Thursday, August 12, 2010

Home Ownership Has Its Priveleges

Lately there has been talk about the loan modificaton program and the administration perhaps passing a law to provide (more) subsidies to mortgage forgiveness programs. As usual the governmental alphabet soup is at play here confusing most of us. I mean who can keep up with HAMP, Fannie Mae (FNMA) and Freddie Mac (FHLMC)? I know not me, but there are some basic principles alive here that our government should start to reconsider in light of what happened in the meltdown, and post-collapse.

Misguided Subsidies?

A recent piece in the USA Today started with this,
If there are two things that middle-class taxpayers who behave responsibly don't like, they are (1) having their money go to irresponsible people, and (2) having their money go to richer people.
Our current housing policies continue to do both. The HAMP which I mentioned above has granted 340,459 permanent modifications but 429,696 trial modifications and over 6,000 permanent modifications were cancelled, generally due to insufficient income documentation. More startling is that only about 10% of these that got to the final stages of modification were able to bring their mortgage current. Another 23% were a variety of short sales, bankruptcies, or foreclosures. So it begs the question, how is that $50 billion dollar program helping? Are we going to continue to encourage bad lending and borrowing habits or should our policies be crafted towards a more fiscally responsible incentive to home ownership.

What we have now is a creation of both parties, and the result of the drive to make home ownership our primary industrial strategy in the last half of the 20th century. When the vote came to the House floor to renew the $8,000 homebuyer tax credit back in June, the vote was 409-5 in favor. Pretty amazing considering how polarized that body is at the moment. It was intentioned to be a one year one off stimulus, now it seems to be stated policy. That credit is a large transfer of wealth that has little to no economic impact for the country. What it did last year was similar to the cash for clunkers program, getting people to hasten a purchase they were going to make anyways. Harvard economist Edward Glaeser likened it to "mindless house swapping".

The effect of this and of our current tax structure (which is to allow mortgage interest deduction) is that it inflates the housing market unnaturally. What I mean by that is it inflates the value of homes outside of what the free market would intend. Because of the tax incentives, people are incentivized to take out a larger mortgage. If you can write off the interest why would you choose the smaller mortgage?  It used to be quite difficult to own your own home, you had to have a good downpayment (back in the 1920's you had to have HALF down), so the political class argued to make it easier and have won that argument. Then in the last fifteen years you had the creation of mortgage finance products that reduced down payments and minimized equity. If homes increase in value for perpetuity then equity is not nearly important, but that is not realistic. What this homeownership without equity does is create macroeconomic costs not benefits. A recent paper written by Christopher Papagianis & Reihan Salam notes:
Andrew Oswald of the University of Warwick has argued that such homeownership can exacerbate unemployment by making workers less likely to move from one labor market to another. Labor mobility is badly undermined when homeowners in a depressed market can’t sell their property for anything approaching the principal balance of the mortgage they originally took out to buy it.....since most homebuyers base their purchase decisions on the monthly after-tax cost of housing, reducing the deduction for mortgage interest would mean that the same monthly payment would buy “less house.” For example, a 25 percent deduction for mortgage interest allows buyers with a 6 percent mortgage to spend an extra $30,000 on a house without seeing any increase in their monthly payments.Similarly, an increase in down-payment requirements from the current 3.5 percent to 20 percent would mean that $20,000 of savings could be used to buy only a $100,000 house, rather than one priced at $570,000.
Combine that with the overall decline in housing equity in the country from 2001 to 2009 to the tune of $1.35 trillion and you have a society that has become stagnant, the opportunity of upward mobility (which so many tied into homeownership) has been damaged. That decline has more or less wiped out the real estate boom and then some on many levels.


The American people unwittingly propped up the housing market and by de facto the construction industry which has hemorrhaged jobs that may never come back. What may work to strengthen our economic prospects long-term is a tax deduction for home ownership akin to the child deduction. It must be a flat rate so as not to incentivize someone to purchase a house they really cannot afford. It would reward middle class homeowners but at a fraction of the cost of the current mortgage interest deduction. Other less likely solutions would be to revamp Fannie and Freddie which will not happen under current leadership. We the taxpayers have been put on the hook to them for over $150 billion dollars. These two GSE's operate as spigots of tax payer money to subsidize housing in this country, without serious reform there and in our tax structure our economy will not be better off for having experienced such a calamatious event. It would be nice, if for once, our policy makers could learn from prior mistakes and not double down on them.


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