We find ourselves today in a crisis of our own making. Well-intentioned politicians on both sides of the aisle looked at the distribution of wealth in our country and realized that not only did home ownership represent a large portion of individual wealth, but that it made up a disproportionate amount of the difference in average family net worth between white America and the rest of the country. To address this difference, policymakers (again, on both sides of the aisle) pushed for programs that would make obtaining mortgages easier. Mortgage lenders were pressured to lower their standards, and they pressed back for government protection from the increased risk of default. Enter Fannie Mae and Freddie Mac, who insured many of these “sub-prime loans” and the financial world who further reduced the risk to lenders by “securitizing” the mortgages—eventually reaching a point in which there was no asset to back the debt. Heavy marketing of these new mortgage vehicles attracted speculators and middle class customers, many of whom improperly assessed their own risk tolerance as they took on more debt than their previously sufficient cash flows could handle. Government regulators looked the other way or improperly assessed risk, all in hopes of fueling the policy ends of increased home ownership and economic growth. Upon a predictable decline in housing prices, the whole house of cards (pun intended) fell in on itself helping to cause our current situation.
Here are a few truths about American wealth. Americans have one of the lowest savings rates in the industrialized world. Compared to other individual investment vehicles, a disproportionate percentage of America’s net worth is bound up in houses, causing many to view their house (and future payoff from its sale) as their retirement plan. Our tax code heavily favors those who carry mortgages over those who rent. This tax advantage aids and enables the disproportionate emphasis and importance Americans place on home ownership, to the detriment of more balanced and diversified investment portfolios. Although real estate has proven in the past to be a relatively safe investment, it is not risk free and housing prices can decline as well as increase.
As policymakers flail about seeking ways to alleviate current economic woe by further reducing risk to this already ennobled class of investors (home owners), little is being done to address the underlying cause; that our entire system fosters and encourages an unhealthy concentration of individual wealth in one class of investment. The over the top efforts at mitigating risk to homeowners have gotten so bad that I have begun to hear reports of people looking to elected officials for relief from the horrific burden of being “upside down” on their mortgage—that is, owing more than the house is worth. While this is unfortunate from an investment standpoint, it is meaningless from a shelter standpoint. As long as someone is not looking to place their house on the market, its day to day value is somewhat less important than its value in taming the elements.
What is to be done? We should eliminate the home mortgage interest deduction, and instead, redistribute the aggregate savings to a decrease in the capital gains and simple interest taxes(such as that gained in savings accounts and CD’s). Houses would still be sought after as an attractive part of any individual investment portfolio, but not more so than 401K’s, stocks, mutual funds, bonds, T-bills, gold, art or any other investment vehicle.
What would be the impact of this change? There are several. First, it would create a market-based incentive for the investing public to limit its own risk through more diversified portfolios. Second, it would encourage savings. Third, it would more quickly create a “level playing field” between whites and minorities with respect to wealth creation than wrong-headed policies designed to increase home-ownership.
What would be the downside? Entrenched interests (construction, labor, finance, legal) would howl. We would hear “this is the end of the American dream of home ownership” and “there will never be a new home built in this country” and many other Cassandra-like statements of this nature. I’m not convinced. People will still buy houses—new and previously owned—based on the new risk calculation of whether or not it will increase in price, and not on the certainty that it will reduce income tax liability. Builders will still build dwellings—whether they are then rented or mortgaged should not ultimately make a difference to them. The financial industry, while perhaps dealing with the fall-out from a reduced mortgage market, would have access to whole new sources of capital for their other investment vehicles flowing from individuals who previously would have invested in their house looking for new places for their money to go.
In the end, this plan would create additional stability in our financial system, increase the national savings rate and lessen our national risk to financial meltdown. Let me know what you think.
Friday, February 13, 2009
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3 comments:
I agree with the concept that the bailout shouldn’t incentivize home ownership through measures that get us right back to what caused this problem to begin with;
1. Incentivizing new home building which creates excessive inventory that competes with and hence dilutes the value of existing homes.
2. Lending money to people who borrowed beyond their means. Aggressive loan to value provisions in primary mortgages and home equity loans allowed people use their homes like an ATM and leverage their investment like a hedge fund would it’s investment portfolio. Leverage works both ways and obviously the risks & losses turned out to be a multiple of what homeowner’s with a concentrated investment portfolio should have taken.
In addition to the obvious need to enforce proper lending standards that limit the leverage a homeowner can use going forward , other governments like the UK have come to a conclusion that I think will end up being the eventual solution in the US. They have focused on structurally reducing the carrying costs of owning a home as a percentage of one’s post tax income. Historically the cyclical range of affordability has been the current high of 22% and lows of 13%. They concluded they would need to take 30yr mortgages rates down to 2% to free up enough income for people to be back at the affordable end of the range. They then nationalized enough banks to control the mortgage market and rates have gotten close to that required level. Importantly they are not forgiving mortgage debts. People will have to live with their mistakes and pay back what they owe. While that obligation might constrain people from selling their homes if they are underwater it limits inventory coming back onto the market unless they have saved enough to afford taking the loss. In the US, my guess that would mean getting 30yr mortgage rates to between 3-4%. Our banks though have yet show an interest in helping solve that problem. They simply can’t until they more accurately quantify what their real liabilities are and how much capital that leaves them to start lending again.
In that context, eliminating the mortgage deduction would increase the carrying cost of mortgages as a % of post tax income and make it less manageable for people to work their way out of a hole. All this obviously presumes people will take any savings from bailout incentives to pay off their debts instead if returning to conspicuous consumption. With unemployment potentially approaching or exceeding previous recession highs of 11% my bet is people will focus on reducing their debts and increasing their savings until they have more visibility about their own ability to put food on the table
We would be better off on regulating the mortgage industry to base loans on personal budgets and documented cash/income. Crazy talk?
And Obama would not want to bail out the folks who invested unwisely? Another imagined entitlement - home ownership, college education, government bailouts, levees around a coastal city that is below sea level, 14 kids and no income, ...
Maybe us folks (who do not qualify for entitlements because we work and pay our bills) are not too keen on socialism. However, as a veteran, I should be entitled to a 1% VA loan refinance.
Gigs and I just had a nice long telephone conversation about this one.
Essentially, Gigs offers a sensible and highly supportable solution to help us get out of the current crisis. I think there is a lot of merit to it, and I know there are folks in the Obama Administration thinking about just such a thing right now.
I think my plan is aimed at what we do once we're back on our feet again....so that we don't find ourselves here again. Of course there are other ways, but as our babyboomers age, finding ways to ensure diversified saving and investment portfolios is going to rise in importance...or the government is just going to keep bailing people out. Fundamentally altering the equation by getting rid of the mortgage interest deduction (or even halving it, as Goldwater's Ghost suggested at lunch today--he really is a reasonable fellow), would go a long way toward that goal.
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