increas ing i n t e r e s t r a t e s , income can be expected to decrease as business investment i s c u r t a i l e d . Given that s u b s t i t u t i o n can be expected to occur in the market f o r e x i s t i n g housing, then housing p r i c e l e v e l s w i l l s t a b i l i z e and the net e f f e c t is that the r a t i o w i l l decrease as i n t e r e s t rates increase . The question a r i s e s whether or not th is expected decrease in the income to p r i c e r a t i o w i l l be accepted by the vendor org inat ing an agreement-for-s a l e . If potent ia l mortgagors are experiencing reduced l e v e l s of income, i t makes l i t t l e sense to o r ig ina te an agreement- for -sa le to a borrower of reduced f i n a n c i a l s ta tu re . The answers to t h i s paradox are s e v e r a l . F i r s t , the pr iva te vendor can 7 8 adjust p r ice or i n t e r e s t rate to r e f l e c t the r i s k invo lved . A l t e r n a t i v e l y , the changes in pr ice to income may tend to be treated as v i r t u a l l y n o n - s i g n i f i c a n t from a r i s k viewpoint . In essence a s h i f t of the p r ice to income r a t i o from 3.0 times earnings to 3.2 times earnings may be considered to be i n s i g n i f i c a n t by the vendor. In both polar cases , the same expected r e s u l t s occurs . As the income to pr ice r a t i o decreases, demand fo r assigned mortgages (or pr iva te vendor f inancing) can be expected to increase . A negative c o r r e l a t i o n can be expected. 5.4.3 Rental Market Subst i tu t ion Rental housing i s a subs t i tu te for ownership. Inc lus ion of the e f f e c t of rent l eve ls i s necessary to account f o r the poss ib le s h i f t from rental to ownership. A rent to house pr ice r a t i o i s used to account fo r th is s h i f t . For example, the Huang^^ housing model considered the value of new houses purchased to be a funct ion of the expected r a t i o of rents to housing p r i c e s ; K a l c h b r e n n e r ^ in summarizing the SSRC-MIT-PENN (SMP) econometric model noted that per cap i ta demand f o r the stock of housing i s a funct ion of the i m p l i c i t renta l p r i c e fo r the stock of houses r e l a t i v e to general consumer p r i c e s . E v a n s ^ U s e d a rent index lagged three quarters in his demand f o r housing f u n c t i o n . The reasoning fo r the use of the above of r a t i o i s that as rent i n c r e a s e s , the r e l a t i v e cost of homeownership can be expected to decrease. A s h i f t from rental uni ts to ownership uni ts can be expected. This r a t i o is p o s i t i v e l y re la ted to the demand fo r m o r t g a g e s . ^ The s p e c i f i c a t i o n of the dependent va r iab le as a c y c l i c a l component of the e x i s t i n g housing market does not change th is expecta t ion . As mortgage ra t ion ing occurs , by conventional l enders , housing s ta r ts d e c l i n e . Assuming no abrupt s h i f t s in underly ing demand, supply of new rental uni ts and supply of new housing ownership uni ts i s reduced. Reduction in the supply of rental uni ts causes an 79 increase in the rental payments o f the tenant. The ownership housing sec tor has two sources o f flows on which to re ly fo r units f o r market. The new housing supply sec tor may s u f f e r a reduct ion in new units due to inc reas ing i n t e r e s t r a t e s . The e x i s t i n g stock however, provides a p ropor t ion -28 ate ly greater supply of e x i s t i n g units which are t r a n s f e r a b l e . i n s p i t e o f the reduct ion in housing s t a r t s . Hence turnover of ownership housing may be d imin ished , but w i l l not be as abrupt ly a f fec ted as w i l l the rental market. Pr ices of owner-ship housing should not move upward as qu ick ly as the pr ices of rental u n i t s . The net e f f e c t is to cause the rent to p r ice r a t i o to increase as the c y c l i c a l propor-t ions of e x i s t i n g mortgage market i n c r e a s e . The p a r t i a l d e r i v a t i v e is expected to be p o s i t i v e . The question o f nominal (recorded) and real ( rea l i zed ) rents does not in f luence the expected d e r i v a t i v e as rental s u b s t i t u t i o n i s being measured. Recorded rents are those paid by the tenant; r e a l i z e d rents are those received .by the investor of rental apartments. In determining demand f o r mortgages of e x i s t i n g housing , concern f o r . t h e s u b s t i t u t i o n o f rental tenure f o r ownership i s measured by the recorded r e n t s , not by r e a l i z e d r e n t s , as the former are subs t i tu ted by the tenant f o r monthly payments on a s i n g l e fami ly house. 5.4.4 A l t e r n a t i v e Investment Demand f o r c y c l i c a l components of the e x i s t i n g housing market may r e s u l t from demand fo r a l t e r n a t i v e investment. For example, th is demand may a r i s e i f the rate o f return on the .s tock market is less than that exh ib i ted in a regional housing market. A l te rna te demand f o r mortgages can be expected to vary i n v e r s e l y with the return on the stock market. Specula t ive demand fo r mortgage can be expected to vary inverse ly with the return on the stock market. The c y c l i c a l components of the e x i s t i n g housing market can be expected to react to the above r e l a t i o n s h i p because of the ease of e n t r y , lack of regula t ion and lack of s tandard iza t ion required in obta in ing an agreement- for -sa le or assigned mortgages. The react ion can be expected to be f e l t f i r s t in these market segments ra ther than the conventional lender market because of the above c h a r a c t e r i s t i c s . 80 5.5 EXPECTED SUPPLY RELATIONSHIPS c Q s = g ( r , V) where r = a measure of c r e d i t r a t i o n i n g . Measured by the d i f f e rence between the mortgage and bond r a t e s . V = i s the occupancy r a t e . Measured by the r a t i o of completed but unoccupied housing to to ta l housing s tock . Measured on a quar te r ly b a s i s . Expected p a r t i a l de r iva t i ves are: 3 Q s e / 9r < o a Q s G / av < o 5.5.1 Vacancy Rates: Vacant housing units are inventory . This inventory may be viewed as a means of determining a v a i l a b l e supply o f housing units in the housing market. Inasmuch as vacancy rate has been introduced in to housing s t a r t models, to determine the r e l a t i o n s h i p between number o f households and dwel l ing u n i t s , vacancy rate i s used in the above model to measure the ava i l ab le supply of hous ing , both in the new and e x i s t i n g housing market. T h e o r e t i c a l l y , the normal vacancy rate (seasonal ly adjusted) should be used. The normal, vacancy rate i s a composite o f dwel l ing units f o r sa le and rent as well as those units needed f o r seasonal demand and those under r e p a i r . In s p i t e of t h e o r e t i c a l completeness however, th is rate i s extcemely d i f f i c u l t to measure. A second measure suggested by Grebler and M a i s e l , i s that 29 of housing. inventory under c o n s t r u c t i o n . This measure may take two forms, i . e . , actual inventory under const ruct ion as well as the leve l of completed but un-occupied housing. The importance o f inventory under const ruc t ion i s noted by Grebler . and Maisel. . "As is true in any inventory , the units under const ruct ion are re la ted to s a l e s . Bu i lders w i l l t ry to maintain a c e r t a i n r a t i o of uni ts under con-s t r u c t i o n to s a l e s . In a market of rapid turnover , they may r a i s e t h i s r a t i o . . . As sa les begin to f a l l , r i s k s increase and b u i l d e r s w i l l cut the r a t i o and reduce the units under const ruct ion by even more than the f i n a l demand."30 The same inventory concept 'app l ies to the completed but unoccupied housing s e r i e s . In choosing th is l a t t e r s e r i e s , recogni t ion is given to units a v a i l a b l e f o r sa le which r e f l e c t more accurate ly r e f l e c t supp ly , as opposed to b u i l d e r expecta t ions . These expectat ions may or may not r e f l e c t the actual supply as Grebler and Maisel 81 note in t h e i r quotat ion above. Hence fo r th is reason, th is completed but unoccupied housing se r ies is considered a more t h e o r e t i c a l l y sound measure, than the inventory under c o n s t r u c t i o n . The var iab le used to measure vacancy rate in the above model, i s the r a t i o o f 31 completed but unoccupied housing r e l a t i v e t o t t o t a l housing s tock . The d e r i v a t i v e of the supply of c y c l i c a l mortgages to the vacancy rate is expected to be negat ive . The s ign depends on the a v a i l a b l e sources of f inanc ing in the mortgage market. I f a l l lending sources are supply ing mortgage c r e d i t , the increase in inventory of housing uni ts could be expected to have a negative e f f e c t on the supply o f c y c l i c a l mortgage d o l l a r s as uncerta inty increases i n . t h e housing market. The pr iva te vendor i s p a r t i c u l a r can be expected to react much l i k e the b u i l d e r in face o f uncer ta in ty . High l e v e l s o f completed but unoccupied housing may reduce the propensi ty of the p r iva te vendor to s e l l . 5.6 COMPLETED MODEL AND METHODOLOGY 5.6.1 Complete Model The complete model i s now presented in terms of quant i ty of c y c l i c a l funds demanded and s u p p l i e d . Q D C = a + b 1 r + b 2 Y + b 3 R + b 4 S + e (5.1) Q S C = + B ] r + B 2 V * u (5.2) Q D C = Q S C (5.3) 5.6.2 Est imat ing Technique The demand and supply equations are estimated separa te ly . Given that the c r e d i t r a t i o n i n g va r iab le (r) in the above equation had been endogenous, then the procedure would have been to solve the system of equations simultaneously 82 using the two stage leas t squares technique." 3 ^ However in t h i s system of equation r i s exogenous, given the l imi ted nature of the regional mortgage market r e l a t i v e to the national cap i ta l markets. Hence, est imat ion of the 'equa,ti<on:5 w i l l be undertaken independently. Second, in the equations estimated in Chapter VI , the c y c l i c a l components of the mortgage market are segregated in to several s u b - s e c t i o n s . Hence, in these s i t u a t i o n s the argument fo r r being exogenous is strengthened cons iderab ly . 5.6.3 Methodology In order to tes t the hypothesis that pr iva te vendor f inanc ing and assigned mortgages s t a b i l i z e the p r i c e of housing, periods of excess demand and excess supply in the housing market were i d e n t i f i e d during the per iod under study. The f i r s t , time period (1954 quarter 1 to 1957 quarter 4) i s one of excess demand ( i . e . , housing p r i ces increased during t h i s p e r i o d ) ; the second time per iod (1959 quarter 1 to 1962 quarter 4) i s one of excess supply ( i . e . , housing pr ices decreased during t h i s per iod from a given p r i c e p e a k ) . 3 3 This methodology of s e l e c t i n g periods of excess supply or excess demand, r e f l e c t s the concern with the s t ruc ture of markets in d i s e q u i l i b r i u m . "The est imat ion of supply and demand schedules f o r such markets has become a problem of p r a c t i c a l importance. The main problem of est imat ion i s that in the absence of an equ i l ib r ium cond i t ion the observed quant i ty traded in the market may not s a t i s f y both the demand and supply schedules . In general approach to th is problem i s to t ry to separate the sample in to demand and supply regimes such that each schedule may be approximately f i t t e d against the observed quant i ty f o r the sample points f a l l i n g wi th in i t s r e g i m e . " 3 4 The observed quant i ty i s equal to e i t h e r the quant i ty demanded or the quant i ty s u p p l i e d . The observed quant i ty w i l l be equal to the minimum of these two q u a n t i t i e s . / " \ Q t = min D t , S t (t = 1 , 2 . . . , T ) (5.4) 83 where i s equal to quant i ty demanded during per iod t ; i s equal to quant i ty suppl ied during per iod t . I f the quant i ty demanded.exceeds the quant i ty s u p p l i e d , demands w i l l go u n s a t i s f i e d ; whereas i f the quant i ty suppl ied exceeds the quant i ty demanded, supp l ie rs w i l l go u n s a t i s f i e d . Pr ice change is assumed to be a p o s i t i v e funct ion of the excess demand in the market. In p a r t i c u l a r i t may be poss ib le to postulate that A P t J 0 as D t - S t J 0 (5.5) Equation 5.5 implies 1 that the d i r e c t i o n o f . p r i c e change may be used as i n d i c a t o r 35 o f the excess demand or excess supply in the market. This above method may be i l l u s t r a t e d by graphing the demand and supply funct ion against p r ice as shown in Figure 5.4. Observing Markets in D isequ i l ib r ium Figure 5.4 Observed .price and quant i ty in periods of excess demand or excess supply . During periods of excess demand, the observed quant i ty w i l l be the supply curve. The reverse w i l l hold true in periods of excess supply . 84 If the quoted p r i c e i s less than P* , then there i s excess demand in the market. This implies from equation 5.5 that p r ice must be r i s i n g . From equation 5.4 i t can be noted that in periods of excess demand, quant i ty suppl ied w i l l equal the observed quant i ty and quant i ty demanded w i l l not be observed. The converse holds true when the quoted p r i c e is greater than P*. In th is case there is excess supply and pr ice must f a l l . Again r e f e r r i n g to equation 5.4, i t can be noted that in periods of excess supply , quant i ty demanded w i l l equal the observed quant i ty and the quant i ty suppl ied w i l l be unobserved. Test ing of the hypothesis , does not inc lude the d i r e c t measurement of p r i c e of housing in the model. The hypothesis w i l l be accepted or re jected on a basis of inference with respect to the demand and supply equations noted during the above two per iods . P r ice measurement i s not involved because s u b s t i t u t i o n of source of f inanc ing does not provide r e a d i l y i d e n t i f i a b l e turning points in the housing pr ice data . The point where one source of f inanc ing stops e f f e c t i v e l y s t a b i l i z i n g the p r ice of housing and the other begins cannot be measured under condi t ions presented in t h i s time p e r i o d . In addi t ion i t must be noted that measurement of housing pr ices is an unresolved area of research . Measurement problems are discussed by Hamilton 3 ** , B a i l e y , Muth and Nourse 37 as well as B h a t i a . 3 ^ Hence use of yea r ly data to obtain periods of excess demand or supply in the housing markets overcomes the short run measure-ment i r r e g u l a r i t i e s . 85 Footnote References - Chapter V 1. (lames £VansHorne. Functions and Ana lys is of Capi ta l Market Rates, (New York: Prent ice H a l l , 1970), pp. 1-14 as well as Terrence C l a u r e t i e . ^Interest Rates, The Business Demand fo r Funds and the Res ident ia l Mortgage Market: A Sect ional Econometric Study," Journal of F inance, December 1973, pp. 1313-1326, develop f low-of - funds models which do not recognize d i r e c t lending by household s e c t o r s . 2. This statement can be c l a r i f i e d by noting that with increased i n t e r e s t r a t e s , pr ivate vendors may supply more f i n a n c i n g . The mortgagor demanding funds is not rat ioned out of the conventional mortgage market by increas ing r a t e , but rather he i s ra t ioned out of the conventional mortgage market by lack of a v a i l a b l e mortgage d o l l a r s . I ns t i tu t ions do not r a t i o n on a basis of r a t e . Short term adjustment to the mortgage rate i s achieved by s t a t i n g that they have (or have not) funds a v a i l a b l e at a given t ime. An analogy can be made to a baker s e l l i n g bread. If only 1 loa f remains in a given day and there are 2 customers wa i t ing , the baker does not auct ion the bread. Rather he s e l l s the l a s t loa f to the f i r s t customer and informs the second that there i s no bread u n t i l to-morrow. The second customer can go to another bakery or returns the next day. 3. The consumer p r i c e index during the time periods under study increased only s l i g h t l y . For example from 1954 quarter 1 u n t i l 1957 quarter 4, the p r ice index rose from 115.5 to 123.1 or a 1.5% increase per year (using 1949 = 100). In the second study p e r i o d , the p r i c e index rose from 100.0 to 102.6 (using 1961 = 100). The rate of increase was less than 1% per year . Hence, in both cases , measurement of real d o l l a r s w i l l not change the r e s u l t s . Source of consumer p r i c e index can be found in The Consumer Pr ice Index fo r Canada (1949 = 100), (Ottawa: Dominion Bureau of S t a t i s t i c s , Mar 1963) and in The Consumer P r i c e Index f o r Canada 1961-1967, (Ottawa: Dominion Bureau of S t a t i s t i c s , 1969). 4. McLeod, Young and Weir weighted bond r a t e s , (Toronto: McLeod, Young and Weir, 1954-1963). 5. Review of Man Hours and Hourly Earnings With Average Weekly Wages 1945-1963. (Ottawa: Dominion Bureau of S t a t i s t i c s , August 1964). 6. Measurement of a rent index was obtained by sampling rental property adver-t i s e d in newspaper ads fo r the per iod under study. Central Mortgage and Housing Corporation c o l l e c t i o n of rental information did not begin u n t i l 1961. 7. Measurement of a l te rnate form of investment i s der ived from rate of return of stocks l i s t e d on the Toronto Stock exchange. Rate of return inc ludes dividends and cap i ta l ga ins . Ser ies developed by Dr. W. Wood, A s s i s t a n t P r o f e s s o r , Un ivers i ty of B . C . , Vancouver, 1975. 86 8. J . Guttentag, "Credi t A v a i l a b l i t y , Interest Rates and Monetary P o l i c y , " Southern Economic J o u r n a l , January 1960, pp. 219-229. 9. Dwight J a f f e e . Cred i t Rationing and the Commercial Loan Market. (New York: John Wiley and Sons I n c . , 1971), pp. 1-183. 10. Marshall Freimer and Myron Gordon. "Why Bankers Ration C r e d i t , " Quarter ly  Journal of Economics, August 1965, pp. 397-416. 11. J a f f e e , Cred i t Rationing and the Commercial Loan Market, pp: 28. 12. E . J . Kane and B.G. M a l k e i l . "Bank P o r t f o l i o A l l o c a t i o n , Deposit V a r i a b i l i t y and the A v a i l a b i l i t y Doc t r ine , " Quarter ly Journal of Economics, February 1965, pp. 113-134. 13. J a f f e e , Cred i t Rationing and the Commercial Loan Market, pp. 69-104. 14. I b i d . , pp. 69-104. 15. Richard Muth. " Interest Rates, Contract Terms and the A l l o c a t i o n of Mortgage Funds," Journal of F inance, December 1963, pp. 63-80. 16. I b i d . , p. 72. 17. I b i d . , p. 78. 18. Lawrence Smith and Gordon Sparks. " S p e c i f i c a t i o n and Est imation of F inanc ia l Stock Adjustment Models Internat ional Economic Review, February, 1971, pp. 14-26. 19. Reasons for business demand i n e l a s t i c i t y are noted in Sect ion 2 . 2 . 1 . 1 . 20. Mi l ton Freidman. A Theory of the Consumption Funct ion , (Pr inceton , N . J . : Princeton Un ivers i ty Press for NBER, 1957), p. 221. 21. Richard Muth. "The Demand fo r Non-Farm Housing," in the Demand f o r Durable Goods ed. by A. Harberger. (Chicago: The Un ive rs i t y of Chicago Press , 1960), pp. 29-56. 22. Michael Evans. "Investment in Res ident ia l C o n s t r u c t i o n , " in Macro-economic  A c t i v i t y . (New York: Harper and Row, 1969), p. 197. 23. Ray F a i r . "D isequi l ib r ium in Housing Models," Journal of F inance, May 1972, pp. 217, notes the model used by Hymans and Shapiro. 24. F a i r , "D isequi l ibr ium in Housing Models," p. 218 notes the model developed by Huang. 25. F a i r , "D isequi l ibr ium in Housing Models,"pp.2.2.17 i-notes the s p e c i f i c a t i o n of the SMP model. 26. Evans, "Investment in Resident ia l C o n s t r u c t i o n , " p. 197. 87 27. This s p e c i f i c a t i o n has the same expected r e s u l t s as noted in T. C l a u r e t i e . "Monetary Growth Rates" . . . PhD. T h e s i s . (Washington:';'Wash'fngtonoState U n i v e r s i t y , 1971), p. 23. 28. Hamilton, Mao et a l . "Turnover Rates in Metropol i tan Vancouver," pp. 1-31. 29. Leo Grebler and Sherman M a i s e l . "Determinants of Resident ia l Const ruc t ion: A Review of the Present Knowledge," in Impacts of Monetary P o l i c y . Commission on Money and C r e d i t . (Englewood C l i f f s : Prent ice H a l l , 1963), p. 566. 30. I b i d . , p. 575. 31. The housing stock ser ies has been adjusted for demol i t ions , conversions based on the evidence of the C i t y of Vancouver. A . F . Eger . Computer Program  Number 16, Un ivers i ty of B .C . 1974 ind ica tes the actual adjustments appl ied to each mun ic ipa l i t y . 32. R . J . Wonnacott and T . H . Wonnacott. Econometrics. (New York: John Wiley and Sons, 1970), pp. 190-192 ind ica te methodology for est imating simultaneous equat ions. 33. Graphic trends of housing p r i c e s , i n t e r e s t rates and vacancy l eve ls can be found in Figure 4 .3 . 34. Ray F a i r and Dwight J a f f e e . "Methods of Est imat ion f o r Markets in D isequ i l ib r ium, Econometrica, V o l . 40, No. 3, May 1972, pp. 497-514. 35. I b i d . , pp. 497-503. D iscussion on d i s e q u i l i b r i u m measurement draws on the source i n d i c a t e d . 36. Hamilton, "Housing Pr ice Index Paper," pp. 1-33. 37. M. B a i l e y , R. Muth and H. Nourse. "A Regression Model f o r Real Estate Pr ice Index Cons t ruc t ion , " Journal of American S t a t i s t i c a l A s s o c i a t i o n , Dec. 1963, V o l . 58, pp. 933-942. 38. K.B. Bhat ia . "A Pr ice Index for Non-Farm One Family Houses 1947-1964," Journal of American S t a t i s t i c a l A s s o c i a t i o n , March 1971, V o l . 66, pp. 23-32. 88 CHAPTER VI STABILIZING EFFECT OF PRIVATE"VENDOR FINANCING AND ASSIGNED MORTGAGES ON HOUSING PRICES: EMPIRICAL RESULTS 6.1 SUMMARY 6.2 INTRODUCTION 6.3 EMPIRICAL RESULTS: EXCESS DEMAND IN THE HOUSING MARKET 6.3.1 Pr ice Rat ioning Var iab le 6.3.2 Rental Market S u b s t i t u t i o n 6.3.3 Income Var iab le 6.3.4 Subst i tu te Investment 6.4 EMPIRICAL RESULTS: EXCESS SUPPLY INTHE HOUSING MARKET 6.4.1 Mortgage Demand Equations 6.4.1.1 Vacancy Rate Var iab le 6 .4 .1 .2 I n s t i t u t i o n a l Ref inancing of Mortgages 6.4.2 Mortgage Supply Equations 6.4.2.1 A l te rna te Measures and Aggregation 6.5 S i g n i f i c a n c e to Hypothesis 6.5.1 Cred i t Rat ioning Var iab le 89 6.1 SUMMARY A major conclus-ion of th is chapter is that the c y c l i c a l mortgage sub-markets demonstrated s i g n i f i c a n t l eve ls of s u b s t i t u t i o n in the excess demand per iod of 1954 to 1957. Th is conclus ion i s based on: the h igh ly s i g n i f i c a n t c r e d i t r a t i o n i n g v a r i a b l e est imated from the der ived demand equations of e i t h e r the agreement f o r -sa le or assigned mortgage markets. The: h y p o t h e s i s . t h a t , the s u b s t i t u t i o n of the agreement- for -sa le and assigned mortgage markets s t a b i l i z e the p r i c e of housing, cannot be r e j e c t e d . Study of the excess housing supply per iod of 1959 to 1962 resu l ted in a s i m i l a r c o n c l u s i o n , i n s p i t e o f i nconc lus ive s t a t i s t i c a l t e s t s . Abnormal i t ies o f high f o r e -c losure r a t e s , and the withdrawal of.non-bank conventional lenders from the market f o r e x i s t i n g housing cause the model to e x h i b i t poor consistency and inconc lus ive r e s u l t s . Review of the d e s c r i p t i v e evidence however, ind ica tes that s u b s t i t u t i o n of the agreement- for -sa le s e c t o r occurred: when i n s t i t u t i o n a l funds were s h i f t e d to the re f inance mortgage market in s p i t e , of. d e c l i n i n g i n t e r e s t r a t e s . Inasmuch as the agreement- for -sa le sec tor remained as the major source o f funds , i t can be i n f e r r e d that th is market supported the p r i c e of housing. Without tfiiis market, greater v o l a t i l i t y in housing p r i c e s could have been expected in the dec l ine in housing p r i ces of 1961 and 1962. Hence in both study p e r i o d s , the c y c l i c a l mortgage submarkets s t a b i l i z e the p r i c e of housing. During periods of excess demand, . i t would appear that there i s a s h i f t from rental.accommodation to lower pr iced .hous ing i f the rent to housing p r i c e r a t i o i n c r e a s e s . . The income to housing p r i c e r a t i o d id not r e s u l t in any d i s c e r n i b l e p a t t e r n . Measurement o f . t h e income var iab le is the reason given fo r the lack o f expected r e l a t i o n s h i p s . The s u b s t i t u t e investment var iab le d id not show the expected r e s u l t s . This outcome could ind ica te that the emphasis of investment by the pr iva te sec tor was in the mul t i -hous ing unit s e c t o r . In a per iod of excess, housing demand., the use of the c r e d i t r a t ion ing va r iab le r m " r b P r o v e s t o b e a s t a t i s t i c a l l y s i g n i f i c a n t measure o f r a t i o n i n g i n the mortgage markets. In a per iod o f excess housing s u p p l y , th is measure i s not adequate. The 90 measure f a i l s to account fo r poss ib le i n t r a - i n s t i t u t i o n a l s h i f t in mortgage lend ing . 6.2 INTRODUCTION This chapter tests the der ived demand and supply model formulated in Chapter V. The model is tested separate ly during an excess housing demand per iod and an excess housing supply p e r i o d . The model def ined in Sect ion 5.4 tested using 7 d e f i n i t i o n s of mortgage f inanc ing found in the market f o r e x i s t i n g housing. The d e f i n i t i o n s of the f i r s t four equations (6.1 to 6.4 i n c l u s i v e ) represent c l a s s i f i c a t i o n combinations which have evolved in the sa le of houses. For example, assignment of e x i s t i n g mortgages or new agreements- for -sa le can be used as a s i n g l e means of f inanc ing (equation 6.1 or 6 .2 ) . Combinations can be used. A new agreement-f o r - s a l e plus assignment of an agreement- for -sale or an agreement- for -sale plus assignment of an e x i s t i n g mortgage (equation 6.3 or 6.4) are the major combinations which have evolved. Type of D e f i n i t i o n Equation Reference (1) Assignment o f e x i s t i n g mortgages 6.1 (2) Agreement- for -sa le sec tor 6.2 (3) Agreement- for -sale and assignment o f agreement- for -sa le 6.3 (4) Agreement- for -sale and assignment of e x i s t i n g mortgage 6.4 (5) Aggregate o f equations 6.1 to 6.4 6.5 (6) Assignment of agreements-for-sa le and assignment of e x i s t i n g mortgages 2 6.6 (7) Agreement- for-sale and assignment of both e x i s t i n g mortgages and agreements- for -sa le 6.7 Table 6.1 D e f i n i t i o n of dependant va r iab les used in the der ived demand and supply model f o r mortgage f i n a n c i n g . The percentages of each mortgage type are based on the numbers of observations per type found in the sample per iod from 1954 to 1963. Sample includes sales and non-sales t r a n s f e r s , recorded from c e r t i f i c a t e s of t i t l e in the Greater Vancouver Regional D i s t r i c t . 91 Equation 6 . 5 to 6 . 7 represent a r t i f i c i a l l y aggregated d e f i n i t i o n s . The combination f o r example, of an assigned mortgage and an assigned agreement-f o r - s a l e (equation 6 . 6 ) -are...not usedutof friinancehthoiJsi.Tig. These a r t i f i c i a l combinations are tested in order to determine the impact on aggregation that the model presents . Aggregat ion, in add i t ion could r e s u l t in reduce sample s i z e f o r fu ture s t u d i e s . Forrexample, i f s i m i l a r expected c o e f f i c i e n t s r e s u l t in equations 6.1 to 6 . 4 , the study of aggregated combinations could al low fo r a reduced sample s i z e in fu ture studies and s t i l l maintain sampling s i g n i f i c a n c e . The labour in tens ive nature and t h e , s p e c i a l permission from the Land Regis t ry O f f i c e s needed to obtain the da ta , make t h i s aspect of aggregation a very important one. The methodology presented in Chapter V , ind icated the basis of s e l e c t i o n 3 of excess demand and excess s u p p l y ; p e r i o d s . Th is methodology es tab l ished two unique study periods f o r the mortgage market of e x i s t i n g housing. The acceptance or r e j e c t i o n of the hypothesis depends on the s i g n i f i c a n c e of the c r e d i t r a t i o n i n g v a r i a b l e and the e l a s t i c i t y of demand obtained from the demand f u n c t i o n s . Examination of equation consistency and s t a b i l i t y of the remaining independent v a r i a b l e s completes the examination;"! of the demand equations. . Demand equations are estimated in two d i s t i n c t time p e r i o d s , i . e . , excess demand and excess supply . The e l a s t i c i t i e s c a l c u l a t e d fo r both these periods are re la ted to the supply equations in the periods o f excess supply in order to measure the impact of vacancy on the c y c l i c a l components of the mortgage market during excess supply p e r i o d s . Equation Reference Equation Type Equation Estimated Percentage Frequency of Mortgage Types Within Sample (*) R2 Durbin Watson F Statistic F Probability Statistic (excludes constant) 6.1 Assigned Mortgages C (L - 47.5 - 37.41r - 57.87R + 1.66Y - 8.44S u (3.7) (-2.28) (-3.37) (1.74) (-1.65) [.00] [.05] [.Oil (.11] [.13] 10 .76 1.84 7.90 .00 New Agreements-for-sale Q n C - -19.61 - 772.6r + 62.36R + .92Y + 18.17S (-.77) (-2.39) (1.84) (.49) (1.80) [-45] [.03] [.10] [.63] [.10] 16 .72 1.84 6.42 .01 6.3 New Agreements-for-sale and assigned agreements-for-sale Q n C - 17.09 - 377.5r - 7.88R - 11.2Y - 3.06S (1.47) (-2.54) (-.51) (-1.3) (-.66) [.17] [.03] [.62] [.22] [.52] 2 .52 2.52 2.75 .09 6.4 New Agreements-for-sale and Assigned Mortgages Q. C - 24.68 - 422.9r - 10.65R - 1.21Y - 7.86S (1.93) (-2.59) (-.62) (-1.28) (-1.54) [.08] [.03] [.55] [.22] [.15] 4 .47 2.16 2.24 .14 6.5 Aggregate of Equation 6.1 to 6.4 Q C - 63.02 - 1964.3r - 3.OR + 2.48Y + 2.72S U (1.59) (-3.77) (-.05) (1.03) (.17) [-14] [.00] [.96] [.32] [.87] 32 .77 1.78 8.62 .00 6.6 Combination of Assigned Agreements-for-sale and Assigned Mortgages Q n C - 38.5 - 599.Or - 33.48R - .64Y - 4.16S u (3.22) (-3.65) (-2.08) (-.72) (-.67) [.01] [.00] [.06] [.48] [.40] 13 .80 1.67 9.89 .00 6.7 Equation 6.6 Plus New Agree-ments for-sale Q„ C • 31.9 - 10.20r - 2.89R + .10Y + 4.82S 0 0.78) (-4.48) (-.12) (.08) (.68) [.10] [.00] [.90] [.94] [.51] 21 .85 1.92 14.51. .00 Table 6.2 Demand equations of cyclical components of the mortgage market for existing housing under excess demand conditions. Period of analysis 1s 1954 to 1957 inclusive for Greater Vancouver Regional District Levels of significance indicated in square brackets; t statistics are shown in rounded brackets. Refer to Section 6.2 for an example of financing technique and 93 6.3 EMPIRICAL RESULTS: EXCESS DEMAND IN THE HOUSING MARKET The demand equations r e l a t i n g to excess demand period 0-H1954 to 1957 are presented in Table 6 .2 . In reviewing the r e s u l t s of the model, t es ts of in terna l consis tency and t e s t s of agreement with the i n i t i a l assumptions of the theory w i l l form the bas is of d i s c u s s i o n . A tes t of in te rna l consis tency such as the Durbin Watson s t a t i s t i c ind ica tes negative- s e r i a l c o r r e l a t i o n in equation 6 . 3 , 6.4 and 6 .6 . Th is suggests that some v a r i a b l e has been omitted from the equat ions. Th is v a r i a b l e i s one which in f luences demand for several p e r i o d s . Examination of the r e s i d u a l s of the above equations ind ica tes that t h i s in f luence occurred in the l a t t e r part of the time s e r i e s . The reason fo r t h i s e r ror pattern is unknown. The F s t a t i s t i c of equations i s s i g n i f i c a n t at a = .01 in a l l but equations 6.3 and 6.4 . The missing v a r i a b l e in these equations could account f o r t h i s lack of s i g n i f i c a n c e . The c o e f f i c i e n t s of determination give reduced l e v e l s of explained var iance in those equations e x h i b i t i n g the high F . s t a t i s t i c s . The above r e s u l t s i n d i c a t e that the c o e f f i c i e n t s of the equation can be expected to be stable in a l l equations except 6 . 4 . s e\i. i M M B a e Examination of Table 6.2 reveals that the p r i c e r a t i o n i n g v a r i a b l e r, i s s i g n i f i c a n t at l e s s than a = .05 and has the expected negative s ign f o r a l l equat ions. The e l a s t i c i t y of c y c l i c a l component demand i s the key v a r i a b l e in t h i s a n a l y s i s . The e l a s t i c i t i e s of each of the equations are recorded in Table 6 .3 . A l l equations demonstrate a high e l a s t i c i t y of demand with respect to changes in p r i c e r a t i o n i n g . C o r r e l a t i o n , "matrices support ing these r e s u l t s can be found in Appendix II. These r e s u l t s i n d i c a t e that s u b s t i t u t i o n occurs 94 in -the mortgage market fo r e x i s t i n g housing by the various c y c l i c a l components. This s u b s t i t u t i o n of f i n a n c i n g , r e s u l t s in mortgage demand being met as con-vent ional lenders ra t ion mortgages. The s t a b i l i t y of the equations as well as the s i g n i f i c a n c e of the p r i c e r a t i o n i n g var iab le i n d i c a t e s i g n i f i c a n t s u b s t i t u t i o n by the c y c l i c a l components o f the mortgage market f o r e x i s t i n g housing. This s u b s t i t u t i o n occurred under condi t ions of excess demand. Under these condi t ions pr ices of housing can be expected to s t a b i l i z e as conventional housing lenders ra t ion mortgage c r e d i t . On the basis of these r e s u l t s , the hypothesis that the s u b s t i t u t i o n e f f e c t of the agreement- for -sa le and assigned mortgage market s t a b i l i z e the p r i c e of housing cannot be r e j e c t e d . Equation Reference Number Equation Type E l a s t i c i t y 6.1 ? Assigned conventional mortgage -1.10 [.04] 6.2 New agreements- for -sa le -1.39 [.03] 6.3 New agreements- for -sa le and assigned agreements- for -sa le -2.39 1.031" , 6.4 New agreements- for -sa le and assigned mortgages -1.95 [.03] 6.5 Aggregation o f equations 6.1 to 6.4 -1.38 [.003] 6.6 Combination of assigned agreements-f o r - s a l e and agreements- for -sa le and assigned mortgages -1.29 [.004] 6.7 Combination of new agreements-for-s a l e as well as assigned mortgages and assigned mortgages and assigned agreements- for -sa le -1.30 [.001] Table 6.3 E l a s t i c i t i e s of demand f o r c y c l i c a l components of- the mortgage market f o r e x i s t i n g housing. Levels o f s i g n i f i c a n c e o f , p r i c e r a t i o n i n g va r iab le ind ica ted by square brackets . 95 In add i t ion to demonstrating a high e l a s t i c i t y , i t can be noted that equations 6.3 and 6.4 have a s i g n i f i c a n t l y greater e l a s t i c i t y than do equations 6.1 or 6.2. The magnitude of each of these e l a s t i c i t i e s can be re la ted to the rate of increase in the p r i c e of housing. During periods of rapid increase in housing p r i c e s , equations 6.3 and 6.4 to have greater e l a s t i c i t i e s than the source of f inanc ing ind ica ted by equations 6.1 or 6.2. These l a t t e r equations : assume a large downpayment in periods of rapid p r i c e i n c r e a s e . If t h i s downpayment i s not a v a i l a b l e , then combinations of mortgage f i n a n c i n g , such as equations 6.3 and 6.4 are necessary. The e l a s t i c i t i e s of equation 6.5 and 6.6 i n d i c a t e on a combined basis the c y c l i c a l components are h igh ly e l a s t i c . The in terna l cons is tency of the equations and expected sign of the p r i c e ra t ion ing v a r i a b l e are „ maintained in equations 6.5 and 6.6. In a d d i t i o n , these equations i n d i c a t e that should future study be necessary for both the pr iva te vendor f inanc ing and assigned mortgage s e c t o r , then a reduced sample s i z e could be cons idered , so as to reduce study costs without c rea t ing sampling e r r o r . Q:6.3.2RER^fa3^MaE^e$u§f#-§td'^l3tlnjon .. The r e s u l t s of the rent to p r ice r a t i o are mixed. The important equation of p r iva te vendor f inanc ing ind ica tes s i g n i f i c a n c e and cor rec t s ign at a = .10. The assigned mortgage f inanc ing sector (equation 6.1) i s h igh ly s i g n i f i c a n t , , as i s the combined assigned agreement - for -sa le and assigned mortgage sector (equation 6.5). However, the observed signs are i n c o r r e c t . The impact of switching from rental accomodation appears to be f e l t most s t rong ly in the agreement - for -sa le s e c t o r . The agreement - for -sa le sector represents lower p r i c e housing. Table 6.4 ind ica tes that the average loan of MORTGAGE TYPE Year New Agreements-for-sale New Mortgages on Existing Housing New Mortgages on New Housing Average Loan Amount $ Average Loan to Value Ratio % Average Loan Amount $ Average Loan to Value Ratio % Average Loan Amount $ Average Loan to Value Ratio % 1954 4,500 76 4,600 . 50 9,400 78 1955 5,400 78 5,900 60 9,900 o 79 1956 5,200 79 8,000 64 10,300 73 1957 5,900 76 7,100 60 10,700 72 1958 6,700 74 8,400 61 11,600 79 1959 7,700 80 8,100 63 11,900 78 1960 7,800 83 9,400 63 11,300 69 1961 8,100 83 8,500 67 11,900 76 1962 7,100 83 8,300 69 12,700 70 1963 7,600 85 9,500 70 12,800 74 0 Table 6.4 Average loan to value ratio and average dollar loan amount of new and existing mortgage market for G.V.R.D. from 1954 to 1963. Data is recorded in current dollars. 97 the agreement- for -sale sec tor is s i g n i f i c a n t l y less than that of convent iona l ly f inanced housing. In addi t ion the loan - to -va lue r a t i o o f . t h e agreement-for-sa le sec tor is higher than that of the convent iona l ly f inanced s e c t o r . Hence the p r i c e of housing in the agreement- for -sale f inanced sec tor is less than that of the convent ional ly f inanced s e c t o r . I f tenants are going to switch from rental to ownership, i t would appear that they would more l i k e l y go to the lower pr iced housing, i l e . , the agreement- for -sale s e c t o r . The lower pr iced housing is a c lose s u b s t i t u t e fo r rental accommodation because of the s i m i l a r i t y in monthly payments. Further ana lys is of the above r e l a t i o n s h i p s is considered necessary before d e f i n i t i v e statements can be expected. 6 . 3 . 3 Income Var iab le The expected r e l a t i o n s h i p between the income to housing pr ice r a t i o and. demand f o r c y c l i c a l funds are not found in Table 6 . 2 . Equation 6.1 (assigned mortgages) has the most s i g n i f i c a n t t - s t a t i s t i c ( .11); however, the sign is i n -c o r r e c t . A l t e r n a t i v e est imat ion of the demand equation was obtained by rep lac ing 4 the income to housing pr ice var iab le with a migrat ion v a r i a b l e . Se lec t ion of the migrat ion var iab le was chosen in order to overcome the problem of measuring populat ion change. The income var iab le was adjusted to r e f l e c t the popluat ion b a s i s . However, the populat ion data se r ies is based on f i v e year census in format ion ; hence short run f l u c t u a t i o n s are not recorded. The migrat ion var iab le was used as a proxy to r e f l e c t changes in demand due to popluat ion i n c r e a s e . The income var iab le was omitted in . these se r ies o f tes ts because of poss ib le problems of m u l t i c o l l i n e a r i t y . 5 The r e s u l t s ind ica te that migrat ion had a . s i g n i f i c a n t impact on demand fo r agree-ments - fo r -sa le (equation 6 . 2 ) , in that the migrat ion to populat ion r a t i o was s i g n i f i c a n t at a = . 0 6 . The other equations showed no s i g n i f i c a n c e and the var iab le was e l iminated . The lack of s i g n i f i c a n c e of the income var iab le stems from one major source . The income var iab le i s an average. D i f fe ren t income s e r i e s , r e f l e c t i n g demographic groups could be analysed. This ana lys is could be extended to a s p a t i a l dimension. 98 However, in th is s tudy , s i g n i f i c a n t sample s i z e d id not e x i s t to permit ana lys is by sub-metropol i tan area . Being unable to study the income and lending behaviour of an i n d i v i d u a l mortgagor i s a.most troublesome one in the housing and mortgage l i t e r a t u r e . General ly proxies fo r income must be used. White fo r example used loan to value r a t i o fo r an income proxy. The bas ic problem i s not overcome by th is approach as only 10% of the housing stock is t rans fe r red wi th in a given y e a r . ^ Hence i t i s u n r e a l i s t i c to expect average income data to r e f l e c t demand of the household purchasing group. 6.3.4 Subst i tu te Investment The expected r e l a t i o n s h i p s between the a l t e r n a t i v e investment va r iab le and demand f o r c y c l i c a l mortgages bears inconc lus ive r e s u l t s . The use of th is s u b s t i t u t e investment va r iab le r e f l e c t e d standard demand theory because o f the poss ib le s u b s t i t u t i o n o o f rates o f return from housing with rates of return on the stock market. The use of th is var iab le represents a pre l iminary probe to determine p o s s i b l e r e l a t i o n s h i p s . This s tudy , dea l t with the s i n g l e family housing market and as such , i t ignored the impact of mul t ip le housing u n i t s . These housing units tend to be f inanced by conventional lenders and as such did not enter the scope of th is s t u d y . ' ' However, in exp la in ing the p o o r - r e s u l t s of the s u b s t i t u t e investment v a r i a b l e , i t should be noted that the bulk o f investment by pr iva te i n d i v i d u a l s , was d i rec ted at the mul t ip le family unit s e c t o r . Favourable c a p i ta l cost allowances and the a b i l i t y to create long run reserves f o r c a p i ta l cost Q al lowance, provided the f i n a n c i a l framework f o r investment in th is s e c t o r . The same concepts could have been appl ied by the ind iv idua l to a s i n g l e family 9 u n i t : however economies of s c a l e do not e x i s t and as a r e s u l t , the mul t ip le housing unit sec to r was the area favoured fo r iimvestment. Equation Reference Equation Type Equation Estimated Percentage Frequency of Mortgage Types Within Sample (%) R 2 Durbin Watson S t a t i s t i c F S t a t i s t i c F P r o b a b i l i t y (excludes constant) 6.1 Assigned Mortgages < = 17.40 + 523.5r + 42.46R - 2.97Y + 2.97S (.35) (.77) (.75) (-.85) (.16) . [.73] [.46] [.47] [.42] [.88] 10 .20 2.01 .61 . 6 7 6.2 Assigned Agreement-for-sale < - 48.84 + 232.9r - 39.32R + 3.36Y - 20.40S (.83) (.28) (-.58) (.82) (-.91) [.42] [.77] [ .57] [.43] [.39] 16 .14 1.16 .41 .80 6.3 New Agreements-fo r - s a l e < = 43.82 - 357.3r - 63.5R + -.65Y - 4.26S (1.86) (-1.10) (-2.35) (-.39) (-.47) [.09] [.30] [.04] [.70] [.64] 2 • .70 2.60 5.70 .02 6.4 New Agreements-f o r - s a l e and assigned agreements-f o r - s a l e = 63.39 - 645.9r - 63.5R .13Y - 21.35S (2.57) (-1.90) (-2.24) (.07) (-2.26) [.03] [.09] [.05] [.94] [.05] 4 j .42 2.60 1.84 .20 6.5 New Agreements-f o r - s a l e and Assigned Mortgages = 143.34 - 108.2r - 126.54R .26Y - 45.645 (2.18) (-.12) (-1.68) (.06) (-1.82) [.05] [.90] [.12] [.951 [.10] 32 .27 2.25 .92 .49 6.6 Aggregate of Equation 6.1 to 6.5 = 50.4 - 18.3r - 36.6R - 2.50Y - 18.9S (1.82) (-.04) (-1.15) (-1.28) (-1.79) [.10] [.96] [.27] [.23] [.10] ! 1 3 i i .38 3.03 1.54 .26 . 6.7 Combination of Assigned Agreements-f o r - s a l e and Assigned Mortgages = 75.64 + 9.4r - 58.3R .74Y - 26.9S (2.01) ( .02) (-1.35) (-.28) (-1.88) [.07] [.99] [.20] [.78] [.09] i 1 21 i i i i i .30 2.40 1.05 .43 Table 6.5 Demand equations of c y c l i c a l components of the mortgage market f o r e x i s t i n g houses under excess  supply conditions i n the housing market. Period of analysis i s from 1959 to 1963 i n c l u s i v e for Greater Vancouver Regional D i s t r i c t . Levels of s i g n i f i c a n c e indicated i n square brackets; t s t a t i s t i c s are shown i n rounded brackets. 100 6.4 EMPIRICAL RESULTS: EXCESS SUPPLY IN THE HOUSING MARKET 6.4.1 Demand Equations The demand equations r e l a t i n g to the excess housing supply period of 1959 to 1962 are presented in Table 6 .5 . The demand equations are s p e c i f i e d in the same manner as those equations estimated in sect ion 6 .3 . However the equation cons is tency has been l o s t . For>: example, a l l equations ind ica te s i g n i f i c a n t degrees of negative auto c o r r e l a t i o n (with the exception of equation 6 .2 ) , c o e f f i c i e n t s of determination are low and the F p r o b a b i l i t i e s are greater than .05 in six of seven equat ions. The lack of s i g n i f i c a n c e of the c r e d i t r a t i o n i n g v a r i a b l e could a r i s e from several p o s s i b l e f a c t o r s . Measurement bias could be instrumental in causing the lack of s i g n i f i c a n t r e s u l t s . A c c o r d i n g l y , an a l te rna te form of the c r e d i t ra t ion ing v a r i a b l e , the f i r s t d i f f e r e n c e of the aggregated bond r a t e , was em-ployed in the est imat ion of the demand equations in the excess supply p e r i o d . However r e s u l t s were no more s i g n i f i c a n t than those recorded in Table 6 .5 . Further exp lora t ion of the use of an a l te rna te measure fo r the c r e d i t r a t ion ing v a r i a b l e was terminated. Another p o s s i b l e reason why the c r e d i t r a t ion ing v a r i a b l e lacked s i g n i f i c a n c e could be due to i n c o r r e c t s p e c i f i c a t i o n of the demand equat ion. The negative a u t o - c o r r e l a t i o n in Table 6.5 suggests that some v a r i a b l e i s m i s s i n g . A most l i k e l y v a r i a b l e to add to the demand equation i s the vacancy ra te v a r i a b l e . 6.4.1.1 Vacancy Rate Var iab le The vacancy v a r i a b l e o r i g i n a l l y had been s p e c i f i e d (Sect ion 5.5.1) as a supply v a r i a b l e in the supply equat ion. The d e r i v a t i v e of the supply of c y c l i c a l mortgages to the vacancy rate was expected to be negat ive . If a l l lending sources are supplying mortgage c r e d i t , the increase in inventory of housing un i ts can be expected to have a negative e f f e c t on the supply of c y c l i c a l mortgage d o l l a r s . 101 High l eve ls of completed but unoccupied housing may reduce the propensity of the pr iva te vendor to s e l l . Inasmuch as the vacancy var iab le can be considered as a supply v a r i a b l e , i t may a lso be•considered as a demand v a r i a b l e . The unoccupied, but completed housing v a r i a b l e m a y be considered as a demand var iab le as i t may represent demand expectation", f o r those persons who are cons ider ing enter ing the housing market. The vacancy var iab le can be used as an expectat ion operand fo r the fo l lowing reasons. Household f o r m a t i o n , r i n part is a postponable d e c i s i o n in that non-fami ly households in p a r t i c u l a r , decrease in numbers during periods of economic uncer ta in ty . F i l t e r i n g up (another postponable d e c i s i o n ) , from low q u a l i t y housing to higher value housing a lso can be expected t o be reduced in periods of economic uncer ta in ty . The vacancy rate can be used to capture the expectat ions of demand fo r reasons noted above. Otherwise these expectat ions would not be accounted f o r . In order to t e s t the impact of Vacancy rate on the demand f o r mortgages, the vacancy var iab le was included in the demand equation fo r the excess supply p e r i o d . The d e r i v a t i v e r 3Qr j /9v i s expected to be negative as with increased uncer ta in ty , demand fo r housing can be expected to decrease. Equation Reference Equation Type Equation Estimated Percentage Frequency of Mortgage Types Within Sampie R2 Durbin Watson Statistic F Statistic F Probabil ity (excludes constant 6.1 Assigned Mortgages -21.69 + 652.9r + 56.8R - 2.5Y + 1.6S - 1.3V (-.41) (.85) (.85) (-.66) (.07) (-.45) [.68] [.42] [.42] [.52] [.94] [.65] 10 .21 2.12 .49 .78 6.2 Assigned Agreement-for-sale % c = 68.87 - 372.Or - 106.4R + 1.20Y - 13.8S + 6.2V (1.36) (-.50) (-1.65) (.33) (-.72) (2.22) [.21] [.63] [.13] [.15] [.49] [.05] 16 .44 1.40 1.44 .30 6.3 New Agreements-for-sale % c = 43.9 - 360.9r - 63.9R -.7Y -4.23S +.04V (1.74) (-.98) (-1.98) (-;36) (-.44) (.03) [.12] [.35] [.07] [.72] [.67] [.97] 2 .69 2.60 5.70 .01 6.5 New Agreements-for-sale and Assigned Mortgages 170.50 - 928.8r - 217.5R -2.67Y - 36.7S + 8.5V (3.5) (-1.30) (-3.5) (-.76) (-1.98) (3.12) [.01] [.22] [.01] [.46] [.07] [.01] 32 .65 3.35 3.34 .06 6.7 Combination of Assigned Agreements-for-sale and Assigned Mortgages % c = 89.0 - 421.2r - 106.IR - 2.34 - 22.25 + 4.5V (2.99) (-.96) (-2.76) (-1.06)(-1.94) (2.66) [.01] [.36] [.02] [.31] [.08] [.03] 21 .61 3.14 2.76 .09 Table 6.6 Selected demand equations of cyclical components of the mortgage market for existing housing under excess supply conditions in the housing market. Demand equations measure affect of vacancy rate on mortgage demand. Period of analysis is from 1959 to 1963 inclusive for the Greater Vancouver Regional District. Levels of significance indicate in square brackets; t statistics are shown in rounded brackets. 103 Table 6.6 summarizes se lec ted demand equations in the excess supply p e r i o d . These equations d i f f e r from those of Table 6.5 only in the f a c t that the vacancy var iab le has been introduced in to the demand equat ion . The demand equations presented in Table 6.6 r e s u l t in some improvement to the equations o f Table 6 .5 . C o e f f i c i e n t s o f determination increase in a l l cases and the F p r o b a b i l i t y improved so that three of the f i v e equations are s i g n i f i c a n t at l ess than.o=.10. Negative auto c o r r e l a t i o n remains a problem however. The c r e d i t ra t ion ing va r iab le has the cor rec t s ign in four o f the f i v e equat ions , although the leve l of s i g n i f i c a n c e is in excess of a=.05. However, compared to Table 6 .5 , the l eve ls of s i g n i f i c a n c e of the c r e d i t r a t ion ing var iab le improves marg ina l l y , in the aggregated equations .(.6.5 and 6 . 7 ) , from .96 and .99 to .22 and .36. No s i g n i f i c a n t conclusions can be determined d i r e c t l y from the c r e d i t r a t i o n i n g va r iab le or the equation r e s u l t s . The s ign of the vacancy c o e f f i c i e n t s was expected to be negat ive . The evidence presented by equations 6 . 2 , 6.4 and 6.7 ind ica tes s i g n i f i c a n t p o s i t i v e c o r r e l a t i o n between the vacancy rate and e i t h e r the agreement- for -sa le sec tor or the assigned mortgage s e c t o r . A l l other equations d id not e x h i b i t s i g n i f i c a n t vacancy c o e f f i c i e n t s It would appear that the vacancy rate var iab le has not added anything s i g n i f i c a n t to the equation r e s u l t s . 104 6 .4 .1 .2 I n s t i t u t i o n a l Ref inancing of Mortgages Two avenues have been explored to determine why the c r e d i t r a t i o n i n g v a r i a b l e . i s not s i g n i f i c a n t , a new var iab le was introduced to the demand equation and in add i t ion a d i f f e r e n t c r e d i t r a t i o n i n g var iab le was s p e c i f i e d . A t h i r d p o s s i b i l i t y i s now explored by examining'the bas ic assumptions of the model. The demand equation was s p e c i f i e d under condi t ions which impl ied a bas ic leve l of i n s t i t u t i o n a l lending a c t i v i t y in the mortgage market. How-ever during the excess supply period., fundamental s h i f t s occurred in i n s t i t u t i o n a l lending behaviour . These s h i f t s cast the agreement- for -sa le sec tor in p a r t i c u l a r , in a d i f f e r e n t ro le than that o r i g i n a l l y postu la ted when the model was s p e c i f i e d . At the beginning of the excess supply p e r i o d , the agreement- for -sale increased c h a r a c t e r i s t i c a l l y as i n t e r e s t rates increased . As i n t e r e s t rates d e c l i n e d , the agreement- for -sale sec tor i n i t i a l l y d e c l i n e d , but then proceeded to increase s i g n i f i c a n t l y in the face of the d e c l i n i n g i n t e r e s t r a t e s . This respond accounts f o r the d i f f i c u l t y in est imat ion o f the demand equations of Sect ion 6 . 4 . 1 . This n o n - c h a r a c t e r i s t i c respond can be accounted f o r by examining the lending patterns o f the conventional lenders . By the end of 1959, the banks had abandoned the new housing market, because of l i m i t a t i o n s on lending rates under the Bank A c t . Non-bank conventional lenders reduced. lending in the e x i s t i n g housing market, because of the high leve l of f i n a l orders of fo rec losures on s i n g l e family housing in 1960 and 1961. The high l e v e l . o f f o r e c l o s u r e , coupled with an excess supply of completed but unoccupied new hous ing , however caused the non-bank con-vent ional lenders to s h i f t from the market f o r e x i s t i n g housing. Reference to Graph 4.5 in Chapter IV reveals the reduct ion of lending in the market f o r e x i s t i n g housing by conventional lenders . This reduced lending by the t r u s t and l i f e 105 insurance companies l e f t the assigned mortgage and agreement- for -sa le sectors as the major sources of funds in the mortgage market. A t h i r d i n s t i t u t i o n a l s h i f t i s a lso important to note. Examination of Graph 4.2 reveals that re f inanc ing by thenon-bank conventional lenders 13 was at a record peak during th is p e r i o d . Not only would the s h i f t of these lenders from the market fo r e x i s t i n g housing to the ref inance market have l e f t the agreement- for -sa le sec tor in p a r t i c u l a r as the major source of funds, but i t would cause a b a s i c measurement problem with the c r e d i t r a t ion ing v a r i a b l e . Consider . the imp l ica t ions o f each o f these points in tu rn . The emergence of the agreement- for -sa le sec tor as the major source of funds is evident from the Graph 6.T reproduced, from Graph 4 .5 . The agreement- for -sa le sec tor ine creased during a per iod of decreasing i n t e r e s t r a t e s , because o f the absence of the other i n s t i t u t i o n a l lenders in the e x i s t i n g housing market. This r e s u l t i s the opposite of that observed and modelled in the excess demand p e r i o d . A minimum leve l of housing turnover o c c u r r e d , supported by the agreement-for-'-sa le s e c t o r . Reference to Table 4.1 ind ica tes a dramatic s h i f t in average per idd o f . s i n g l e fami ly residence ownership from 8.6 years to 1960 to 11.9 .years in 1961 and 12.9 years in 1962. A decrease in demand fo r housing had occur red . Reference to the same table reveals a drop in the p r i c e of housing at th is time (1961). While i t has not been poss ib le to develop e l a s t i c i t i e s of agreement- for -sa le s u b s t i t u t i o n , i t i s poss ib le to conclude, from the d e s c r i p t i v e evidence i t i s poss ib le to i n f e r that the agreement- for -sa le sec tor s t a b i l i z e d housing pr ices during the excess supply . Without th is commonly accepted market, housing pr ices would have experienced greater v o l a t i l i t y YEARS TB3T •fssr \////// ///////////// ' ' ' /INCREASING INTEREST RATES •1956 '195/ . .. T93B" W/////A DECREASING INTEREST RATES "t5BT —vm Graph S. 1 Percent of p r iva te vendor f inanc ing sector 1n comparison to (new) conventional lending on new houses as well as on new conventional lending on ex is t ing housi..^ Series covers period 1954-1963 f o r G.V.R.D. and represents gross mortgage f lows. Changes in in te res t rate indicated by bar graph. ng. 107 downward during th is p e r i o d . A second major i m p l i c a t i o n of the i n s t i t u t i o n a l lender s h i f t to the re f inance market concerns the use of the c r e d i t r a t i o n i n g v a r i a b l e . The mortgage r m - r b va r i ab le is a composite of conventional and N.H.A. mortgages. No s p e c i f i c concern i s given to the type of mortgage lending ( i . e . t r a n s f e r or ref inance) in recording the mortgage component. Nor i s there any attempt to weight each component par t . A s h i f t to the re -f inance market from the e x i s t i n g housing t r a n s f e r market, would have no e f f e c t whatsoever on the measured r v a r i a b l e . One conventional m mortgage ( e x i s t i n g mortgage i n v o l v i n g a t rans fe r ) would be subs t i tu ted f o r another conventional mortgage (a . re f inanced mortgage). The s h i f t to the ref inance market causes no change in the recording o f . t h e mortgage r a t e . The c r e d i t r a t ion ing var iab le does not proper ly account f o r the s h i f t in mortgage funds wi th in the conventional mortgage lender group, or between the previous group and the agreement- for -sa le sec tor dur ing . the exeess supply p e r i o d . 6.4.2 Mortgage Supply Equation .. .. Supply equations est imat ing the supply of c y c l i c a l mortgage were a lso examined to see i f form ( i . e . demand or supply) a f f e c t the r e s u l t s . Table 6.7 ind ica tes the r e l a t i o n s h i p s der ived from the study. The equations show minor v a r i a t i o n in the var iab les used in es t imat ion . S e l e c t i o n of the f i n a l va r iab le form of equation was based on the most s i g n i f i c a n t va r iab le in the equations analyzed. The in terna l con-s i s t e n c y that the demand equations exh ib i ted in Table 6.2 are not evident in the supply equations of the excess supply pe r iod . Co-e f f i c i e n t s of determination are less than 50 percent , negative auto c o r r e l a -Dub in .. St a t i s t i c F Probability £.qua L X O H Reference Equation Estimated Watson ; " •' Statistic (excludes constant) 6.1 = 7.44 + 132.6r + 1.01V (.86) (.25) (.65) [.41] [.80] [.53] .03 1.95 .20 .81 6.2 '«." = .73 + 465.5r+ 3.07V (.08) (.85) (1.89) [.93] [.41] [.08] .23 1.19 1.82 .20 6.3 <.° = 7.17 + 235.Or - 2.53V11 (1.48) (.79) (-2.83) [.16] [.44] [.01] .50 2.10 6.03 .01 6.4 = 10.43 - 559.2r + 3.16V (2.82) (-2.11) (2.23) [.02] [.06] [.05] .37 2.68 3.55 .06 6.5 = 19.85 + 714.25r +2.74V (1.74) (1.02) (1.33) [.10] [.32] [.21] .15 2.07 1.05 .37 6.6 = 13.37 - l.Olr + 1.6V (2.86) (-.30) (.87) [.01] [.76] [.40] .06 2.67 .38 .68 6.7 - 11.21 + 319.3r + 2.2V (1.79) (.83) (1.90) [.09] [.42] [.08] .23 2.33 1.82 .20 Table 6.7- Supply equations of the cy c l i c a l components i n the.mortgage market for existing housing under excess supply conditions. Period of analysis is 1959 to 1962 inclusive for the Greater Vancouver Regional District. T-statistics are shown as rounded brackets. Levels of significance are indicated in square brackets. : ' 109 t ion e x i s t s in four equations and the F p r o b a b i l i t y is greater than .05 , in s i x of the seven equat ions. However the r e s u l t s , given the i n s t i t u t i o n a l s h i f t s as ou t l ined above, are not unexpected. It i s not poss ib le to comment fu r ther on the form of the equations because o f the i n s t i t u t i o n a l s h i f t s . 6.4.2.1 A l t e r n a t i v e Measures and Aggregation The vacancy rate was a l t e r n a t i v e l y measured as a f i r s t d i f f e rence r a t i o , to determine i f measurement e f f e c t would improve the equation r e s u l t s . The r e s u l t s can be noted in equation 6.4 . A lagged pr ice var iab le a lso was in t roduced. The impact of th is va r iab le change was s l i g h t . The s i g n i f i c a n c e of the equation was not improved. Aggregation of equations 6.5 to 6.7 caused no improvement. 6.5 SIGNIFICANCE TO HYPOTHESIS The most conc lus ive r e s u l t s regarding the s u b s t i t u t i o n e f f e c t of the agreement-f o r - s a l e and assigned mortgage market can be f o u n d i n the excess demand p e r i o d . The texts o f consistency ind ica te s t a b i l i t y of the p r i c e r a t i o n i n g v a r i a b l e . This var iab le is h igh ly e l a s t i c and s i g n i f i c a n t at a-.05. A major conclus ion from th is r e s u l t is that s u b s t i t u t i o n occurs in the mortgage market fo r e x i s t i n g housing when changes in i n t e r e s t rates occur in the c a p i t a l markets. The agreement-for-sa le and assigned mortgage sector, provide f inanc ing which allows an e f f e c t i v e out -l e t f o r demand. This demand s t a b i l i z e s the p r ice of housing during periods o f excess demand in the housing market. . The same conclus ion cannot be. ascer ta ined with the same degree of c e r t a i n t y because o f the mortgage s h i f t . o f non-bank conventional lenders to the ref inance market, during the excess supply p e r i o d . The s h i f t by non-bank conventional lenders to the new housing and ref inance mortgage markets have not been incorporated in to the model. Hence any inference based on s t a t i s t i c a l resu l ts with respect to s u b s t i t u t i o n by the c y c l i c a l mortgage funds cannot be va l ida ted e m p i r i c a l l y , in the excess supply p e r i o d , but only i n f e r r e d . n o With reference to Graph 6.1 i t can be noted that the agreement- for -sa le sec tor increased propor t ionate ly as i n t e r e s t rates increased during the beginning of the excess supply p e r i o d . As i n t e r e s t rates d e c l i n e d , the agreement- for -sa le sec tor i n i t i a l l y d e c l i n e d , but then proceeded to increase s i g n i f i c a n t l y in face o f the d e c l i n i n g i n t e r e s t r a t e s . Non-bank conventional lenders in view of high l e v e l s o f f o r e c l o s u r e , s h i f t e d from f inanc ing e x i s t i n g mortgages which involved a s a l e , to re f inanc ing mortgages which d id not involve a s a l e . Banks being proh ib i ted by the Bank Act from lending at rates in excess o f s i x percent , withdrew from the new housing market. The vacumm created by the withdrawal of these i n s t i t u t i o n a l lenders caused the agreement- for -sa le sec tor to increase in a per iod of decreasing i n t e r e s t r a t e s . Inasmuch as the agreement- for -sa le sec tor provided a source o f funds when i n t e r e s t rates during the i n i t i a l stages of the excess supply p e r i o d , th is mortgage market s t a b i l i z e d the p r ice of housing. Inasmuch as t h i s agreement- for -sa le sector provided a source of funds when i n t e r e s t rates dec l ined and when i n s t i t u t i o n a l sources of funds s h i f t e d to the ref inance market, th is mortgage market s t a b i l i z e d the pr ice of housing. This is not to s a y , that the p r i c e of housing d id not f a l l during th is p e r i o d . The housing pr ice index su f fe red a dec l ine o f 8 percent from 1960 to 1961. Lack of demand caused the p r ice d e c l i n e . However, without the agreement- for -sa le sec tor func t ion ing as a commonly accepted mortgage t r a n s f e r mechanism, greater v o l a t i l i t y could have been expected in housing pr ices during that time p e r i o d . Unfor tunate ly , th is l a t t e r conclus ion cannot be substant ia ted s t a t i s t i c a l l y . It remains however, no less v a l i d . The r e s u l t s of the other independant var iab les in both the excess supply and excess demand per iod have been prev ious ly o u t l i n e d . These var iab les are not c r i t i c a l to the acceptance or r e j e c t i o n of the hypothes is , but rather serve to complete the demand and supply equat ions. This funct ion has been served. No fu r ther d i s c u s s i o n at th is point is deemed necessary. i n 6.5.1 C red i t Rat ioning Var iab le The v a r i a b l e used to measure mortgage ra t ion ing in the mortgage market i s the d i f f e r e n c e between the mortgage and bond rate ( r m - r^). In a period of excess demand in the housing market, i t has been shown that th is v a r i a b l e provided a s t a t i s t i c a l l y s i g n i f i c a n t measure of r a t i o n i n g in the mortgage market. In a per iod of excess supply in the housing market, i t has been shown that th is measure th is was not adequate. The measure f a i l e d because the f m component must r e f l e c t poss ib le i n s t i t u t i o n a l s h i f t wi th in the mortgage market. As prev ious ly o u t l i n e d , non-bank conventional lenders s h i f t e d to the re f inance market during the excess supply p e r i o d . This s h i f t would not a f f e c t the measurement of the mortgage r a t e , as in the n a t i o n a l l y consol ida ted f i g u r e s , no record of the s h i f t i s p o s s i b l e , using data present ly a v a i l a b l e . This d i s s e r t a t i o n has focused on the s u b s t i t u t i o n of funds between the agreement - for -sa le s e c t o r , as well as the assigned mortgage s e c t o r , with that of the conventional l enders . In a d d i t i o n , i t i s now apparent that fu r ther study must be d i r e c t e d to the e f f e c t of i n t r a - i n s t i t u t i o n a l s h i f t s as noted in sect ion 6.5. Future work in developing an adequate measure of p r i c e r a t i o n i n g in the mortgage market must incorporate the r e s u l t s noted above. 112 Footnote References - Chapter VI 1. Equation 6.6 represents combinations of f inanc ing associa ted with e i ther the agreement- for -sale sector or the assigned mortgage s e c t o r . t c 3 QT £g*"e r> '•- - .1 2. Equation 6.7 and 6.8 are combinations which inc lude assigned mortgages and arguments- for -sa le which are l inked to conventional l end ing . If a mortgagor e lected to f inance by means of a new conventional mortgage and an assigned mortgage, the assigned amount would be represented in data used to estimate 6.7 and 6.8. Equation 6.6 does not inc lude any conventional mortgage re la ted lend ing . 3. Ray Fa i r and Dwight J a f f e e . "Methods of Est imation fo r Markets in D i s e q u i l i b r i u m , " Econometrica, V o l . 40, No. 3, May 1972, pp. 497-514. 44. MMeasuremehtcofttotal migrat ion to B r i t i s h Columbia was made poss ib le by an annual data ser ies compiled from payments made under the Family Allowance A c t . Ser ies are referenced in Net Migrat ion B r i t i s h Columbia 1951-1970. Dept. of Industr ia l Development. V i c t o r i a , B .C . 1971. 5. The expected r e l a t i o n s h i p of the c y c l i c a l components to changes in demand i s p o s i t i v e . Less s t r ingent c r e d i t ana lys is by ind iv idua l vendors such th is group could demand a s i g n i f i c a n t proport ion of e i t h e r p r iva te vendor f inanc ing or the assigned mortgage f i n a n c i n g . 6. P h i l i p H. White. "Proloque to an Ana lys is of the Res ident ia l Mortgage Market in Vancouver," Unpublished paper, (Vancouver: Un ive rs i t y of B r i t i s h Columbia, 1965), pp. 1-35. 7. S. Hamil ton, et a l . "Turnover Rates in Metropol i tan Vancouver," pp. 1-31. 8. B. Swirsky. "Income Tax Treatment of Depreciable Proper ty ," in Papers on Real  Estate and Income Tax, (Don M i l l s , Ontar io : Real Estate Ins t i tu te of Canada, 1972), pp. 11-18. Swirsky explains the pre 1972 cap i ta l cost allowance procedure, together with the changes introduced at that t ime. 9. Real Estate Trends in Metropol i tan Vancouver, (Vancouver: Real Estate Board of Greater Vancouver, 1975-1976), p. B - l 0 , ind ica tes the economies of sca le of rental u n i t s . 10. The v a r i a b l e P represents a lagged housing p r i c e v a r i a b l e to account fo r the p o s s i b l e impact on supply of c y c l i c a l mortgage d o l l a r s . 11. The vacancy va r iab le was measured as the f i r s t d i f f e r e n c e in the completed but unoccupied housing data s e r i e s in both equations 6.5 and 6.6. The expected r e l a t i o n s h i p is p o s i t i v e . 113 12. F ina l orders of fo rec losure fo r the years 1956 to 1961 were recorded as fo l lows: Source of t h i s information is Central Mortgage and Housing Corporat ion Mortgage Accounts in A r r e a r s . Central Mortgage and Housing Corpora t ion , (Vancouver: Central Mortgage and Housing, 1963). Furthervdata c o l l e c t i o n of the s e r i e s was not continued by Central Mortgage and Housing Corporat ion a f te r 1961. 13. B. S y s o c k i . "Remodelling of Housing Booms Amidst Slump in New Home S a l e s , " Wall Street J o u r n a l , December 26, 1975, p. 1. Year Number in Greater Metropol i tan Vancouver 1956 1957 1958 1959 1960 1961 25 75 90 92 490 464 114 CHAPTER VII IMPACT OF PRIVATE VENDOR FINANCING AND ASSIGNMENT OF MORTGAGES ON THE NARROW AMPLITUDE OF MORTGAGE RATES 7.1 SUMMARY 7.2 INTRODUCTION 7.3 BACKGROUND LITERATURE SURVEY ON NARROW AMPLITUDE OF MORTGAGE RATES 7.3.1 P r i c i n g Arguments 7.3.2 Commitment Procedure 7 .3 .3 I n s t i t u t i o n a l Factors 7.4 MORTGAGE RATE AMPLITUDE HYPOTHESIS 7.5 TEST OF HYPOTHESIS 7.5.1 Subs t i tu t ion E f f e c t 7.6 IMPLICATIONS FOR FURTHER RESEARCH 115 7.1 SUMMARY This chapter reveals that the s u b s t i t u t i o n of sources of mortgage f inanc ing during periods of increas ing i n t e r e s t rates could account fo r the reduced ampl i -tude of observed mortgage r a t e s . The narrow amplitude of mortgage rates should not be considered as a s ign of i n e f f i c i e n t mortgage markets. 7.2 INTRODUCTION The narrow amplitude of mortgage r a t e s , r e l a t i v e to bond r a t e s , has been the subject of considerable d i s c u s s i o n . There has been a tendency to l ink the observed narrow amplitude of mortgage rates to problems of mortgage market i n e f f i c i e n c y . In t h i s chapter a hypothesis i s developed to expla in the narrow amplitude of mortgage r a t e s . Before the hypothesis is in t roduced, a l i t e r a t u r e review of the narrow amplitude of mortgage rates is presented. 7.3 BACKGROUND LITERATURE SURVEY ON THE NARROW AMPLITUDE OF MORTGAGE RATES 7.3.1 P r i c i n g Arguments Guttentag and Beck^ provide an important summary of the research into the quest ion of why the c y c l i c a l amplitude of mortgage rates i s narrow in comparison to bond r a t e s . The f i r s t few references noted below p a r a l l e l those noted by Guttentag and Beck. 2 Greb le r , Blank and Winnick suggested that the sluggishness of mortgage rates vi-ssdue to the fac t that charges, above the cont ract rate are often paid by the mortgagor in securing a mortgage. These se rv ice charges could manifest themselves as discounted mortgages which in fac t would give the lender a higher rate of return than ind icated by the cont ract r a t e . In essence Greb le r , Blank and Winnick are arguing that the wrong mortgage rate is being measured and used for comparison 116 to the bond ra te . Guttentag and Beck analyzed a mortgage rate ser ies of discounted mortgages and found that gross y i e l d was s l i g h t l y less than contract y i e l d . They did not consider the tes t conclus ive and noted that d e f i n i t i o n of fees and lack of comparable s t u d i e s , prevented them from r e j e c t i n g the Greb le r , Blank, Winnick hypothesis. Klaman suggested that the r e l a t i v e l y narrow c y c l i c a l amplitude of mortgage y i e l d s was due to the f ixed cost of adminis t ra t ing mortgages. "In genera l , the la rger such costs are r e l a t i v e to the i n t e r e s t r a t e , the more stable the i n t e r e s t rate w i l l be. The reason is s imple; a minimum margin must be maintained between the i n t e r e s t rate and a l ender 's f i xed admin is t ra t ive costs to assure him a reasonable return . . . on r e s i d e n t i a l l oans , admin is t ra t ive costs of a c q u i s i t i o n , s e r v i c i n g and record-keep ing , perhaps 75 basis points compared to 10 on corporate s e c u r i t i e s , create a r e l a t i v e l y s tab le s ta te in r e s i d e n t i a l mortgage i n t e r e s t r a t e s . " 4 Guttentag and Beck re jec t t h i s concept by noting that the e x p l i c i t costs forementioned are several times less than the mortgage c o s t s , hence, t h e i r in f luence on the sluggishness is indeed s l i g h t . Furthermore, Klaman's concept implies that mortgage rates are add i t i ve rather than compet i t ive . Hence, the concept as suggested by Klaman is in doubt. However,. Klaman noted another poss ib le reason for the lack of s e n s i t i v i t y of the mortgage ra tes . He noted that : "as we move away from standardized to more d i f f e r e n t i a t e d markets . . . the number of v a r i a b l e s , in add i t ion to p r i c e , to be negotiated mul t ip les . . . Numerous contract terms other than p r i c e are subject to i n d i v i d u a l negot ia t ion -downpayment p r o v i s i o n s , . . . prepayment p e n a l i t i e s and non- in te res t c o s t s . The nature and loca t ion of the p a r t i c u l a r r e s i d e n t i a l un i t securing the mortgage however, are important fac tors in the mortgage t r a n s a c t i o n . " 6 Klaman introduces the concept of non-pr ice r a t i o n i n g . The observat ion of changes in non-pr ice terms has led to considerable research as out l ined in Sect ion 5 .4 .1 . Muth'7 reasoned that changes in i n t e r e s t rates brought d i f f e r e n t c lasses of borrower to the market, rather than e x p l i c i t ra t ion ing by means of non-pr ice terms. Evidence by Jaf fee^ and Eger^ would appear to substant ia te the Muth concept. The mul t ip le 117 term hypothesis i s not a s i g n i f i c a n t fac tor in the c r e d i t ra t ion ing procedure. Interest rate remains.the s i g n i f i c a n t ra t ion ing dev ice . 7.3.2 Commitment Procedure Perhaps more fundamental than the p r i c i n g arguments are those problems involved in the observat ion of mortgage r a t e s . The more r e a d i l y a v a i l a b l e data i s approved (committed) mortgage loan information of conventional lending i n s t i t u t i o n s . Hence, t h i s data i s genera l ly used fo r es t imat ion . Problems a lso a r i s e due to the time lags between commitment of mortgage funds by a lender and the actual use of mortgage funds by a mortgagor. During periods of increas ing i n t e r e s t r a t e s , a long lag between commitment and a c q u i s i t i o n tends to dampen the observed mortgage ra te . With a shortened l a g , the dampening e f f e c t i s much l e s s . Observed mortgage rates then tend to react less v igorous ly to changes in c r e d i t condi t ions and from th is lack of r e a c t i o n , concern fo r e f f i c i e n c y a r i s e s . The problem in observat ion and v a r i a b i l i t y of mortgage rate concerns the recording of the actual mortgage rate determined at the time of loan . There is a d i f f e rence between the observed mortgage rate at time of commitment and the actual mortgage recorded when the funds are r e q u i r e d . The commitment process causes th is d i f f e r e n c e . The forward commitment process i s in f luenced by several f a c t o r s . F i r s t , type of const ruc t ion i s important. A bu i lder of s i n g l e fami ly houses w i l l seek a mortgage loan commitment several months in advance of the requirements f o r a long term (take-out) mortgage. In the case of commercial bu i ld ings the commitment per iod may be two or three years . Second, lender preference and p o r t f o l i o ad jus t -ment a f f e c t the commitment process. Banks and near-banks are more l i k e l y to t i e in commitments to a prime rate because of t h e i r dependence on short term savings as a source of funds; l i f e insurance companies tended to commit funds at a f i x e d rate because of t h e i r des i re to match current sources and uses of funds. T h i r d , 118 the Canadian cl imate a f f e c t s commitment process. A commitment iw the"second quarter may not be taken-out u n t i l the second quarter of the fo l lowing year because of a more lengthy bu i ld ing process in winter . In order to overcome the problems of using mortgage commitment date , d i s t r i b u t e d lags have been used to account fo r the entrance of the take-out mortgages in to the mortgage data stream. Unfortunately because of the lack of work at the d e s c r i p t i v e l e v e l ^ ' i t i s d i f f i c u l t to substant ia te the r e s u l t s . 7.3.3 I n s t i t u t i o n a l Factors F i n a l l y to complete the review of the major c a u s e s ^ of the narrow amplitude of mortgage rates Smith notes that the lack of a secondary market a f f e c t s the responsiveness of the mortgage r a t e s . Smith argues tha t : ) "because of the negotiated nature of the t ransact ions and lender des i res to maintain good borrower - lender r e l a t i o n s h i p s , primary ra te adjustments usua l ly lag adjustments on outstanding issues . "12 This argument i s a repeat of the non-pr ice r a t i o n i n g d iscussed e a r l i e r . It i s not apparent that these non-pr ice considerat ions are a s i g n i f i c a n t f a c t o r in e s t a b l i s h i n g mortgages r a t e s . The above reason does not ind ica te that the ex is tence of a secondary mortgage market would m a t e r i a l l y a f f e c t the amplitude of the mortgage r a t e . 7.4 MORTGAGE RATE AMPLITUDE HYPOTHESIS The nul l hypothesis presented in t h i s chapter is that there i s no d i f f e r e n c e between the amplitude of the observed mortgage rate ( r m ) and the bond rate (r^) . Ifcie a l te rnate hypothesis is that there is a d i f f e r e n c e between the amplitude of r m and r ^ The observed mortgage rate is def ined as the simple average mortgage rate i s of a l l conventional and government lenders of f i r s t mortgages. The bond rate- i s a weighted average of a l l f e d e r a l , p r o v i n c i a l , municipal and corporate bonds. 119 7.5 TEST OF THE HYPOTHESIS Di rect t es t ing of the nul l hypothesis is not poss ib le because of the s u b s t i t u t i o n in sources of funds that occur in the mortgage market during periods of c r e d i t r a t i o n i n g . To counteract t h i s problem three tes ts were dev ised . F i r s t , the a l te rnate hypothesis was tested fo r the time period 1954 to 1957 i n c l u s i v e . Re-su l ts are shown in Table 7 .1 . Durbin Watson F F R ? S t a t i s t i c S t a t i s t i c prob. r - r, = .036 - .40 r L .90 1.14 114.6 .00 m b b (22.27) (- 10.7) [.00 ] [ .00 ] Table 7.1 Regression of the d i f f e r e n c e between observed mortgage rate and bond rate ( r m r. ) and the bond rate (r^) fo r 1954 to 1957. t s t a t i s t i c s are in rounded brackets; square brackets ind ica te leve ls of s i g n i f i c a n c e . The s i g n i f i c a n t negative r e l a t i o n s h i p between r m - r^ and r^ ind ica tes that the amplitude of the r m i s less than that of r^ under changing c r e d i t c o n d i t i o n s . The a l ternate hypothesis can be accepted. Reasons f o r t h i s d i f f e r e n c e are out l ined below. 7.5.1 Subst i tu t ion E f f e c t The r e s u l t s of demand equations in Chapter VI , ind ica ted strong s u b s t i t u t i o n by the c y c l i c a l components of the mortgage market fo r e x i s t i n g housing. The r e s u l t s ^ ' a r e repeated in Table 7.2. 120 Equation reference number 6.1 6.2 6.3 6.4 6.5 6.6 6.7 Equation type Assigned conventional mortgage New agreements- for -sa le New agreements- for -sa le and assigned agreements- for -sale New agreements- for -sa le and assigned mortgages Combination of equations 6.1 to 6.5 Combination of assigned agreements- for -sa le and agreements- for -sa le and assigned mortgages Combination of new agreements- for -sa le as well as assigned mortgages and assigned mortgages and assigned agreements- for -sa le E l a s t i c i t y -1.10 [.045] -1.39 [.03] -2.39 [.03] -1.95 [.03] -1.38 [.003] -1.29 [.004] -1.30 [.001] Table 7.2 E l a s t i c i t i e s o f demand fo r c y c l i c a l components of the mortgage market fo r e x i s t i n g housing. Levels of s i g n i f i c a n c e o f p r ice ra t ion ing var iab le ind ica ted by square brackets . The h ighly e l a s t i c c o e f f i c i e n t s ind ica te that s u b s t i t u t i o n occurs during periods o f c r e d i t r a t i o n i n g . Th is s u b s t i t u t i o n provides strong evidence that the narrow amplitude o f mortgage rates is a measurement problem, not a mortgage market i n e f f i c i e n c y problem. In fac t the s u b s t i t u t i o n oiff one type of mortgage fo r the o ther , causes the observed mortgage rate to appear s l u g g i s h . Completion o f the tes t of the hypothesis suggests that the observed mortgage rate and c y c l i c a l component rate should be compared. S i m i l a r i t y o f rates would fur ther substant ia te that s u b s t i t u t i o n occurs with c r e d i t r a t i o n i n g . Table 7.3 reveals 121 the mortgage rates by component. Chi -square t e s t s ' " ind ica te that the c y c l i c a l 1 C components of the market f o r e x i s t i n g housing are not s i g n i f i c a n t l y d i f f e r e n t from the observed mortgage r a t e s . As the a l te rna te sources of f inanc ing occurs at rates competi t ive with the observed mortgage r a t e s , the a l te rna te hypothesis can be accepted with the in ference that the s u b s t i t u t i o n of source of f inanc ing at competi t ive rates reduces observed mortgage rate ampli tude. 7 . 6 IMPLICATIONS FOR FURTHER RESEARCH The foregoing observations ind ica te that the narrow amplitude of the mortgage market should not be considered as a s ign of mortgage market i n e f f i c i e n c y . The e f f e c t of s u b s t i t u t i o n causes the observed rate to react with a dampened ampli tude. These observat ions are important in that c r i t i c i s m s that the mortgage rate does not c l e a r the market can be rebut ted . ~J The rebut ta l would be based on a market in which numerous buyers and s e l l e r s do indeed e x i s t . Hence, charges of 1.8 o l i g o p o l i s t i c mortgage l e n d i n g ^ by conventional i n s t i t u t i o n s should be subject to fu r ther study. 1;9 Second, the hypothesis presented by S p a r k s " - , that there i s a f i xed supply of funds to be a l loca ted between mortgages and bonds should rece ive carefu l s c r u t i n y . Demand fo r bonds has been assumed to be i n e l a s t i c ; whereas demand for mortgage has been assumed to be e l a s t i c . The s u b s t i t u t i o n of sources of mortgage funds during periods of c r e d i t r a t i o n i n g suggests that the f i xed supply of funds theory needs fu r ther a t t e n t i o n . MORTGAGE RATES BY TYPES OF MORTGAGE MARKET FOR EXISTING HOUSING Market for New Housing Aggregate Market Rates Year Assigned Mortgages Column 1 q, •& Assigned Agreements for Sale Column 2 % Agreements for Sale Column 3 % New a Mortgages Column 4 % Refinanceda Mortgages Column 5 % New a Mortgage Column 6 9- -20 Observed Rate Column 7 % (Col.4+5+6) Cyclical Component Rate Column 8 (Col.1+2+3) 21 Market Rate Column 9 % (Col.7+8) 1954 5.49 5.76 6.00 6.08 6.22 5.33 5.94 5.75 5.84 1955 5.51 5.73 6.05 6.29 6.41 5.28 6.00 5.76 5.88 ' • 1956 5.55 5.98 ; 6.14 5.97 6.59 5.57 6.04 5.89 5.96 1957 5.77 5.89 6.45 6.71 7.18. 6.24 6.71 6.07 6.39 ' .' 195S 5.90 6.01 6.51 • 6.66 .7.32 6.17 6.72 6.14 6.43 1959 6.09 6.37 6.73 6.65 6.91 6.21 6.59 6.40 6.50 1960 6.13 6.22 '. ' 6.87 7.09 7.47 . 6.72 7.09 6.41 6.75 1961 6.29 6.48 6.72 6.93 7.54 6.96 6.81 6.50 6.05 1962 6.33 6.40 6.71 7.25 7.36 6.89 .7.16 6.48 6.82 1963 6.32 6.60 6.74 . 6.95 7.41 6.74 7.03 6.55 6.79 ro ro TABLE: 7.3 Average mortgage rates by type of mortgage for both markets in existing housing and new housing in G.V.R.D. 1954 to 1963. aIncludes both con-ventional and governmental lenders. Data represents f i r s t mortgage data. 123 Footnote References - Chapter VII 1. Jack Guttentag and Morris Beck. New Ser ies on Home Mortgage Y ie lds Since  1951. National Bureau of Economic Research. . General Ser ies No. 92. (New York: Columbia Un ivers i ty Press , 1970), pp. 1-357. 2. Leo G r e b l e r , D. Blank and L. Winnick. Capi ta l Formation in Res ident ia l Real  Es ta te . (Pr inceton: Pr inceton Un ive rs i t y P r e s s , 1956), p. 223. 3. Guttentag, op. c i t . , p. 36. 4. Saul Klaman. The Postwar Res ident ia l Mortgage Market. (Pr inceton: Pr inceton U n i v e r s i t y Press , 1961), p. 78. 5. Under l in ing is that of t h i s author . 6. Klaman, op. c i t . , p. 78. 7. Richard Muth. " Interest Rates, Contract Terms and A l l o c a t i o n of Mortgage Funds," in Journal of F inance, March 1962, pp. 63-80. 8. Dwight J a f f e e . C r e d i t Rat ioning and the Commercial Loan Market. (New York: John Wiley and Sons, 1971), pp. 1-183. 9. A . F . Eger. "A Case fo r the Muth Hypothesis ," Unpublished paper, (Vancouver: U n i v e r s i t y of B . C . , 1975), pp. 1-27. 10. Studies that e x p l i c i t l y descr ibe the U.S. forward commitment procedure are l imi ted and are found in Klaman, op. c i t . , pp. 175-238, as well as in Mortimer Kaplan. "Recent I n s t i t u t i o n a l Arrangements in Mortgage Lending ," in Journal of F inance, March 1958, p. 195. Kaplan notes there is considerable v a r i a t i o n in the lag between commitment and a c q u i s i t i o n . Lawrence Smith and Gordon Sparks. " S p e c i f i c a t i o n and Est imation of F inanc ia l Stock Adjustment Models," . . . . I n t e r n a t i o n a l Economic  Review, February 1971, pp. 14-26, use U.S. commitment data in a study of stock adjustment models for l i f e insurance companies fo r Canada. Canadian commitment data or s tudies are l a c k i n g . 11. Other reasons suggested are d i f f e rences in leve l of r i s k premium. Guttentag, op. c i t . , p. 93 found no d i f f e r e n c e in mortgage premium at business cyc le peaks and trough in comparing conventional mortgages and corporate bonds. A l l an Winger "Regional Growth D i s p a r i t i e s and the Mortgage Market," Journal  of Finance 1969, pp. 659-662 suggests that d i f f e rences in regional flow could a f f e c t mortgage rate ampli tude. The f ixed rate theory on F .H .A . mortgages has been developed by Gordon Sparks, "Economic Ana lys is of the Role of F inanc ia l Intermediaries in the Postwar C y c l e , " in Determinants of Investment  Behavious, (New York: Columbia Un ive rs i t y P r e s s , 1967), pp. 301-332. 12. Lawrence B. Smith. The Postwar Canadian Housing and Res ident ia l Mortgage 124 Markets and the Role of Government, (Toronto: Un ivers i ty of Toronto Press , T374), pp. 76-77. ~ 13. Dwight J a f f e e . "Credi t Rationing and the Commercial Loan Market," p. 30. 14. The data used in t h i s study represents actual mortgage r a t e s . There is no need to introduce lags in to the data se r ies f o r the commitment p rocess , because the data represents actual r a t e s , rather than committed ra tes . 15. In th is study a simple weighting of various mortgage markets was used. A weighted market r a t e , would not change the r e s u l t s because of the s i m i l a r i t y in s i ze of the submarkets to each other . 16. The nu l l hypothesis tested was that there i s no d i f f e rence between the market mortgage rate and the observed mortgage ra te . On the basis of ch i -square t e s t s , the nul l hypothesis cannot be re jected at a p r o b a b i l i t y of .99. S imi la r r e s u l t s were found in comparing the c y c l i c a l component rate and the observed mortgage ra te . 17. Ray F a i r . "D isequi l ib r ium in Housing Model ," Journal of F inance, May 1972, pp. 207-230. 18. John Evans. The Resident ia l Mortgage Market in Canada: Market Structure and  I n s t i t u t i o n a l Behaviour. Unpublished paper, (Vancouver: Un ivers i ty of B . C . , 1974), pp. 1-180. 19. Sparks, op. c i t . , p. 302. 20. The mortgage rate used to study mortgage rate amplitude is that of the conventional lenders . This rate includes mortgages on new and e x i s t i n g housing f inanced by conventional lenders . This rate has been studied because of the ease of data c o l l e c t i o n . For purposes of th is chapter the observed rate i s considered to be synonymous with conventional mortgage r a t e s . 21. The market mortgage rate i s the aggregate of a l l poss ib le sub-markets and includes rates of lending on e x i s t i n g and new housing by conventional and non-conventional lenders . 125 CHAPTER VIII  IMPLICATIONS FOR FURTHER STUDY 8.1 FURTHER STUDIES AND POLICY IMPLICATIONS 8.2 COMMENTS ON THE USE OF MORE ACCURATE DATA 126 8.1 FURTHER STUDIES AND POLICY IMPLICATIONS The resul ts presented in the previous chapters have provided a framework from which further studies may be undertaken. Such studies are challenging and exc i t ing because of the wide range poss ib le . For example, th is study did not include the combined mortgage f inancing of agreements-for-sale and new conventional mortgages on ex is t ing housing as well as the combination of new mortgages and assigned mortgages on ex is t ing housing. These two groups account for 5% of a l l housing t rans fe rs . E x p l i c i t recognit ion of combining pr ivate and conventional f inancing needs fur ther study. The ro le of the ref inancing in the market for ex is t ing housing is one which has been ignored. Refinancing in the sense used here, does not involve a t ransfer of ownership. For example, ref inancing can occur for purposes of conversion of ex is t ing housing stock. Exploration of the cor re la t ion between pr ice ra t ion ing , income level and indicators such as bui ld ing permits for conversion, purchase of bui ld ing suppl ies would pr ivate the basis for the study. The use of ref inancing to increase the supply of housing units would accomplish two major goals. F i r s t , mortgage capi ta l would go d i r e c t l y to the supply of new housing uni ts without the s i gn i f i can t delays current ly hampering subdivis ion process in CanadaJ Increased mortgage funds for housing i f not d i rected immediately towards increasing the housing supply, tend only to increase the pr ice of housing, because of the short run i n e l a s t i c i t i e s ' of housing supply. Second, the supply of wel l located housing units by conversion of ex is t ing stock, could be achieved with minimum disrupt ion of ex is t ing neighborhoods. In addit ion ref inancing for non-real estate purposes has been noted by Gelb^ as well as Sommers and Rhine.^ Size of the refinance loan re l a t i ve pr inc ipa l outstanding on the or ig ina l mortgage provides the key to the purpose of the loan. For example, i f the new loan is greater than the pr inc ipa l outstanding on the 127 o r i g i n a l l o a n , then non-real estate mot ivat ion can be expected. With t h i s in fo rmat ion , the r e l a t i o n s h i p s between the more c o s t l y consumer c r e d i t market and the ref inance mortgage market fo r non-real estate purposes could be exp lored . This type of s u b s t i t u t i o n can be expected as renewal of the mandatory f i v e year c a l l s on mortgages become commonplace. Such a study would have p o l i c y impl ica t ions in that N.H.A. mortgages could be found to be used f o r non-real estate purposes. The use of N.H.A. mortgages fo r non-real estate purposes suggests a non-desi rab le use of mortgage funds. A t h i r d study which stems from the study of the narrow amplitude of mortgage r a t e s , would u t i l i z e the recogni t ion of the p r iva te vendor f inance and assigned mortgage markets. Such a study would draw on studies by Evans^ and Poapst^ and would determine the magnitude of mortgage market e f f i c i e n c y by est imat ing the a l l o c a t i v e and operat ional e f f i c i e n c y of the mortgage market. Operational e f f i c i e n c y involves the r e d i s t r i b u t i o n of wealth from consumers to producers; whereas a l l o c a t i v e e f f i c i e n c y represents a welfare loss to the economy due to a mi sa l l o c a t i o n of resources .^ This t h i r d study would necess i ta te the up-dat ing of the mortgage data bases in order to a s c e r t a i n the r e l a t i v e magnitude of the p r iva te vendor f inanc ing and assigned mortgage s e c t o r s . I n s t i t u t i o n a l changes such as in t roduct ion of the f i v e year var iab le rate on mortgages has removed some of the advantage of the obta in ing an assignable mortgages. The magnitude of the reduct ion is unknown. However, a study cont ras t ing a Canadian mortgage market with and without a f i v e year c a l l would permit the mortgage market e f f i c i e n c y measures to be compared under polar c o n d i t i o n s . This p i l o t study could be i n i t i a t e d in the regional housing market of metropol i tan Vancouver. The land r e g i s t r y system allows the observat ion to the required da ta . The p i l o t study could then be expanded on a 128 regional basis for Montreal , Toronto , provided that the mortgage data could be obtained. A fourth study would involve the use of p r iva te vendor f inanc ing as a source of funds for the mortgage market. Th is study, drawing on the basic data of the mortgage market e f f i c i e n c y study, would ascer ta in the d e s i r a b i l i t y of a c t i v e l y promoting the use of pr iva te vendor f inanc ing as a source of funds in the mortgage market. Government insurance, taxat ion i n c e n t i v e s , fo r the pr iva te vendor sector would provide the necessary framework. Co- insurance concepts could be appl ied so as to reduce the problem of v a l u a t i o n . Such a scheme could be expected to provide a source of funds fo r the market for e x i s t i n g housing and at same time achieving two important goa ls . F i r s t , mortgages could perhaps be d i s t r i b u t e d more compet i t ive ly and second, conventional lender funds cur rent ly u t i l i z e d to t rans fe r proper ty , could be sought by the new housing market or by the corporate s e c t o r . 8.2 COMMENTS ON THE USE OF MORE ACCURATE DATA The necess i ty fo r accurate data has been demonstrated by the new horizons opened with the data analyzed from the land r e g i s t r y system. C o l l e c t i o n of such data is not only c o s t l y , but extremely tedious and in the main only r e -warded a f t e r a s i g n i f i c a n t e f f o r t has been put forward. K l e i n ' s comments regarding improvements in economic judgment are indeed noteworthy at th is t ime. "Improvements in economic judgment come from several sources . Improved econometric techniques present powerful means of s t a t i s t i c a l in fe rence . However, these econometric techniques only r e s u l t in useful a p p l i c a t i o n s i f research of a rather pedestrain nature i s undertaken. The bu i ld ing of i n s t i t u t i o n a l r e a l i t y in to a p r i o r i fo rmula t ions .o f economic r e l a t i o n s h i p s and the refinement of bas ic data c o l l e c t i o n have contr ibuted much more to the improvement of empir ica l econometric r e s u l t s than have more elaborate means of s t a t i s t i c a l in fe rence . I look forward towards improvements in p r e c i s i o n of econometric judgments of the order 129 of magnitude of 50% as a r e s u l t of a bet ter knowledge of the funct ion ing of economic i n s t i t u t i o n s , through the use of new measurements on var iab les or through the use of more accurate data . In contrast I would expect marginal improvements of 5 or 10% through the use of more powerful means of s t a t i s t i c a l in fe rence ."8 130 Footnote References - Chapter VIII 1. Res ident ia l Land Development in Ontar io . (Toronto: Urban Development Ins t i tu te of Onta r io , 1972), pp. 1-73. 2. D. David-Johnson. "Government Housing P o l i c i e s and Programs: The i r Impact on Housing Demand," Unpublished paper, (Vancouver: Un ive rs i t y of B r i t i s h Columbia, 1975), pp. 1-45. 3 . Gelibi Mortgage Debt fo r Non-Real Estate Purposes. 4. Sommers and Rhine, The New Dimension of Mortgage Debt. 5. 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The E f f e c t of Government Housing and Mortgage C r e d i t Programs  on Savings and Loan A s s o c i a t i o n s . U.S. Savings and Loan League, Occasional Paper No. 6, 1973. U.S. Congress. Senate. Subcommittee on Housing and Urban A f f a i r s . Committee on Banking and Currency, Study of Mortgage C r e d i t . 90th Congress, F i r s t s e s s i o n , 1967. Van Home, J . Functions and Ana lys is of Capi ta l Market Rates. New York: P ren t i ce -H a l l , 1970. Winger, A .R . "An Economic Analyses of MortgagessDuring Periods of Monetary Res t ra in t : C h a r a c t e r i s t i c s and A c q u i s i t i o n s by Lenders," in Ways to Moderate  F luctuat ions in Housing Const ruc t ion . Board of Governors. Federal Reserve System, 1972, pp. 456-487. Wonnacott, R . J . and Wonnacott, T . H . Econometrics. Toronto: John Wiley & Sons, 1970. 138 Appendix I: Data Source and Der iva t ion Var iab le Comment Mortgage flows C r e d i t ra t ion ing va r iab le Income var iab le Rental Subs t i tu t ion Var iab le Subst i tu te investment va r iab le Quarter ly mortgage flows measured in current d o l l a r s . Random sample of c e r t i f i c a t e s of t i t l e of Vancouver and New Westminster Land Reg is t ry O f f i c e s . Sample represents 2.8 percent of a l l s ing le fami ly housing. Sample p e r i o d , 1954 to 1963. Measured as the d i f f e rence between the mortgage and bond rate on a quar te r ly b a s i s . Mortgage and bond rate obtained from McLeod, Young, Weir, bond s e r i e s . Mortgage and bond rate represent aggregated rates in t h e i r own c l a s s . For example, the aggregated bond rate is a weighted average of f e d e r a l , p r o v i n c i a l , corporate and municipal bond r a t e s . Measured quar ter ly in current d o l l a r s as the r a t i o of income to housing pr ice r a t i o . Income data obtained from Review of Man Hours_and Hourly Earnings With  Average WeekTy Wages 194*5-1"963, Dominion Bureau of S t a t i s t i c s , August , 1964'. Housing pr ice data obtained from Hamilton, S.W. , "Housing Pr ice Index Paper". Unpublished paper. U n i v e r s i t y of B r i t i s h Columbia, 1974. Measured quar te r l y in current d o l l a r s as a r a t i o of rent to housing p r i c e s . Rent index was obtained by sampling renta l property adver t ised in newspapers^ads. for the per iod 1954-1963. Housing pr ices noted above. Measured quar ter ly in current d o l l a r s , from stocks l i s t e d on the Toronto Stock Exchange. Rate of return of stocks inc ludes r e a l i z e d div idends and quar te r ly c a p i t a l g a i n s . Transact ions costs are ignored in the c a l c u l a t i o n of the c a p i t a l g a i n . Ser ies developed by Dr. W. Wood, U n i v e r s i t y of B r i t i s h Columbia, Vancouver 1975. Vacancy vvariabil'e Measured quar te r ly as the Ratio of completed, but un-occupied housing to to ta l housing s tock . Completed but unoccupied housing uni ts obtained from Central Mortgage and Housing Corpora t ion , Vancouver Regional Branch, 1954-1963. Housing stock data developed from informat ion suppl ied by Central Mortgage and Housing Corpora t ion , Vancouver Regional Branch, 1954-1963. Housing stock adjusted for demol i t ions , conversions in accordance with information suppl ied by Planning Department, C i t y of Vancouver. Appendix II: 139 C o r r e l a t i o n C o e f f i c i e n t s The fo l lowing c o r r e l a t i o n matr ices are representa t ive of those found in the mortgage demand equation of the excess demand period 1954-1957. Equation 6.1 - (Assigned conventional mortgage) Assigned C r e d i t Rent/ Unemployment Speculat ive Vacancy] Conventional Rat ioning Pr ice r a t i o Subs t i tu t ion r a t i o mortgage r a t i o r a t i o r a t i o Assigned Conventional mortgage 1.0 C r e d i t Rat ioning r a t i o - .65 Rent /Pr ice r a t i o - .74 Unemployment r a t i o - .25 Specula t ive Subst i tu t ion r a t i o .61 Vacancy r a t i o .27 1.00 ,52 .07 ,71 ,56 1.00 .42 - .80 -.18 1.00 -.49 .04 1.00 .54 1.00 Equation 6.5 - (Combination of Equation 6.1 to 6.4) C y c l i c a l mortgages C r e d i t ra t ion ing r a t i o Rent /Pr ice r a t i o Unemployment r a t i o Speculat ive Subst i tu t ion r a t i o Vacancy r a t i o C y c l i c a l mortgages 1.00 - .80 - . 80 - .09 .65 .37 C r e d i t Rationing v a r i a b l e 1.00 .52 - .07 -.71 - .56 Rent/ Pr ice r a t i o 1.00 .42 - .80 -.18_ Unemployment r a t i o 1.00 - .49 - .04 Specula t ive Vacancy Subs t i tu t ion Ratio r a t i o 1.00 .54 1.00 140 The above matr ices reveal that the c o r r e l a t i o n c o e f f i c i e n t of the c r e d i t r a t ion ing v a r i a b l e has s i g n i f i c a n c e . For example, in equation 6.1 r m r = - . 65 and in equation 6.5 r m . r = Q.80. Hence the s i g n i f i c a n c e of t h i s c r e d i t r a t ion ing v a r i a b l e as descr ibed in sec t ion 6.3.1 r e s u l t s from basic r e l a t i o n s h i p s between the c y c l i c a l components and the c r e d i t r a t i o n i n g v a r i a b l e . Because of the i n -s t a b i l i t y of the other independent va r iab les in the model, the s i g n i f i c a n c e of the c r e d i t r a t ion ing v a r i a b l e could have been spur ious . However, the above matr ices i n d i c a t e t h i s not to be the case . A basic r e l a t i o n s h i p does e x i s t between the c y c l i c a l components and the c r e d i t r a t i o n i n g v a r i a b l e . 

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