Mapping the Road to Ruin: Lessons from the Housing Collapse

By Robert Preer
Photography: Julie Ann Woodford
Published: Spring 2011

Robert Van Order, a professor of finance, arrived at The George Washington University School of Business in August 2009 with extensive experience, impressive credentials and a daunting challenge. His mission? To discover why the U.S. housing market collapsed and what could be done to prevent it from happening again.

Van Order was chief economist at Freddie Mac from 1987 to 2002. He taught at more than a half dozen universities, most recently the University of Michigan, and was sought after as a consultant to businesses, governments and international organizations. He’s now the new director of GWSB’s Center for Real Estate and Urban Analysis.

Van Order even had his own first-hand experience with the housing debacle, relocating from recession-plagued Michigan a year into the crisis. “I had to sell a house for less than I paid for it three years earlier,” he said. “But I’ve owned other houses, and they mostly went up in value, so I can’t really complain.”

At GWSB, Van Order analyzes the housing crisis and develops strategies to prevent future catastrophes at the research center that Dean Doug Guthrie has identified as key to the School’s mission of leading the conversation on business and public policy. “This is not a typical real estate center,” Guthrie said. “It is a real estate center that is engaged markedly with questions about business and society, and business and public policy. Our economy is shaped by real estate markets, both housing and commercial.”

The School has a long tradition of approaching real estate as an essential component in the study of business. GWSB is the only school in metropolitan D.C. that offers real estate courses as part of an MBA program. Most other schools that teach advanced real estate offer a separate master’s degree in the field. The GW approach has won high praise from the real estate community.

“I’d rather hire someone with an MBA than someone with a master’s in real estate because an MBA education provides the leadership qualities, critical thinking and versatility that are critical to success in real estate or any other industry,” said Jeffrey Berkes, executive vice president and chief investment officer at Federal Realty Investment Trust.

Van Order, who also carries the title of Oliver T. Carr Professor of Real Estate, became the center’s first full-time director late last year and got the revived center off to a vigorous start.

“We are becoming really good at fostering research and promoting discussions,” Van Order said. “We had a conference last spring on the credit crunch and another in January jointly with GW Law School on the Dodd-Frank financial reform bill. We are trying to capitalize on the School’s location in the nation’s capital and its mission to interpret and influence public policy.”

Another conference, on commercial real estate, is scheduled for mid-May.

Van Order would like the center to sponsor scholars-in-residence. “I’m hoping that as time goes on, we will be able to invite researchers from around the world to come in, spend some time with us and work with us,” he said.

At the Corner of Business and Policy

The center is preparing a series of reports on the Federal Housing Administration and its role in promoting a U.S. housing recovery. In its first report on the federal agency, issued in February, the center questioned the FHA’s current practice of insuring larger loans—up to $729,750 in some markets. The report, co-authored by Van Order and GW Center for Economic Research Director Anthony Yezer, points out that big loans are risky and a departure from the FHA’s original mission of assisting the poor and minorities.

The report recommends that the FHA return to its role of helping first-time and low-to-moderate-income buyers and leave the risks that are associated with larger loans to the private sector.

Van Order is now in the midst of another major research project with a goal of determining why so many mortgages in the United States went bad. He is analyzing data on thousands of mortgages issued around the United States before the financial crisis. His preliminary conclusion: Borrowers defaulted because their property values collapsed.

“It didn’t matter what the mortgages were, whether they were sub-prime, riskier alternative loans or plain vanilla,” Van Order said. “They all had high default rates when property values fell.”

The sharp decline in values was a consequence of the real estate bubble, which began to boil in 2003 and burst several years later, according to Van Order. The residential real estate bubble had many causes, he said, but “it clearly correlated with the rise of the sub-prime market.”

Van Order’s work is supported by the center’s other staff member, Executive Director Robert J. Valero, who received his bachelor’s degree in public affairs from GW in 1982. Valero is former vice president of investor relations for the National Association of Real Estate Investment Trusts. He served on the center’s advisory board from 2007 until his appointment last fall. His new position with the center is funded with a generous contribution from GWSB alumnus Charles Bendit, BBA, ’75 (see story on page 20).

Valero’s role is to develop and market the center’s brand to alumni, media and the real estate community in Washington, D.C., and around the country. He is creating programs to showcase research conducted at the center, enhance the curriculum and help students find internships and employment.

“GW’s real estate program is positioned to be at the forefront of real estate research and education in this country,” Valero said. “Most of the major U.S. real estate associations have their headquarters in downtown Washington.”

Commercial real estate will be the topic of the center’s May 17-18 conference, which is cosponsored by George Mason University and will be held on the GW campus. Topics to be covered include REITs, commercial mortgage-backed securities and the state of real estate markets in metro D.C and the Atlantic Coast region.

The financial crisis dealt a blow to commercial real estate although the dynamics were different from what happened with housing. “In many ways, the problems with commercial real estate were more related to the downturn in the economy,” Van Order said. “Housing and especially the sub-prime mortgage market started to have problems before the economy did.”

Continuing weakness in commercial real estate could affect lenders. “We don’t know how it will play out, but commercial real estate is putting banks, both big ones and little ones, at risk still,” Van Order said.

Vantage Points

The recent upheaval in real estate markets has been a tragedy for those who lost their homes, fortunes and livelihoods. But for Van Order, a real estate economist, it has also been a remarkable and even exciting time to be working. “I tell my friends, it’s more fun being on the outside looking in,” he said.

A Chicago native who received his doctorate in economics from Johns Hopkins University, Van Order has had a long and varied career in real estate finance, with stints in private industry, government and academia. “I’m sort of a utility infielder,” he said in a recent interview in his fifth-floor office in Funger Hall. “My parents often wondered when I was ever going to have a steady job.”

Van Order has taught at the University of Pennsylvania, UCLA, University of Southern California, American University, the University of Aberdeen in Scotland, Queen’s University in Canada, Purdue, Ohio State University and the University of Michigan’s Ross School of Business. He was an economist for the U.S. Department of Housing and Urban Development before beginning his 15-year career at Freddie Mac. He has done consulting for the U.S. Agency for International Development, U.S. Department of Housing and Urban Development, the World Bank and other agencies and corporations. He frequently consults on international mortgage markets. In recent years, he has worked in Latvia, Russia, Ghana, Nicaragua, Brazil, Egypt, Colombia, Poland and Pakistan.

“Professor Van Order is a great leader for this center,” Guthrie said. “He brings deep experience in policy and economic analysis from within the government and from an academic perspective. He’s the perfect person to build this center.”

Guthrie said Van Order’s blend of practical experience and research skills will propel the center forward in the months and years ahead. The center’s focus will encompass urban development as well as real estate.

“Washington, D.C., is the perfect place to build a broadly defined real estate program—not just because Washington, D.C., is the heart of public policy, but also because we want to explore and influence regional economic development in the area,” Guthrie said.

Van Order’s research indicates that ideologues on the left and right both concocted explanations for the credit crisis to advance their agendas. Senate Minority Leader Mitch McConnell, a Kentucky Republican, has repeatedly blamed mortgage giants Fannie Mae and Freddie Mac for causing the crisis by trying to promote low-income housing.

“That just doesn’t fit the data,” Van Order said. “Fannie and Freddie did get into trouble, but it was not because of low-income lending.”

In his research with Jason Thomas, a doctoral student in the Department of Finance, Van Order determined that Fannie and Freddie had no substantial involvement with the sub-prime market, which was the most important underlying cause of the crisis. The two mortgage enterprises got into hot water by investing in what are known as “Alt-A” mortgages, which are less risky than sub-prime but not as safe as conventional loans, Van Order and Thomas found.

“They were not the victims of housing policy,” the researchers say in a forthcoming paper. “Their goals explain a small share of their risk-taking. The ramping up of credit risk was especially in Alt-A lending, and it was based on business decisions, most likely regarding market share.”

Liberals, meanwhile, blame deregulation, saying it allowed the growth of too-big-to-fail financial institutions. Former House Speaker Nancy Pelosi, a California Democrat, said in late 2008 that “the Bush Administration’s eight long years of failed deregulation policies have resulted in our nation’s largest bailout ever, leaving the American taxpayers on the hook potentially for billions of dollars.”

Deregulation and the fact that some financial institutions grew too big to fail do not explain the crisis either, according to Van Order. “A whole range of institutions, big and little, were involved,” he said.

Still Van Order believes that the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was signed into law in July 2010 as the government’s policy response to the crisis, may help prevent future crises through strategically positioned and applied regulation of financial institutions.

The law established a Financial Stability Oversight Council to identify threats to the overall financial system. The council includes the Federal Reserve chair, treasury secretary and heads of the major financial regulatory agencies. Dodd-Frank also set up procedures to be followed when big financial institutions get into trouble. The Federal Deposit Insurance Corp., in consultation with the Federal Reserve System, is authorized to take control of failing institutions and wind them down in much the same way it does with faltering commercial banks.

“The law is moving in the right direction,” Van Order said. “It appears that the Fed and regulators in general will have broader powers that are not limited to specific institutions.” But Van Order could not say for sure that the financial reform law will prevent future crises.

“We don’t really know what the institutional structure of the financial system will be 20 or 30 years from now,” he noted. “It turned out to be rather different this time than it was 30 years earlier.”

Van Order described the housing bubble as “a regional issue” in many ways. “The places that really got clobbered—parts of California, Nevada, Arizona, Florida—won’t come back very quickly,” he predicted. “They were just too overbuilt.”

But he predicted that conditions will gradually improve in much of the rest of the country.

“The underlying demographics require production, maybe something close to a million and a half units a year,” he said. “Household formation is growing. Population is growing at about one percent a year, and old houses wear out. We won’t see a boom, but in a couple of years most parts of the country will have had sufficiently low levels of housing production that they may start heading back to normal.” GW