By Kathleen Lynn

As director of the Joint Center for Housing Studies at Harvard, Nicolas Retsinas has had a front-row seat on the real estate market’s dramatic boom and bust. After 12 years at the center, Retsinas is leaving the director’s job to teach housing finance at Harvard Business School. He spoke with The Record recently about the center’s annual State of the Nation’s Housing report, why buyers got mortgages they couldn’t afford and why real estate matters so much:

Q. Were you surprised by the magnitude of the housing bust, and how long it has lasted?

Yes, by the severity of the housing bust but even more so, how credit just seized up. It was a reminder of how dependent the housing market is on credit.

Q. In terms of credit, we’re not back to normal levels of lending, are we?

What is absolutely astounding is that essentially all housing credit is controlled by the government. Somewhere between 90 and 95 percent of all the residential mortgages this year have been insured by, guaranteed by or securitized by the government. That’s what’s keeping whatever housing market we have alive. But I, among others, do not believe over the long run that is sustainable.

Q. When do you see any kind of loosening up of the credit markets?

I would suspect we’re likely to see the same dominance of the government at least through the balance of this year. One of the big issues facing public policymakers is what to do with Fannie Mae and Freddie Mac.
If we want to attract private capital, not only from this country but also global capital, some part of that credit risk has to be borne by the government.

Q. One of the biggest factors in the bust was that credit standards got too easy. Buyers who weren’t qualified got mortgages. Do you have any ideas about why this happened?

In part, people were granted mortgages not on their ability to repay the mortgage, because it was clear that wasn’t going to happen. But there was an expectation that even if they couldn’t pay, the future increase in the value of the property would end up being the collateral for that loan. For a long time, that was a formula that worked. But we reached a point where even with these exotic—what turned out to be toxic—mortgage terms, they just weren’t affordable.

It’s as if the exit light was turned off. So people, if they couldn’t pay, couldn’t just do what they could do a year earlier, which is sell the house, probably for more than they paid, and pay off that mortgage.

Q. What has been the biggest human cost of the housing bust?

The biggest human cost is the millions of people who have lost their homes. One can look back coldly and say, well, maybe a lot of them shouldn’t have bought a home in the first place. But a lot of people lost their homes the old-fashioned way: They lost their jobs.

What is also striking about what’s happened in the last few years is that it’s more than the individual family. I think we have found out that housing really matters, not only for families, but for neighborhoods, and indeed, as it turns out, it matters for our national economy.

Q. Who has benefited from the bust?

Beside the investors who played with different sorts of financial products, I think the key winners probably have been first-time home buyers, who have maybe longed to buy a house but could not afford to. Now we’ve essentially transferred wealth from existing homeowners to new homeowners.

Q. Some observers have been disappointed by the number of homeowners helped by the federal loan modification program. And the State of the Nation’s Housing report points out that the Treasury says that 40 percent who get relief will default again. Do you have any ideas about how it could have been done differently?

In defense of the government, when they designed this program 18 months ago, they based it on a premise that the principal problem in the housing market was egregious mortgage terms. And if those mortgage terms could be reset and recalibrated to more typical mortgage terms and could be afforded, through subsidy or whatever means, by the borrower, that would stem the hemorrhage of the defaulted loans and foreclosures.

As we moved into 2009, the problem was less about the subprime loans and more the traditional reason why people have problems making ends meet—which is that they lost their job. If you modify the loan so that your monthly payments are only 31 percent of your income, and your income is zero, that’s probably not going to work.

The problem outran the solution.

Q. Looking ahead, your report points out that between immigration and the aging of the echo boomers, there’ll be a need for 1.7 million housing units a year in the next decade—many more than builders are currently producing. But the new home buyers, on average, are expected to have lower incomes than previous generations of home buyers. Will this change what gets built?

Some of the big builders have really changed their marketing strategy. They’re going back to where they were 40 or 50 years ago, building product for first-time buyers and young families, so they’re building much smaller homes. For the first time in 50 years, building sizes have started to decline.

You talk to some of those big home builders and they’re building homes that are 1,400 square feet, 1,500 square feet. There’s even one that has a 900-square-foot product.

Income is stagnating. Home buyers are going to have to make a choice. They’re either going to have to pay a greater share of their income for housing, which means less money available for other things, or they’re going to have to accept less of a house, in terms of size or amenities.

Q. What’s the role of local and state governments? Some builders say they wouldn’t mind building smaller units and more dense developments, but often the zoning regulations won’t allow it.

I think communities are going to have to reawaken to the concept of transit-oriented development and think about where that housing is, what the impact is on commuting patterns and access to other urban amenities. There often is a disconnect between local governments’ self-interest and the broader regional interest. That one we haven’t quite figured out.

Q. Will home price appreciation return anytime soon?

The next couple of months will be an interesting test, because we’ve had the withdrawal of the home buyer tax credit. Once we reach the bottom, whenever that is, that doesn’t mean there’ll be a rapid recovery. I think we’re likely to have a sort of trawl-along-the-bottom type of recovery, a little bit lumpy for a year or so. The black cloud overhead is the foreclosures.

Q. Congress is looking at new financial regulations. What effect are these likely to have on mortgages?

I think it’ll make it more difficult to go back to the wild wild West. There will be a new consumer financial agency, and I think that will be more likely to look at some of these [mortgage] products. I think that’s going to be critical.