August 2008 - Mark B. Raven, Esq.
No Subprime Crisis in Mexico
Mark B. Raven, Esq. Raven & Associates
As a lawyer in private practice who represents many U.S. investors, buyers, service providers and other clients involved in the Mexican residential real estate market, I have had the opportunity to observe the development of the Mexican housing sector at close hand during the past several years.
There is an interesting contrast between what has happened in the Mexican residential housing market and the United States residential housing market during those years.
In Mexico, there has been an unprecedented growth in residential housing, especially in the so-called “affordable housing” sector, accompanied by a stable market. In the United States, on the other hand, the same period has seen the meltdown of the housing market due in large part to the much talked about sub-prime crisis.
The purpose of this article is to suggest some possible reasons for the very different courses taken by these close and economically interdependent neighbors, contrary to the conventional wisdom that economic problems in the United States inevitably have a strong ripple effect in Mexico.
Most Americans know that in recent years there has been a boom in the purchase of second homes in Mexico by United States and Canadian citizens, usually in beachfront resort areas. Far fewer are aware that the domestic residential housing sector in Mexico, that is, housing for Mexican citizens, also underwent a transformation during the same period. Not so long ago it was difficult if not impossible for a Mexican citizen to obtain a mortgage to purchase a home. Following the severe financial crisis suffered by Mexico in 1995, credit was nearly impossible to come by, and when it was available, interest rates were sky high. Only the rich could afford to own their own homes.
Many observers felt that the lack of a vigorous housing industry in Mexico was an important contributing factor to the migration problem, because of the negative social impact of substandard living conditions and the lack of employment within Mexico itself. Mexico needed the increased employment
opportunities which could be provided by a strong domestic housing construction industry.
At this juncture, the Mexican government decided as a matter of national policy that the expansion of the housing industry needed to become one of the country’s top national priorities. If housing was one of the keys to post- World War II middle class prosperity in the United States, why could it not play the same role in Mexico? If such a goal were to be achieved, there were two key requirements: (1) the working class and the middle class had to be supplied with affordable mortgage financing, and (2) a secondary market had to be created. Most people understood that these things could not happen without government guarantees, at least in the initial years while the industry was getting off the ground. However, policymakers also made the crucial decision to have the private sector participate as an essential player. The private sector was to provide the mortgages and create the secondary market. As a result, one could characterize the Mexican mortgage industry as a public-private partnership.
In the secondary market, mortgages are combined and packaged into pools, which then provide the financial backing for securities sold to investors. Typically, thousands of mortgages are placed into a single trust. Bonds, sometimes called mortgage backed securities, are then issued by the trust to institutional investors such as pension funds. When the bonds are sold, the proceeds are used to replenish the funds used to make the mortgage loans, so that there is money to make more loans. The cash flow consisting of the combined principal and interest payments on all of the mortgages in the pool is dedicated to paying the investors a return on their bonds. To provide necessary reassurance to investors, the government provided guarantees against default. This process is referred to as “securitization”.
To encourage the origination of new mortgage loans, new mortgage companies called Sofoles were authorized and their loans were guaranteed by the government. The Sociedad Hipotecaria Federal, or SHF, provided the guarantees and oversaw the securitization of the newly issued mortgages to provide new funds to lend.
These initiatives have met with noteworthy success, and hold even greater promise for the future. Mexican housing officials estimate that even now, not more than 20% of Mexicans own their own homes, so there is still much room for the industry to grow. Widespread availability of affordable
mortgage financing and the consequent expansion of home ownership is a relatively new development in Mexico. Therefore, as the Mexican residential
market expands and matures, should we anticipate that the same kind of sub-prime problems plaguing the United States are going to emerge in Mexico as well?
This is a question of more than merely academic interest for the United States. Aside from the importance of the Mexican housing industry as an economic building block to diminish the flow of economically-motivated migration to the United States, if Mexican mortgage backed securities are a secure investment, they furnish a potentially attractive alternative for U.S. and other investors. Such an alternative is needed because the issuance of U.S. mortgage backed securities is currently greatly curtailed due to the default and foreclosure crisis in the United States. Lastly, we in the United States can learn important lessons from the Mexican experience in terms of looking at different ways to structure the mortgage industry to lessen the risk of a systemic meltdown.
One significant aspect in which the Mexican housing market is different from that which produced an unsustainable bubble in the United States is that so-called creative financing is not available in Mexico. As in the “good old days” in the United States, the standard mortgage is a 25 or 30 year mortgage with a sizeable down payment and a fixed interest rate. The borrower’s ability to repay is carefully evaluated. There are no adjustable rate mortgages with low initial “teaser” rates and resets to much higher rates after a few years, no zero-down mortgages and no “liar loans”, where the lender takes the borrowers’ word regarding their ability to repay. As we have learned in the U.S., these kinds of loans induced people to buy houses they could not afford and created the conditions for a collapse in home values.
Another factor promoting stability in the Mexican market is the absence of home equity loans and cash-out refinancings. In the United States, the easy availability of these devices has encouraged U.S. homeowners to treat their homes as ATM’s and as a result left no equity cushion to help weather a decline in property values.
Another unique aspect of the Mexican housing industry is the role played by the Mexican social security fund, known as Infonavit. Infonavit uses retirement funds generated by payroll deductions to provide participating low income workers with mortgages to buy homes. Not only that, Infonavit is able to deduct monthly mortgage payments from the workers’ salary. This obviously minimizes the likelihood of default.
Infonavit has played an extremely active role in making first time housing available to low income workers, providing over 40% of the mortgages in Mexico to date. Its projections are to continue providing between 500,000 and 1,000,000 new mortgages each year for the next several years. Infonavit also provides subsidies to help fund the necessary down payment, and it engages in cooperative joint programs with private sector lenders such as the Sofoles and banks to lower the cost to the borrower to the point where the monthly charges are affordable. The fact that the government agency which controls such a large percentage of the affordable housing market in Mexico is committed to conservative, cautious loans lends an anchor of stability that has not been present in the affordable housing sector in the United States. One need only look at the troubles of Fannie Mae and Freddie Mac to see the contrast in approach.
While this article does not seek to list all of the characteristics of the Mexican system which make it unlikely that a subprime crisis similar to that in the United States will develop in Mexico, I hope I have mentioned enough of such factors to allow the reader to share my sense of optimism about the future of the Mexican housing industry.
Mark B. Raven
520-798-5224
mraven@ravlaw.com
www.MarkRavenLaw.com