1. Smart Subsidies Marja Hoek-Smit Wharton School University of Pennsylvania Conference on Housing Finance in Emerging Economies World Bank, March 19, 2006

2. The Case of Central Subsidia An imaginary country named Central Subsidia …. deeply subsidizes housing finance for reasons that plagued the sector in the past, e.g., high and/or volatile inflation (decreasing real incomes) lack of financial institutions able to carry long-term mortgage loans; past financial sector restrictions undeveloped capital markets lack of legal infrastructure to curb credit risk

3. Central Subsidia’s Subsidy Package Interest rate subsidies on Fixed Rate Mortgages and construction loans Off-budget funding support to state-finance institutions or labor tax funds High hidden subsidies caused by high NPLs on subsidized portfolio Direct construction of public housing Small upgrading program for slum or squatter areas

4. Consequences for Households Subsidies benefit only those households who can acquire a mortgage (or civil servants rentals) Relative high incomes Stable employment Sound collateral Gap in market place for credit worthy lower-middle income/self-employed Subsidies are regressive and increase income inequality Result: Continuous growth in informal housing

5. Consequences for HF Market Subsidies allow inefficiencies in the mortgage market to continue/compensate for them Bail-outs of Govt. HF institutions; hidden subsidies Developers focus housing production towards subsidized outcomes only Overall housing production remains limited New subsidies are added to increase production Result: conflicting / overlapping subsidies that hinder market development

6. Current Improving Macro/Fin. Sector Conditions in Subsidia Macro stability, fin. sector liberalization, capital market dev. Reasons for old subsidies no longer valid But, existing institutions interested in keeping status quo/ gate keepers Need for high level process to guide subsidy reform and readjustment Where to start?

7. Supply costs/ real side: land and infrastructure cost and availability long run elasticity of supply of land and housing Agreed housing/planning standards for different market segments Level and distribution of income /other demand factors Who pays and how? Cash – Equity, Debt, Subsidies? Financing? Availability, costs, risks? Reconsidering the Affordability Problem

8. Designing a Subsidy Policy to Address Affordability Issues Scarcity of funds and efficiency considerations dictate 3 types of actions in the country: 1. Regulatory adjustments; requires use of subsidies as triggers 2. Improvements in housing finance system and expansion of access to debt finance; transparent subsidy incentives? 3. Design of effective household subsidies to: Assist in accessing finance Help pay for a minimum acceptable house

9. International Housing Finance Program Wharton Real Estate Center Make access to federal subsides conditional upon local government reforms to: adjust development regulations allow incremental house construction ease permitting process (source of corruption) improve property right and registration systems Repeal federal regulatory subsidies that hinder formal low income development, incl rent control, stringent tenant protection legislation 1. Reform Inappropriate Regulations: Role of Subsidies

10. International Housing Finance Program Wharton Real Estate Center Use transparent subsidy incentives to the mortgage finance sector, e.g.: Improve information and research Address specific risks that private sector cannot yet handle; e.g., funding and liquidity risks, credit risks Subsidize borrower education programs Subsidize part of transaction costs Improve collateral stability by supporting LG to invest in risky neighborhoods Use policies and subsidy incentives to strengthen micro-finance lenders involved in housing: e.g., liquidity funding, technical assistance 2. Improve Housing Finance Policies: Role of Subsidies cont.

11. International Housing Finance Program Wharton Real Estate Center Increase competition to access subsidies where feasible Expand pool of lenders by leveling playing field across govt. and private lenders Use auctions for govt. subsidy programs linked to finance NB: Complematary to improving micro-policies to increase sector efficiency: e.g., mortgage law; consumer protection law (court guidance), securitization law, regulations about sharing of credit information, foreclosure process 2. Improve Housing Finance Sector Policies: Role of Subsidies

12. International Housing Finance Program Wharton Real Estate Center Many such subsidies discussed during the conference Design of such types of subsidy should: Limit the period in which change has to occur/ phase out Calculate short and long-term costs and risk to government/ run scenarios Have an on-budget subsidy allocation, where possible Avoid possibility of “skeletons” 2. Improve Housing Finance Policies: Role of Subsidies cont.

13. International Housing Finance Program Wharton Real Estate Center Design of subsidy package needs to reflect two different market segments: 1. Middle and Lower-middle income households who can access the mortgage market with some help and filter up in formal housing mkt 2. Low income households whose income/ risk profile prevents them from accessing formal housing and finance market (a small group if actions above have been taken/ Thailand) 3. Strategic Household Subsidies

14. International Housing Finance Program Wharton Real Estate Center 1. Lower-middle/ middle income households/examples Lump-sum cash grant towards down-payment or loan amount/ requires land/finance mkt to work Transparent interest subsidy for initial period of the loan (buy down of payment) Payment for mortgage default insurance; lowers LTV, extends mortgage lending Avoid interest rate and individual tax subsidies Often regressive Non-transparent cost Tax subsidies ineffective 3. Strategic Household Subsidies

15. 2. Low income households excluded from the market (income, employment or collateral constraints) Serviced lot with core house as upfront subsidy Upfront capital grant or rental subsidies in transition economies Upgrading of informal areas Avoid government credit subsidies! Poor repayment record, high admin. cost 3. Strategic Household Subsidies

16. Complement with subsidies to facilitate progressive home improvement /expansion: Support to market micro-finance institutions/ product design Support for community participation efforts/ local government or specialized NGOs 3. Strategic Household Subsidies

17. Summary of Smart Subsidy Package for Subsidia 1.Subsidies to complement regulatory /legal change 2.Reform existing subsidies that do not facilitate leveraging of private and household resources 3.Incentivice critical change in HF systems Only for limited period Only when short and long-term costs are known and transparent 4.Address specific household constraints in low and middle income markets Equitability Transparency Efficiency

18. Contact: Marja C. Hoek-Smit International Housing Finance Program Wharton School University of Pennsylvania http://housingfinance.wharton.upenn.edu mhoek@wharton.upenn.edu http://housingfinance.wharton.upenn.edu