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

Abstract

Guttentag demonstrated that the demand for mortgages was negatively related to the demand for bonds. He reasoned that during periods of increasing interest rates, that mortgages are rationed from the capital markets more rapidly than bonds because of short run inelasticity of business firms and because of the highly elastic demand of mortgagors. This behaviour of the mortgage market was identified as a countercyclical hypothesis. Because of the lack of available data, Guttentag assumed that the mortgage market for existing housing reacted in a manner similar to the institutional mortgage market. The countercyclical hypothesis would suggest that during periods of rationing in the capital markets, that the price of housing would fall in response to lack of demand. The evidence by Hamilton indicates that the price of housing continued to rise in periods of increasing interest rates. This conflict of theory and observation suggests that the study of housing price behaviour in relation to the mortgage market for existing housing is one worthy of examination. In order to establish a framework for analysis of the existing housing market, a classification system relating sources of financing to types of housing market is devised. Research to date has centered on the new housing market and the lenders who finance the mortgages to support that housing market. Specification of the mortgage market as a consequence has dealt with two sections, the institutional lenders and government agencies. Complete specification of the mortgage market must include the non-institutional (private) lenders. A descriptive analysis of the existing housing market by classification type, not only gives dimension to a market previously uncharted, but the impact of cyclical, seasonal and substitutional effects are contrasted by type during periods of changing interest rates and variances in vacancy rates. A derived demand and supply model is developed to determine the effect of substitution by the components of the mortgage market for existing housing on the price of housing. Proper specification of the credit rationing variable is crucial to the testing of the model because of the problem of measuring changes in interest rates in the mortgage market. A special chapter is devoted to explaining the impact that the substitution of mortgages funds has on the measurement of the mortgage rate. Several conclusions are noted. First, a classification system which specifies the total mortgage market in terms of new and existing housing as well as source and purpose of financing has been established. This classification system completes the specification of the mortgage and housing markets. Future research can be undertaken from this basis. Second, two segments of the mortgage market for existing housing prove to be significant. In total, the private vendor finance and assigned mortgage sectors account for more than fifty percent of the total mortgage funds for financing new and existing housing. The above markets provide an important source of funds hitherto unexplored. The lack of exploration has been due to the fact that data on the above type of mortgage must come from a labor intensive title search of individual residential properties over a period of time. Third, during periods of increasing interest rates, the private vendor financing and assigned mortgage sectors of the mortgage market increase absolutely and relatively. Consequently these markets stabilize the price of housing by providing substitute financing when mortgages supplied by conventional lenders are rationed from the mortgage market. This conclusion is valid when excess demand conditions exist in the housing market. A similar conclusion can be inferred in the excess housing supply period from descriptive evidence, although statistical validation is not possible. Review of the descriptive evidence, indicates that the substitution of the agreement-for-sector occurred when institutional funds were shifted to the refinance market during the excess supply period. Inasmuch as the agreement-for-sale sector remained as the major source of funds, it can be inferred that this market stabilized housing prices during the excess supply period in spite of the fact that interest rates declined during the latter part of the study period. Greater volatility could have been expected in housing prices in 1961 and 1962 if the agreement-for-sale sector had been absent. Finally, the substitution of mortgage financing during, periods of increasing interest rates could account for the reduced amplitude of observed mortgage rates. The narrow amplitude of mortgage rates should not be considered as a sign of inefficient mortgage markets. During periods of excess housing demand, the use of the credit rationing variable rm - rb proves to be a statistically significant measure of rationing in the mortgage markets. In a period of excess housing supply, this measure is not adequate. The measure fails to account for infra-institutional shifts in funds in the mortgage market.

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