Fund will finance the sector through the Federal Mortgage Bank of Nigeria ..... The ongoing U.S. Savings and Loan Crisis provides an example of the possible.
TWURD WP #5 4
URBAN DEVELOPMENT DIVISION TRANSPORTATION, WATER AND URBAN DEVELOPMENT DEPARTMENT ENVIRONMENTALLY SUSTAINABLE DEVELOPMENT THE WORLD BANK
Private Sector Participation, Structural Adjustment and Nigeria’s New National Housing Policy: Lessons from Foreign Experience
Robert M. Buckley Dagney Faulk Leke Olajide October 1993 WORKING
The TWUFUI interpretations any individual
PAPER
Working Papers present preliminaty research findings and are intended for internal review and discussion. The views and herein expressed are those of the authors and should not be attributed to the World Bank, to its affiliated organizations or tc acting on their behalf.
copyright 1993 The World Bank Washington, D.C.
All Rights Reserved First Printing July 1993
This is a document published informally by the World Bank. In order that the information contained in it can be presented with the least possible delay, the typescript has not been prepared in accordance with the procedures appropriate to formally primed texts, and the World Bank accepts no responsibility for errors. The World Bank does not accept responsibility for the views herein, which are those of the author and should not be attributed to the World Bank or its affiliated organizations. The findings, interpretations, and conclusions are results of research supported by the Bank; they do not necessarily represent official policy of the Bank. The designation employed, the presentation of material, and any maps used in the document are purely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliite concerning the legal status of any country, territory, city, area, or of its authorities, or concerning the deliitations of its boundaries or national affiliation. This paper was prepared by Robert M. Buckley, a Senior Economist, Dagney Faulk, a Research Assistant at the World Bank and Leke Olajide, General Manager for Research and Project Development at the Federal Mortgage Bank of Nigeria. Comments and discussions with 0. J. Dosunmu, H. Ueno, J. Wright, J. Kendall, A. Cbhibber, Patricia Annez and Akin Mobogunje were extremely helpful although they may disagree with some of our views.
THE WORLD BANK
Private Sector Participation, Structural Adjustment And Nigeria’s New National Housing Policy: Lessons From Experience
Robert M. Buckley Dagney Faulk Leke Olajide
WORKING PAPER
*
One of the main objectivesof a structural adjustmentprogram is to shift the demandfor goods so that fewer goods are imported and domesticproduction increases. In the Nigerian sheltersectorthis shift appearsnot to haveoccurredeventhoughthe adjustmentprogram is now six yearsold. In fact, domesticproductionhasbeenrapidly decliningasa shareof GDP for the past decadeto a level 40 percentof that achievedin the late 1970s. In addition, it appearsthat the import contentof new housingproductionis relativelyunchanged.Further, the public sector housingthat is producedis affordableonly with enormoussubsidies,addingto the problems in implementingthe budget cuts required for the Adjustment Program to be sustainable.” In responseto this problem the government of Nigeria has recently adopteda new National Housing Policy (NHP). The languageof the new policy approachembracesthe private sector as the chief meansto addressthe severeshortagesand costs of shelter. It also calls for the “government to becomean enabler,promoter and facilitator conduciveto individual and cooperativehousingefforts,” rather thana direct implementerof housingpolicy asit hasattempted to be in the past. This is an effective governmentpolicy objective for both the sector and the economy. Not only could it makethe sectormore productive, but also it could contributeto the kinds of increaseddomesticproductionthat the StructuralAdjustmentProgramaims to achieve. However, the financial instrumentsproposedto fulfill theseobjectiveswill not producethese results; furthermore, they may well have the oppositeeffect: increasingthe role of the public sectorandexpandingthe distortionsthat haveunderminedthe functioningof the housingmarket. The broader “stakes” involved with reforming the sector have increasedbecausethe reforms enactedare not only inefficient instrumentsfor the sectorbut also couldbe detrimental to overall economic growth and facial stability. If the private sector is to contribute to improving the performanceof the shelter sector, fundamentalmodifications in the NHP are necessary. By reviewing strategiesand programsthat other countrieshaveusedunder similar circumstancesto rejuvenatetheir sheltersector, this paperprovidesinformation on how housing policy can operate efficiently and sustainably. The plan of the paper is as follows. First, private sectorparticipationin the Nigerian housingsectoris examined. Then, the main financial instrumentsof the new National Housing Policy are described, followed by a discussionof internationalexperiencewith similar programs. Other methodsof financing the new Nigerian housingpolicy are considered,and in a final sectionthe most likely implications of the new policy are discussed.
” See T. Agbola and C. Olatubara (1989).
TABLE OF CONTENTS
EXECUTIVE I.
i
SUMMARY
THE ROLE OF THE PRIVATE
SECTOR IN NIGERIAN
HOUSING
1
II.
HOUSING
FINANCE
POLICY
UNDER THE NHP
3
III.
HOUSING
FINANCE
POLICY
IN OTHER COUNTRIES
5
l-V.
AN ALTERNATE
HOUSING FINANCE
POLICY
Addressingthe Affordability Problem Credit Subsidiesas a Responseto High Interest Rates Indexationas a Means to Addressthe Mortgage Affordability Problem
9
9 9 11
CONCLUSION
14
REFERENCES
16
EXECUTIVESUMMARY This paper provides an overview of the new National Housing Policy (NHP) that was recently adoptedin Nigeria. The languageof the new policy approachadvocatedin the NHP promotes the private sector as the chief meansto addressthe severeshortagesand costs of shelterin Nigeria. However, it appearsthat many of the key measuresadvocatedin the NHP couldbe counteractiveto both private sectordevelopmentandthe StructuralAdjustmentProgram (SAP). Through a review of the strategiesand programs that other countries have used to rejuvenatetheir sheltersector, this paperprovidesinformation on how the NHP can be revised to better exploit the private sector, operate more efficiently and sustainablyas well as to contribute to rather than impedethe StructuralAdjustmentProgram. For the past decade,the averagelevel of GDP investedin housinghas beendeclining. In addition, imported materialscontinue to account for a large portion of the inputs used in housingconstruction, and mortgagefinancehas becomeincreasinglyscarceand unaffordable. In an effort to reform the housing sector, the Nigerian governmentrecently adopteda new National Housing Policy (NHP). The government’srole is to act as “an enabler,promoter and facilitator conduciveto individualandco-operativehousingefforts, n insteadof actingas a direct implementerof housingpolicy as it has been in the past. This new approachcould serveto make the housing sector more productive and contribute to increaseddomestic production especially of housing inputs. However, the financial instruments proposed to fulfill these objectivesare not conduciveto theseendsand may well producethe oppositeeffect: increasing the role of the public sector and expandingthe distortionsthat haveunderminedthe functioning of the housingmarket. The main instruments of the NHP are (1) a new wage tax to finance housing, (2) increaseddirectedcredit for housingat low interest rates and increasedcompetitionfor deposit resourcesfrom newly createdandundercapitalized mortgageinstitutionsand (3) increasedaccess to subsidizedcredit for public sector housingproducers. The newly createdNational Housing Fund will financethe sectorthrough the FederalMortgage Bank of Nigeria (FMBN) which will then on-lend to newly created private sector institutions. The National Housing Fund will operatethrough (a) a mandatory2.5 percenttax on all wageearnersearningmore than N3000 per year, (aboutUS$ 150): thesecontributionswould be put into a retirement fund with a low nominalyield that is currently aboutnegative25 percent. (b) contributionsequalling10 percent of loanablefunds from all commercialandmerchantbanks: they would earn an interestrate one percenthigher than the rate chargeableon currentaccountdepositstherebyreducingprofitability of thesebanks. (c) investmentsof 10 percentof non-life funds and 20 percent of life funds of insurancecompanies: thesefunds will be investedat a four percentnominalinterest rate which will result in substantiallossesfor the insuranceindustry at the current level of inflation, in excess of 20 percent. Problems, possible alternatives and more sustainableschemesare discussedfurther in the paper. Alternatives to the forced savings schemeproposed in the NHP are available and currently underimplementationin other countries,suchas Ghana,Mexico, andPoland. Indexed mortgagesmay be a viable alternative. Indexation can operateto make housingfinanceboth affordable and sustainableby financial meansrather than by governmenttransfers. However, great care must be takenin the designof indexedmortgagesystems,otherwise, they caneasily becomea more circuitous, less transparentway of providing credit subsidies.
I. THE ROLE OF THE PRIVATE SECTOR IN NIGERIAN HOUSING Private sectordevelopmentin the Nigeriansheltersectorhasbeenat a standstillfor more than a decade. With few exceptions,the private sectortransactionsthat have taken placehave beeninformal and on the fringe of legality. At the oppositeend of the spectrum,public sector activity is plaguedwith manyproblems. Insteadof operatingas a socialpolicy, it operatesmore like a regressive lottery or patronage system. The results have been the simultaneous construction of some of the most luxurious subsidizedhousing in Africa, and general deteriorationin the housingconditionsof most Nigerians,particularly the housingconditionsof the poor. The changesproposedin the new National HousingPolicy (NHP) could well expand the public sector role in thoseareaswhere private sectordevelopmentcould make the greatest contribution--in the financingandproduction of housing. Over the four yearsof the SAPendingin 1990the averagelevel of investmentin housing was 1.7 percent of GDP. This figure is almost half the 3.3 percent share achievedin the precedingdecade,and this sharehas secularlydeclinedfrom over 3.6 percent of GDP in 1975 to 1.5 percentin 1990.” The adjustmentprocessis clearly relatedto a reductionin the amount investedin housing. However, this period alsowitnessedan oscillationanddeclinein oil prices and correspondinglynationalincome. Suchmacroeconomictrends would also have negative effects on long-term investmentssuchashousing. Hence, the exact causeof the seculardecline in housinginvestmentover the past 15 years is impossibleto identify with any precision. But, what is clear is that the full cost of new housing, as produced in Nigeria, is reflected increasinglyin the prices paid. For example,a conservativeestimateof the foreign exchange contentof housinginvestmentin 1990was suchthat the price of imported materialsfor housing constructionwas greater than incomefrom all non-oil exports. With the depreciationof the naira, the full cost of housingconstructedprimarily from importedmaterials(on the order of 50 to 60 percentof inputs)becomesclearer.3’ For instance, considerthe caseof a family who in 1986purchaseda new home, constructedfrom 50 percent importedmaterials. Suppose,conservatively,that the structureaccountedfor 70 percent of the cost of the house, and that the cost of the housewas five times annualincome.4’ If that family were to buy the samehousewith the sameimportedmaterialsin 1991becauseof the reduced value of the naira, the housewould require more than 12 times annualincome. If the further reductionsin the r&a’s valueover 1992are takeninto accountthesecost increasesbecomeeven more pronounced. In this kind of cost environmentthe surpriseis not that import-basedhousing investmentdeclined, but that the decline was not greater.
2/ The figures are from Economic and Social Statistics, Federal Office of Statistics. Lagos, Nigeria. The first four years of observations are from a 1985 publication; the data through 1990 are the most recent available. 3’ Onibokun (1986). 4’ This figure is not unusual for those developing countries that have reasonable regulatory regimes.
2 As the aboveexampleshows,domesticinput marketshavefailed to replacethe imported materialsusedin housingconstruction. One reasonfor this failure is the lack of credibility that a completeadjustmenthas occurredin the foreign exchangemarket. Until March of 1992, a parallel market for foreign exchangeexisted, with premia averagingover 30 percent. Hence, even though the official value of the naira had fallen, for domesticproducers, there was the reasonableexpectationof the needfor further substantialreductions. Sucha prospectdoesnot provide a credible basis for domesticproducersto begin a serious investmentprogram in an industry that produces non-tradablegoods. The result is a lack of private sector interest in developingthe input industry, even though significantbut not completeadjustmenthad taken place.5’ A credible foreign exchangemarket is essentialfor encouragingprivate investmentin the housingsector. For the encouragementof private sectorinput production. the most important stepis the developmentof a credible macro and sectoralenvironment. This credibility will have much more important effects than increasedfunding for researchinto low-cost housingproduction techniquesandmanpowertraining programsas recommendedin the NHP. Of course,attention should be given to making sure that building approval standardsare not inhospitableto the developmentof more reliance on locally-producedgoods. But, the keys to credibility on a macro level are : (1) a freely determinedexchangerate--so that imports are not subsidized relativeto domesticproduction, and(2) a lessinflationaryenvironmentso that long-term finance canprosper. On a sectorallevel, credibility requiresaccessto land and financeon competitive, affordable terms, and the allocation of domestic input production on a market rather than administrativebasis. If this kind of credibleenvironmentcanbe put in place, then an important complementarypolicy changecould make the NHP consistentrather than competitivewith the Structural Adjustment Program. This policy could substitutethe expansionof finance for the currently proposedexpansionof governmenttransfersand contingentliabilities.@
5’ Uko (1992) discusses the case of the unsubscribed common stock shares for the Nigerian cement producer Nigercem. It says that despite bright industry prospects, investors were wary because of the heavy involvement of government in the company. 6’ As far as government transfers go, an issue that also merits consideration is the structure of compensation for employees. As a rule housing allowances are granted in cash or in kind, with 50 percent of basic salary as median for middle management and much higher for senior management. Especially as such allowances may not be reported for personal taxation it confers a greater purchasing power on these employees and has a significant effect on the price of housing, apart from making the taxation system less transparent and progressive.
II. HOUSING FINANCE POLICY UNDER THE NHP Thepart of the new NationalHousingPolicy (NHP) that hasreceivedthe greatestamount of public attention and which the policy documentrefers to as the center piece of the new approachis the establishmentof a NationalHousing Fund which will financethe sectorthrough the Federal Mortgage Bank of Nigeria (FMBN). The FMBN which is a designatedAPEX lending institution will on-lend to newly createdprivate sector mortgageinstitutions. Capital for the National HousingFund will be raisedthrough three main sources:
6)
A mandatory2.5 percenttax on all wage-earnersearningN3000 (aboutUS$ 150) or more per year. Thesecontributorswould be able to withdraw thesefunds at retirement, with a low nominalyield that is currently about negative25 percent. Families saving at this real after inflation rate of interest will have serious problems. For instance,in ten years their current contributions will be worth about 10 kobo on eachnaira of contribution. And, if inflation increases,even less.
@)
All commercialand merchantbankswould contribute 10percentof their loanable funds in this Fund at the FMBN. They would earn an interest rate one percent higher than the rate (currently a maximumof five percent)chargeableon current account deposits. Hence, this measure would imply that commercial bank profitability would be reducedby the difference in the rate they would have earnedon their current undirectedloansthat would in the future have to be put in the housingfund. In the Spring of 1992, the interest on inter-bank loanswas on the order of 45 percent. The difference is thus a reductionin return of about 40 percent, and becausethis lower return appliesto 10 percent of bank lending it would in turn result in an averagereturn on total lending that was lower by about four percent. To maintaintheir current level of profitability, bankswould have to increasetheir spreadby three to four percent. Hence, even ignoring commercialbank problemswith bad loansand the Central Bank’s estimatethat about one-third of the country banks are “unhealthy” or “distressed”,” this policy is not consistentwith a well-functioning bankingsystem. For Merchant Banks the implied tax rate could be even higher becausetheir return on unrestrictedlendingis higher. They can, however, avoid at least someof the tax by changingthe mix of their investmentsaway from lending.
w
Insurancecompanieswould be required to invest 10 percent of their non-life funds and 20 percent of their life funds in real estatewith at least half of these amountsgoing to the housingfund at a four percentnominalinterest rate. Once againthe losseswould be substantialat an estimatedN52.7 million annually.*’
” See Hawkins for a more detailed analysis of Nigeria’s banking system. 81 Business and Financial Analyst.
4 Unless inflation were to fall quickly and permanently,theseinvestmentsin the National Housing Fund would not be sustainable. In addition, the Federal governmenthas releaseda N250 million take-off grant to ensurethe viability of the Fund.” The FMBN will lendthe proceedsto newly establishedprimary lenders,calledmortgage institutions. As of August 1992, 61 suchinstitutions had beenlicensedwith an extremelylow capitalrequirementof five million naira, (aboutUS$ 220,000) and over 200 other firms were seekingsuch licenses. The plan is for the mortgageinstitutions to on-lend the proceedsto individual borrowers, with 80 to 85 percent financing from the National Housing Fund while thesemortgageinstitutionswill mobilizethe residualportion of the loan, earninga four percent spreadon their cost of borrowing from FMBN. Earning this four percentspreadon 80 percent of the loan would permit thesenew institutionsto competeaggressivelyfor deposits. Hence, other deposit-basedlenders,suchas banks,would be confrontedon both sidesof their balance sheets:more competition for depositsfrom new institutions and more constraintson earnings from the lower interest rates on their earmarkedassets. Perhapsthe most striking deficiency of the National Housing Fund is ‘that it fails to benefit its target population-- families of modestincome -- due to fundamentalloopholesin the plan. Workers earning at least N3000 per year contribute to the Fund and are its expected beneficiaries. The Fund authorizesN80,OOOasthe minimum amountof a loan and 25 yearsas the maximum lending period. At the current rates of interest, N3200 is the minimal yearly mortgagepaymentundertheseconditions. This amountis higher thanthe annualsalaryof many contributors, and when the interest rate is considered,the disparity between the borrower’s annualincome and the expectedmortgagepaymentis more acute.lO’ Other details of the fund’s operationare designedto assurethat it operatesequitably; such as preferencesfor lower income families, and perhapslimits on the loan amounts,but rather than focusingon the problemswith thesedetailsit is important to clearly identify the main problem with this approach: severefinancial sector problems are a likely result. Using (1) thinly-capitalized,new institutions in (2) an inflationary environmentto on-lend funds that (3) are mobilizedthrough tax and regulatory coercionfor (4) a sector that has significantcollection problemswill not work. The likelihood of very costly failure is almostcertain. The possibility that this financial schemewill contribute to private sector developmentis highly doubtful.
9’ Daily Times. lo’ This and other deficiencies are discussed in greater detail in the Business and Financial Analyst.
III. HOUSING FINANCE POLICY IN OTHER COUNTRIES Other countrieshavehadlittle successin implementinghousingfinanceschemesthrough strictly public sectorinstitutionssuchasthe FMBN. There is no obviousreasonwhy institutions of this sort should be wholly publically-owned. Nor is there a rationale for operationsto be outside the purview of financial sector regulations,as is often the caseand is currently the situation with the FMBN. The reliance on public sector institutions to finance the sale and construction of housing has proven to be extremely problematic and ultimately inefficient .in other nations. Often such arrangementsincreasestagnationof the housing sector. Ghana provides an instructive example. The housingsector in Ghanahas many characteristicsin commonwith that of Nigeria. The Ghaniansheltersector hasbeencharacterizedby a high cost relative to income ratio, low housingquality, housingparastatalsthat are barely functional, and a bankrupteddomesticinputs market existing in a financial environmentof high inflation, low, unindexednominal interest rates, and extensivedirection of credit to unsuccessfulparastatals. For the past three decades, two parastatalorganizations,the StateHousingCorporation (SHC) and the TemaDevelopment Corporation (TDC), were the primary sourcesof housingproduction. The Bank for Housing andConstructionprovidedmortgagefinance. All arepublic sectororganizations.Both the SHC and TDC have operatedin deficit for severalyearssurviving through the governmentsubsidies that they receive. Thesepublic sector organizationshave been ineffective in fostering the developmentof the housingandconstructionindustry. As a result, the production of housing through these agencieshas dwindled to only a few hundredunits per year. The World Bank fundedUrban project now under implementationin Ghanawas designedto begin counteracting these problems, mainly through restructuring the housing production industry and housing finance system. The project will also providetechnicalassistanceto perform detailedfinancial and institutional studies on the housing parastatalsfor developing a plan to reform and restructure the agencies. The main objective will be to privatize the agenciesto the extent possibleand improve their operatingefficiency through commercialization.I” In Nigeria, as in other countries,the relianceon a large number of new private sector institutions with little or no nominal capitalrequirementsis extremely risky under the best of circumstances. Usually the capitalrequirementsfor private sector mortgageinstitutions is at least four or five times higher than that authorizedunder the NHP. In other countries, such insufficientcapitalrequirementshaveresultedin the governmenthavingto subsidizeor “bailout” the private sector institution. The ongoing U.S. Savings and Loan Crisis provides an example of the possible detrimentaleffects of undercapitalizedfirms operatingin the financial sector. The S&L crisis can be tracedback to policy decisionsduring the early 1980swhich permittedthe S&&s capital to erode from a level considerablyhigher than thosemandatedby the NHP.12’ Traditionally, ‘l’ World Bank, Housing Sector Review for Ghana (1989). 12/ Colembe and Dembitz (1976) offer a thorough analysis of the capital requirements of S&s.
6 S&Ls lent funds on 20 to 30 year mortgagesat fried rates of interest and funded themselves through short term deposits;a structurevery similar to that proposedfor Nigeria’s new lenders. During the late 1970sand early 198Os,higher inflation rates, and correspondingly,the higher interest rates that the S&Ls had to pay depositorssharply decreasedearnings,eroding capital. At the sametime that capital was erodedby increasesin interest rates, financial deregulation phasedout interest rate ceilingson deposits,allowednew lending practices,and increasedthe maximum size of insured depositsfrom US$ 40,000 to US$ 100,000. This new regulatory regime provided greater freedom of investmentsincethe S&Ls were required to risk little of their own capital. Any lossesbeyondthe low levelsof capital in the firms would be absorbed by the U. S. govemment. While this type of structureinsuredthe plentiful supply of mortgage credit and competitivemortgagelenders,it also inducedmuch greater risk-taking by the S&&s; risk-taking with capital they did not have. This risk-taking resulted in bankruptcy for many S&Ls; in the end the U.S. governmentwill pay in excessof $200billion sothat the Savingsand Loan Associationscan meet their obligations. The useof ear-markedtaxesto mobilizefunds for low cost mortgagecredit, as hasbeen proposedin the NHP, is problematicin an inflationaryenvironment. As an alternativeto this forced savingsschemethat expropriatessavings,savingscouldbe investedin indexedmortgages rather than in negativereturn governmentsecuritiesthat, for example, the National Provident Fund (NPF) now holds. However, the inability of the NPF to accountfor the paymentsby contributors for the past five years is a causefor seriousconcern as to whether this type of change can be implemented.13’ Investment in indexed mortgages would be a significant improvementfor its savers,and is exactly what was donein the recent Bank project in Ghana. If done appropriatelyit would also eliminatethe needfor the additionaltax on wage-earners. Once again, Ghanahas confronteda similar policy situation. Ghanahas recently implementeda three year pilot housingfinanceproject to establish the Home FinanceCompany Ltd (HFC) which would implementa mortgagesystem aimed at moderateand middle income households. The HFC is owned and operatedon a commercial basisby the National Bank of Ghana. To financethe mortgagesystemthe HFC floats 30 year mortgage backed housing bonds which are subscribedto by the governmentand the social security fund. The proceedsfrom the bonds are lent to approvedOriginating and Servicing Institutions (OSIs) for mortgagelendingto householdsmeetingspecificeligibility requirements. Operating under a Dual Index Mortgage system (DIM), repaymentsare based on 25% of verifiable householdincomethrough a payroll deductionscheme,and the outstandingprincipal on all bonds and mortgagesare indexed to inflation on a monthly basis. This system will finance about 2000 modest (l-3 rooms) housingunits. Private sector developerswill design, market and build thesehouseson a commercialbasis. The program will alsohelp finance the sale of about 1000 existing government-ownedhousingunits to the private sector as part of a long-term effort to restructurethe huge, inefficient housingparastatals. Exactly how this kind
13’ The Guardian, Lagos, March 1992.
7 of lending can be made affordable to householdsyet simultaneouslyattractive to lenders is describedfurther below. While the sectoraland fiscal situationin Ghanais most easily comparableto Nigeria, indexedmortgagesystemshavealsobeenintroducedin Mexico andPoland. The housingsector in Poland, as in Nigeria, is characterizedby high nominal interestrates, high inflation, a high cost relative to income ratio, low housingquality and large subsidies. The transition from a central to a market economyhas exacerbatedthe situation. To confront theseproblems, expand the supply of housing,and make housingmore affordable, the governmentin cooperationwith the World Bank housingproject has establisheda dual indexedmortgage systemthat will be financedthrough a MortgageFund establishedin the HousingDevelopmentBank (BUDBANK). The purpose of the Mortgage Fund is to provide a stable source of long-term funding for housingthat replacesthe large interestrate subsidiesthat were given. It was designedto help encouragecommercialand savingsbanksto underwrite mortgagesfor individuals, and develop mortgageconditionsto usein the prevailingeconomicconditionsin Poland. The MortgageFund will make long-term loans to participating banks on commercial terms. Initial capital contributionsfor the MortgageFundwill comefrom the Government,the World Bankand other multi and bilateral sources. After several years of operation the Mortgage fund will raise funding through the saleof bonds. During the first six years the Fund is expectedto disburse about $400 million and to finance some27,000 new housingunits. Similarly, in Mexico, high nominal interestrates during the 1980smade standardfixed paymentmortgageswith high initial paymentsu&fordable to most homeborrowers. In 1984, the Central Bank implementeda new “dual rate” mortgage instrument designedto make mortgagelendingmore attractivein an inflationaryenvironment. In 1986the World Bank made the first of four housingloansto variousfinancialagencies.While Ghanaand Polandhave only recently implementedindexedmortgage systems,Mexico has been experimentingwith such systemsfor almosta decade.In Mexico, indexedmortgageschemesare now an acceptedmeans to financehousing. TheWorld Bankhasmost recently supportedtheseoperationswith the 1992 loan to the Housing Fund for CommercialBanks(FOVI). FOVI is a trust fund within the Central Bankwhich was createdto channelfederal funds from the Central Bank to commercial banks to finance low-cost housing for low-income beneficiaries. FOVI is financed through loans from the Central Bank, federal government transfers, and retainedearnings. The commercialbanks acquireFOVI funds through a funds auction andthen offer mortgagefinancingto the homebuyer at a variablerate of interest equal to the averagecost of funds. The interest rate on all FOVI loans is recalculatedmonthly to reflect changesin the averagecost of funds. The loan amount is linked to the homebuyer’s householdincome, andthe initial monthly paymentis establishedas a percentageof the average loan amount. Subsequentmonthly paymentsare adjustedas the minimum wage increases. If adjustedmonthly paymentsare not sufficient to cover the accruedinterest, the difference is capitalized,and the loan term is extended. However, if the life of the loan extendsmore than 20 years, FOVI assumesthe outstandingbalance. As part of the World Bank project, FOVI is currently working on a new indexationschemethat will reducethe contingentliabilitiesresulting
from the 20 year limit of the mortgageterm. Over the next five years, FOVI is expectedto finance32,000housingunits annuallyat a yearly investmentcostof USS400million equivalent. Table 1 summarizesthe indexedmortgagesystemsunderimplementationin Poland,Mexico, and Ghana. Table 1 Dual IndexedMortgage Systems
Expected Inflation Rate (%)
Downpaymen 0)
Real Interest Rate on Loans ( %)14’
LTV (%)
Loan Maturity Ole=s)
Spread Over Cost of Funds (%I
Poland
40
25
6
80
30
3
Mexico”’
12
10-20
6.8
80-90
12-15 25 max
5
25
, 20-30 ,
2.5-3.5
, Ghana
,
,
80
,
15-25
Source: SARs (Poland,Ghana); SAR and Country Department(Mexico).
14’ The real interest rate varies with the average cost of funds. 15’ This is the actual 1992 inflation rate for Mexico.
,
1
,
IV. AN ALTERNATIVE HOUSING FINANCE POLICY’6’ Addressing the Affordability Problem Among lower and moderateincome families,17’the primary impedimentto affordable housingfinance arises when inflation makeshousingunaffordableat market rates of interest. Under conventionallending instrumentssuch as Fixed rate Mortgages (FRM) and Adjustable RateMortgages(ARM), operatingin an environmentof high inflation andnominalinterestrates, paymentscan quickly rise to a level that is unaffordablefor most homebuyers. The underlying problem -- commonly referred to as the repaymenttilt problem -- is that loan repaymentsare heaviestin real terms at the beginningof the contract period. In most countries, the mortgagerepaymenttilt problem has beentreated in one of two ways: (1) asan affordability problemthat requiressubsidies;or (2) as a contractingproblem that can be solved by redesigningthe mortgage instrument. In principle, this secondapproach attemptsto dealwith the concernof lendersby ensuringthat the real value of repaymentsis not affectedby inflation. It is discussedmore fully later. But, first considerthe former approach-credit subsidies-- as a meansto addressthe inflation-causedaffordability problem. Credit Subsidiesas a Responseto High Interest Rates Most countries in the world have at one time or anotherused interest rate subsidiesto reducemortgageborrowing costs. Throughthis approachthe cash-flowproblemsof households are solved by ?-e-tilting” the early paymentsback to what they would have been without inflation. Credit subsidies,such as those proposedby the NHP, are usedto “buy down” the cost of housingfinance at below-market interest rates. While this practice is widespreadand attractiveto borrowers, there are at leastthree problemswith this approachthat make subsidies an inefficient method of increasinghousingaffordability. First, below-marketcredit providesa subsidyto solvewhat in most casesis a contracting problem. While preciselymeasuringthe real amountof a credit subsidyis difficult becauseof the complexity of projecting inflation and the real interest rate, the per unit subsidy level necessaryto eliminate the inflation-relatedtilting of repaymentis certainly very large. For instance,with an inflation rate of 30 percentand a real interestrate of eight percent,the subsidy necessaryto eliminate the tilt problem is on the order of 60 to 70 percent. In Table 2 the impliedsubsidyrate is given for a H-year mortgagewith variousassumptionsaboutreal interest
16/ This section is based on Buckley et al (1992). I” Housing problems for the absolute poor -- those families who cannot afford the minimum standard of shelter that is available -- is most effectively addressed by improvements in the functioning of basic infrastructure supply and/or providing tenure security. The encouragement of homeownership through a highly subsidized credit mechanism is m the most practical direct method of providing shelter for the very poor. Rather than improve the efficiency of the housing system, it merely increases the size of the transfers within it. For a detailed analysis of housing policy for low income groups see World Bank (1993).
10 rates, the expectedinflation, and the nominalinterestrate charged. The last column showsthe subsidyrate required to get mortgagepaymentsback to the sameproportion of family income put towardspaymentswhen there is no inflation. Affordability problemsresultingfrom inflation can be addressedmore efficiently through modificationsin the mortgagecontract. At rates of inflation lower than 50 percent a year, carefully designedindexed mortgage schemescan eliminatethe cash-flow costsimposedby high nominalpayments,andcando so without subsidy.
Table2 Credit SubsidiesImplied by Different Interest Terms ExpectedInflation Rate:
Real Interest Rate:
SubsidyRate Neededto Eliminate Tilt:
15%
8%
53%
30%
8%
71%
30%
10%
68%
40%
8%
77%
30%
6%
73%
Second,interest rate subsidiesreducereal repaymentsthroughout the life of the loan rather than shifting the repaymenttilt by reducingthe higher costs during the early years of a loan when the default risk is highest. As a result, with a subsidy,interestpaymentsin the later yearsof the loan becometrivial rather thanjust small. For example,insteadof being required to allocateas much as 60 percentof incometo repaymentsas could be the casewith a fixed rate loan,a subsidysufficient to reduceearly paymentsto affordablelevelswould call for repayments in later years that account for one or two percent of income. Clearly this kind of subsidy mechanismgives beneficiarieslarger than necessarysubsidies. Third, if the objectiveof the subsidyis to increasehousingconsumption,then, because credit is at least partially fungible, subsidizingcredit is less efficient than is subsidizingthe housingexpenditureitself. It is inefficient becauseover the long-term sucha subsidypermits householdsto substitutesubsidizedcredit for their own savingsand, thereby, frees their savings to be usedfor other purchases. Hence, it allowsthe subsidyto be spenton activities other than thoseit was intendedto encourage. Consequently,the efficiency of the subsidyin inducingthe intendedbehavior is diminished.
11 Indexation as a Means to Address the Mortgage Affordability Problem Sincemortgagecontractsare generallywritten in nominalterms, they canquickly become u&fordable in an inflationaryenvironment. To makemortgagesaffordablemortgagecontracts must addressthe financing problems that result from inflation. From this perspective, the objectivefor redesigningmortgagecontractsis to eliminatefacial constraintsthat impedethe affordability of housingfor lower and moderateincomehouseholds.In Nigeria during the mid 1980swhen inflation was five percent per annum, the effect of interest rates on mortgage contractswere trivial; but at current inflation ratesof about 30 percent, interestrates are so high that mortgagefinancingis u&fordable in nominalterms. The objectivesof adjustingmortgage repaymentschemesunder inflation are not to producemore housing,althoughthat outcomewill often result. Rather, it is to provide a financingvehicleso that thosewho can afford to, and so desire, can purchasehomes. As a meansof reducingmortgageaffordability concerns,rather than housingaffordability problems, indexation has much to recommendit, particularly relative to credit subsidies.18’ With indexed repaymentslong-term mortgagescan be attractive investments to long-term investors. However, the importanceof crediblemortgagedesignto the successof suchefforts and the likelihood that such instruments will not perform in facial environments with extremely high and volatile levels of inflation cannotbe exaggerated. Hence, the costs and benefitsof mortgageindexationdependon the designof the instrument. Becauseof housing’s durability, mortgage designmust take real as opposedto nominal repaymentsinto account. Otherwise, the cash flow problems of mortgagecontracting, rather than rates of return on investment, will dominate decision making with respect to housing investment. EsU~lY important in mortgage designis the recognitionthat solving the mortgagecash-flow problem through indexationexposesthe lender to anotherrisk, i.e., that real wages will permit higher nominalpaymentsto be made. In someenvironmentsthis risk is a large oneand failure to price or reward this kind of risk-taking will result in a contractingprocessthat is not credible. 18/ Three types of indexed mortgages are commonly used. Each type has different advantages and drawbacks. Mortgage payments indexed to priceslower the high front end cost of a mortgage. The real interest rate is set when the loan is made, and both the repayment and the outstanding balance are linked to the price index. If the burden of real mortgage repayments increases, repayment becomes more uncertain, and the lending institution is faced with repayment difftculties. Mortgage systems indexed to wages protect borrowers from the sudden shocks that can, occur if real incomes fall, since the portion of income devoted to repayment remains the same. Each year as wages nominally increase, so do the monthly payments and vice versa. This type of indexation can be disadvantageous to the lender since the real value of the loan is uncertain. A dual system of wage and price indexation is designed to address the concerns of both borrowers and lenders. Mortgage payments are indexed to wages so that the borrower never has to pay more than a comfortable proportion of his income. The loan balance is indexed to prices so that any portion of interest and principal due over and above a given portion of income is capitalized into the loan outstanding. The loan maturity varies to permit shortfalls in real repayments to be offset by extending the life of the mortgage or earlier real repayments to pay off the loan more rapidly. This protects the lender from substantial losses. As noted earlier, such systems have been introduced in Ghana, Mexico, Poland; they have also been introduced in France.
12 In countries with high levels of inflation such as those of Latin America, mortgage indexationwas introducedto amelioratehousingaffordability problems. The movementaway from the use of nominal-interestrate, level-paymentmortgageschedules(as occurred Chile in 1959,Brazil in 1964,Colombia in 1972,andArgentinain 1976)was the result of governments’ selectivecredit policiesto lower costsrather thanmarketparticipantsmodifying their contracting methods.lp’ While the kinds of indexedcontracts introduced were a cost-effective meansof restructuringpaymentsto lower paymentsandredistributethe high real initial costs, they were not an effective meansof introducingthe kindsof crediblecontractsthat would induceinvestors to be willing to sharethe risks posedby indexation. Ex post, in every caseexcept Columbia, the approachesthat have beenimplementedhaveexperiencedseriousproblems. In principle, indexedmortgageinstrumentsafford a way for modifications in financial contractsto replaceinterest rate subsidies. However, considerablecare needsto be practiced in their usebecausetheseloansallow nominalloan balancesto increaseover time, andthereby exposethe lender or governmentto potentiallylarge contingentliabilities. In Nigeria there has been some experiencewith the issuesinvolved. Merchant bankers in Lagos have already developedand issueda convertiblebond schemeto finance real estatedevelopment. Most of the principles involved could be appliedmuch more simply to innovationsin the form of the mortgage instrument. An indexed mortgage system can operate to counteract credibility problemsthat effect the housingfinancesystemand can make housingaffordable to lower and middle incomefamilies who otherwisewould not be able to afford to buy a house. However, as discussedpreviously, great care must be taken in the designof an indexedmortgagesystem within a country’s macroeconomicenvironment. Considera householdwith a family incomeof N3,OOOper year, and paying 20 percent of this initial incomefor mortgagepaymentson a 30-year fully-amortizing fixed-rate loan. In a world of zero inflation, and a 3 percentreal interest rate, this paymentwould be sufficient to finance a loan for almost N12,000, an amountfour times annualincome. In a free market if inflation increasesto 10 percent, nominal lending rates rise to approximately 13 percent to compensatethe lender for the erosion in the value of later payments. With the sameshareof incomethe householdcan now afford a mortgageof only N4,500, an amount1.5 timesof annual income. But anotherway, when the inflation rate increasesby 10 percent, householdsmust more than doublethe initial shareof incomespenton mortgagerepaymentsin order to finance the sameamountof real debt. At the sametime, however, the real paymentsrequired in the latter years of the loan are cut in half. Given the scale of the increasein initial payment burden that occurs with only a 10 percent increasein the rate of inflation, an increasewhich is much less than the 50 percent averageannualrate of inflation experiencedby developingcountriesover the 1983-1987period, it is obvious that under typical inflationary conditions in developing countries, mortgage
lg’ See Fishlow (1978) for a discussion of the policy objectives of indexation in Brazil.
13 financing is not affordable for most families.20’ In Nigeria, where housing is built from imported inputs making it expensiveto start with and inflation pushingup the cost of finance, housing is increasingly unaffordable. Indexation is a viable alternative to overcome macroeconomiceffects that make mortgagefinance unaffordable. While mortgageindexationhasbeentried with limited successin a numberof countries as an alternative to lowering interest rates, its failings have not been the result of the naive applicationof an abstract economicconceptto “real world problems.” Nor have the failings beenthe inevitableconsequenceof “surrenderingto inflation.” Rather, problemshave arisen for two reasons. First, under the extremelyhigh rates of inflation that have occurredin Latin America, indexationof mortgagerepaymentsprovides little help. When inflation rates exceed 50 percent per year, even indexedinstrumentscannotadjust fast enoughto keep up with the inflation rate.21’ Second,there have often been inherent flaws in the way repaymentshave beenimplemented.Mortgage systemsoften did not adequatelyaddressthe effectsthat real wage volatility could have on loan values. In many casesonly price indexes, which made no provision for the real wage shocksthat occur, were usedor only wage indexes, which over compensatefor real wage shocks,were used. In principle, instrumentsexist which canprovide sufficient cushioningagainsttheseshocksand can makehousingfinanceboth affordableand in most circumstancessustainableby financial meansrather than with governmenttransfers.22’ Simple models can be used to determinewhether this type of instrument can be effectively implemented in a particular economic environment. Nevertheless, the difficulties in implementing an indexed mortgageinstrument should not be understated. Many technical questionsthat require equallytechnicalrather than political answersmustbe addressedfor these kinds of instrumentsto work and be sustainable. Otherwise, indexed instrumentscan easily becomean even more circuitous way of providing credit subsidies.
20’ Data on the inflation rate in developing countries from the World Develonment Report, (1989), p. 63. 21’ While any simple measure of the limits to indexation’s effectiveness is arbitrary, our cut off of 50 percent per annum as an upper limit receives some indirect empirical support from Cardoso and Fishlow (1989). In a crosssectional study of 17 Latin American countries, they show that at a rate of inflation of less than 50 percent per annum there is no systematic effect of inflation on growth--except in one period during which it is positive. They also show that if the sample is not limited to inflation rates below 50 percent, there is a negative correlation between inflation and growth. pl For example, if the contract is viewed as a mortgage with a put at maturity, the put would be priced by a wellfunctioning market, in principle. Alternatively, even if the state accepts this contingent transfer, it is clearly a more effective way to subsidize mortgage credit, if that is desirable, than is an interest rate reduction.
CONCLUSION The primary prerequisiteconditionnecessaryfor the developmentof a well functioning shelter sector in Nigeria is a crediblemacro economicenvironmentwith a free exchangerate anddeclininginflation. At the sectorallevel a prerequisiteis to endunfair competitionbetween private and public firms. The private sector cannot competewith public sector institutions receivingmassivegovernmentsubsidies. And, while this is a necessarycondition for a more efficiently run shelter sector, it is not sufficient. Even if public sector firms were eliminated, the developmentof a housingfinancesystembasedon significantlyunderpricedcredit will only createpressuresfor favoritism in accessto the fundsbasedon noneconomic criteria. Sucha result is the opposite of what a well-functioning market would produce. Hence, equally important as the privatization of state housingproducersis the needto privatize the housing financesystem, and basethe delivery of mortgagecredit on commercial, and well-capitalized, rather than coercivemeans. If the latter step were carried out, then thesecommercially-sound institutionscould developa sustainable meansof providing affordableface. Adaptionsto the NationalHousingPolicy areavailable,andhaverecentlybeenintroducedin other countriessuch as Ghana, Poland, and Mexico. On the other hand, proposalsmade to expandthe supply of face and state housing corporationactivity in Nigeria will extend the public sector in ways that have not worked in some basic ways. Indeed, the most important of the proposals adopted in the NHP are inconsistentwith both the broaderapproachtakenin the Structural AdjustmentProgram (SAP), and the efforts to developgreaterprivate sectorparticipation in the economy. Proposalssuch asdirectedcredit and increasedtax approacheswere often followed in other countriesduring the lower inflation daysof the late 1970sandearly 1980s. Like theseproposalsfollowed elsewhere, the Nigerian proposalsalso datefrom the low inflation days before the SAP beganin 1986.23’ Nigeria, in fact, is introducing and strengtheningpoliciesthat other countrieshave eliminated or significantly restructuredwhile undergoingstructuraladjustmentprograms. Hence, it is not clear that this is an appropriateenvironmentin which to introduce financial innovations(such as indexed mortgages) to make mortgagesmore affordable, particularly if these instruments would be used to fund clearly inefficient suppliers. Therefore, before making the housing financesystemmore private sectororiented, it would be prudent to makesure that the objective of such a policy is to exploit the enormousefficiency gains for the sector rather than just increasethe size of the transfersto the sector.24’
~3’ The Reportof the Special Conkttee on New National Housing Policy, July 1985, contains the recommendations implemented in the 1991 policies. It is worth noting that the inflation rate at the time of these recommendations in 1985 was 5 percent per ammm, so that the low interest rate proposals of the recommendations were much more innocuous than they are now when inflation is much higher. ~4’ Such improvements are necessary according to the fmdings of papers prepared for a recent development conference--“Ameliorating the Impact of the Structural Adjustment Program on Housing and Environmental Development in Nigeria,” by the Center for African Settlement Studies and Development, January 1992, Ibadan, Nigeria--which argue that overcrowding has increased substautially and housing conditions have deteriorated generally since 1986.
15 While the objectivesof the NIP are laudable,the measuresproposedto achievethese objectiveswill most likely causeseriousproblemswhen implemented. As currently structured, the National Housing Fund, the financialcomponentof the NIP, is an unsustainabletransfer that will createsignificantproblemsfor analreadytroubledfinancialsystem. It will alsoimpose significant costs on wage earnerswho will pay for this system with the expropriationof the return on as well as a portion of their retirement savings. Finally, it is almost certainly a regressivesystem that will encouragean increasedpolitization of the shelter sector. Hence, rather than contributing to a much greaterprivate sector role in the housingsector, this policy will havethe oppositeresult: it will broadenthe public role in the financial sector, increasethe public claims on wage earners, and it will likely reinvigorate public housing producers. Alternativesare availableand shouldbe considered.
REFERENCES Agbola Tunde and C. 0. Olatubara, “Housing Subsidy, Mortgage Default, and Housing Replicability in Nigeria: A CaseStudy of the Public Housing Delivery System,” African Urban Quarterly Vol. 4, No. 1 & 2 (Feb. and May 1989) pp. 90-96. “Ameliorating the Impact of the StructuralAdjustmentProgram on HousingandEnvironmental Development in Nigeria,” Centre for African Settlement Studies and Development, January1992,Ibadan,Nigeria. Buckley, Robert, BarbaraLipmanand ThakoorPersaud,“Mortgage DesignUnder Inflation and Real Wage Uncertainty: The Use of a Dual Indexed Instrument,” World Development, February 1993. Buckley, Robert, “The Measurementand Targetingof Housing FinanceSubsidies: The Case of Argentina,” Public FinancelFinunces Publiques Vol. 46, NO. 3 (1991) pp. 355-372. Business and Financial Analyst, “National HousingFund: An Octopus?” 1992pp. 8-10.
Cardoso Eliana and Albert Fishlow, “Latin American Economic Development: 1950-1980” National Bureauof EconomicResearchWorking Paper No. 3161,Nov. 1989. Daily Times, “FG ReleasesN250m grant to NationalHousing Fund,” 9 Sept. 1992pp. 4. Economic and Social Statistics, FederalOffice of Statistics.Lagos, Nigeria, 1985.
FederalRepublic of Nigeria, The Report of the Special Committee on New National Housing Policy, July 1985. Fishlow, Albert, “Indexing Brazilian Style: Inflation Without Tears?” Brookings Papers on Economic Activity, 1974:l pp. 261-282. Friedman,Milton, “Using Escalatorsto Help Fight Inflation,” Fortune July, 1974. The Guardian, Lagos, March 1992.
Golembe,Carter H. and Lewis N, Dembitz. “Capital Needs of S&L Associations,” Change in the Savings and Loan Industry, Proceedingsof the SecondAnnual Conferenceof the FederalLoan Bank of SanFrancisco,Dec. 9-10, 1976. Hawkins, Tony, “A Sectorthat NeedsReform,” Financial Times 1 Apr. 1993,III: 4. Kontagora,M.T., “National and StateHousingPolicies:An Assessmentof On-Going Programmes,” Speech,24 March 1992.
17 Onibokun,Poju, Urban Housing in Nigeria, NationalInstitute of SocialandEconomicResearch, Ibadan,Nigeria, 1986. Uko, Inyang Joseph,“Public Unimpressedby Nigercem Ownership” The Guardian, Lagos 12 Apr. 1992,Al 1. World Bank, “Housing: EnablingMarkets to Work,” A World Bank Policy Paper.Washington, D.C. 1993. 1;
: I
-.
1988a.“Housing Financein Turkey: BackgroundDocument.” mimeo.
*
-.
1988b.“Review of Brazilian HousingInstitutions andRent Legislation.” mimeo.
-.
“Staff AppraisalReports,” VariousProjects,Various Years.Washington,D.C.
-.
1989.Sustaining the Structural Adjustment Program: A Shelter Strategyfor Ghana, Report No. 8099-GH. (December)
-.
1989.World Development Report 1989. Washington,DC.
