Smart Subsidies
Marja Hoek-Smit
Wharton School
University of Pennsylvania
Conference on Housing Finance in Emerging Economies
World Bank, March 19, 2006
The Case of Central Subsidia
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An imaginary country named Central Subsidia ….
deeply subsidizes housing finance
for reasons that plagued the sector in the past, e.g.,
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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
Central Subsidia’s Subsidy Package
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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
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
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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
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Current Improving Macro/Fin.
Sector Conditions in Subsidia
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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Reasons for old subsidies no longer valid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?
Reconsidering the
Affordability Problem
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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
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Level and distribution of income /other demand factors
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Who pays and how?
Cash – Equity, Debt, Subsidies?
Financing? Availability, costs, risks?
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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:
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Assist in accessing finance
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Help pay for a minimum acceptable house
1. Reform Inappropriate
Regulations: Role of Subsidies
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Make access to federal subsides conditional upon
local government reforms to:
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adjust development regulations
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allow incremental house construction
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ease permitting process (source of corruption)
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improve property right and registration systems
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Repeal federal regulatory subsidies that hinder
formal low income development, incl rent control,
stringent tenant protection legislation
International Housing Finance Program
Wharton Real Estate Center
2. Improve Housing Finance
Policies: Role of Subsidies cont.
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Use transparent subsidy incentives to the mortgage
finance sector, e.g.:
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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
International Housing Finance Program
Wharton Real Estate Center
2. Improve Housing Finance
Sector Policies: Role of Subsidies
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Increase competition to access subsidies where
feasible
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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
International Housing Finance Program
Wharton Real Estate Center
2. Improve Housing Finance
Policies: Role of Subsidies cont.
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Many such subsidies discussed during the conference
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Design of such types of subsidy should:
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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”
International Housing Finance Program
Wharton Real Estate Center
3. Strategic Household Subsidies
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)
International Housing Finance Program
Wharton Real Estate Center
3. Strategic Household Subsidies
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
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Often regressive
Non-transparent cost
Tax subsidies ineffective
International Housing Finance Program
Wharton Real Estate Center
3. Strategic Household Subsidies
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!
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Poor repayment record, high admin. cost
3. Strategic Household Subsidies
Complement with subsidies to facilitate
progressive home improvement /expansion:
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Support to market micro-finance institutions/
product design
Support for community participation efforts/ local
government or specialized NGOs
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
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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
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Equitability
Transparency
Efficiency
Contact:
Marja C. Hoek-Smit
International Housing Finance Program
Wharton School
University of Pennsylvania
http://housingfinance.wharton.upenn.edu
mhoek@wharton.upenn.edu