Root Cause

Arnold Kling argues that the root cause of mortgage and student debt problems is not the structure of mortgage and student debt contracts

What these forms of bad debt have in common, in my view, is that they reflect clumsy social engineering. Public policy was based on the idea that getting as many people into home “ownership” with as little money down as possible was a great idea. It was based on the idea of getting as many people into college with student loans as possible.

The problem, therefore, is not that debt contracts are too rigid. The problem is that the social engineers are trying to make too many people into home “owners” and to send too many people to college. Home ownership is meaningful only when people put equity into the homes that they purchase. College is meaningful only if students graduate and do so having learned something (or a least enjoyed the party, but not with taxpayers footing the bill).

  • ErikTheRed

    Social engineers trying to reverse cause and effect, as always...

  • me

    Taking this argument one level further: ultimately, home ownership and going to college are idols of cargo cults - it's desirable for societies to have people contributing in a strong economic situation (high paying job with predictable financial future), and it's desirable to have very well educated citizenry (thereby raising the general level of intellect, mapping to services and products that will sell internationally). Enticing entirely unqualified folks to buy into homeownership or giving everyone a diploma doesn't help but actually hinder these desirable objectives.

  • tmitsss

    Reynolds’ Law: “Subsidizing the markers of status doesn’t produce the character traits that result in that status; it undermines them.”

  • Mercury

    After several decades of countless acts, laws, subsidies, government sponsored entities and billions of dollars, the US homeownership rate is now back down to ~65% (and falling) which is pretty close to where it was in the mid-1960s and is also probably pretty close to some sort of natural equilibrium level:

    http://catosdomain.com/wp-content/uploads/2013/06/ABOOK-May-2013-Housing-Home-Ownership-Rate.jpg

    It’s actually kind of amazing that all that demand-driving only juiced the rate a few percentage points to the ~69% level it touched during the circa 2006 peak of the recent housing bubble.

    What this implies for the current US college degree/debt situation is left as an exercise for the class.

  • Matthew Slyfield

    They aren't trying to reverse cause and effect, their understanding of cause and effect is bass ackwards.

  • kidmugsy

    "pretty close to some sort of natural equilibrium level": only if by 'natural' you mean "as influenced by tax exemptions and other forms of government interference".

  • Canvasback

    Their understanding of how to buy votes is pretty solid.

  • Matthew Slyfield

    True.

  • obloodyhell

    }}} College is meaningful only if students graduate and do so having learned something (or a least enjoyed the party, but not with taxpayers footing the bill).

    Well, it's also got a hell of a lot to do with getting a degree in something that society is interested in paying you for having, like, say, Engineering, rather than Early Renaissance Art History (French)...

  • Daniel Barger

    Commonly known as having "skin in the game". If you don't invest something you value into something that has risk your willingness to walk away increases and your incentive to try harder diminishes. It's a fundamental part of human nature that power brokers make nefarious use of for their own purposes.....especially as they invariably assign the risks for their actions to be paid for by others.

  • morganovich

    exactly. the notion that if you buy a house or go to college, you become middle class is pure cargo cult thinking.

  • Jess1

    Not really. "home ownership rates" didn't really move much at all in the early days of the income tax, and declined to the historic low of 42% in 1940. Postwar saw the climb from that low to crossing the 60% line in the early 1960s, then staying in the 60 percent range after. Interestingly enough, the homeownership rates declined after the 1984 Income Tax act that bolstered the Mortgage deduction, an event that caused much consternation and such amongst the chattering classes.

  • Harry

    This was a problem that simmered for years before 2006, a pivotal year that changed everything for the worse. The idea, promoted by wishful people in government, was to heavily subsidize home mortgages, another failure not of free markets, but of progressivism.

    In 2007, George W, Bush ceded the financial ground to Reid and Pelosi, who had declared that the Iraq war was lost, in exchange for the surge, which, because it appealed to Iraqis, succeeded.

    But he folded his hand, conceding everything to Barney Frank and FNMA. I think GWB did this because he was concerned about the future of the nation.

    So we got loose money and a financial collapse. Remember, banks were required to mark their mortgages to market, and how do you do that when you have offloaded all but a small piece to the brokers who sold those pieces in the form of diversified bonds?

    Don't get me wrong. I do not blame Lehman Brothers. I blame Barney Frank and his colleagues and friends who subsidized people to borrow beyond their means. I blame progressive education, which pushed children, the ones who were mature adults, into underwater mortgages.

    Looming over us all is what Janet Yellen might do, but the damage has already been done by the likes of Jack Lew, a political hack playing the part of Secretary of the Treasury, and his boss, playing President of the U.S., both of whom hopes it will hit the fan after 2016.

  • B. Cole

    So, we end the homeowners mortgage interest tax deduction?

  • Matthew Slyfield

    "The idea, promoted by wishful people in government, was to heavily subsidize home mortgages, another failure not of free markets, but of progressivism."

    This is true, but your timeline is way off. This goes all the way back to 1938 and the creation of Fannie Mae by Roosevelt.

    http://content.time.com/time/business/article/0,8599,1822766,00.html

  • Matthew Slyfield

    If we can trade it for a flat tax, I'm in.

  • Harry

    Good point. But the lending standards loosened under Clinton, and GWB went along, especially after 2006.

  • Matthew Slyfield

    The entire point of creating Fannie Mae was to loosen lending standards, though I won't deny that Clinton and Shrub Jr. were responsible for further loosening.

  • obloodyhell

    That's about the level of intellectual capacity of most liberal "intelligencia"...

  • obloodyhell
  • marque2

    I think Jr was more guilty along with GOP in congress of not tightening the rules when they knew the bubble was getting bad. McCain wrot some letter about it in 2005 - but Dems played the race card (how racist to not want minorities to have loans) and the chicken Republicans backed away. They are guilty of being feckless.

  • marque2

    When o start my engineering company - I am going to employ Woman's studies majors exclusively. ;P

  • marque2

    I never understand this one. What we should do is treat a home lime any other investment - allow full deduction of the loan interest -,and even depreciation if yo want. On the other hand all the little cap gains breaks we get for selling should be discontinued.

    I don't know of any other investment where you can not write off full expenses - we are already being hurt by that.

  • marque2

    I agree - but then I would put the home in an LLC and write off the interest as a business expense while paying just enough rent to cover the costs.

  • marque2

    I should point out that the "don't write off deduction" crowd is really just saying that to collect more tax revenue. They aren't taking a principled stand

  • markm

    Your house is NOT an investment. The ground underneath it may increase in value because they aren't making any more, but the house is a depreciating asset. If it increases in market value above inflation, it's a bubble.

  • markm

    The mortgage deduction has never been much help to people who aren't rich and have some sense about finances. If your income is too high for the standard deduction, the mortgage deduction becomes valuable - but that's only for the rich. Otherwise, the mortgage deduction is considerably less than the standard deduction, unless you lack the sense to not tie up more than half of your income in mortgage payments.

  • marque2

    It is an investment. First off though the building technically depreciates per accounting standards, if you were actually allowed to depreciate the house- the value of the building actually does go up - which you can verify by looking at the assessed value of your home at your county tax offices.

    When my house increased 10% in value over the last year 2/3 of that is attributed to increase in value of the home.

    Don't confuse accounting practices with actual facts.

    Info have an "accidental" rental property and I can attest that in 24.5 years the building will still have value but will be higher than it is today. IRS forces depreciation on rental property because it gives them a tax windfall when you sell the home ( selling a fully depreciate home would definitely put you in the top income bracket that year - while they force us to take breaks in the 15% range and refuse to give a break for depreciation if my income goes too high.

  • Harry

    Matthew, maybe I did not make my point clear enough in the first place, which I think is not an argument between you and me. As an armchair economist and former dairy farmer, I wish the Department of Agriculture and Farm Credit would never have been created, along with every other agency, including FNMA. I also agree that World War II was not the stimulus that led to recovery from the Great Depression, but that was before my time.

    I never bought shares in FNMA, but I did buy for my own account FHLB bonds and recommended them to others paying for my advice, fully aware that the credit risk was less than T anything, but putting them in the same class or a notch below Exxon Pipeline notes.

    Nine months before the fit hit the Shan, I was already resistant to any paper from banks promoted by brokers, but I did bite on 30m of Lehman Brothers Senior Notes, which turned out to be a packaged combination of mortgages and other loans, diversified and rated Aa1.

    During the summer, financial institutions were required to mark their mortgages to market.

    For the previous two years, credit standards for homebuyers loosened for political and ideological purposes. Barney Frank headed the House Banking Committee, which is the reason why I picked on him. Barney, and many of his allies wanted to give away free houses and redistribute the wealth.

    Real estate prices grew through 2007, and the folks who waited for the top to sell all rushed for the door at the same time. This is not the first time this has happened. However, Congress, socialists in Congress, deliberately caused this problem to become severe with no regard for its consequences. They get the blame, and they are still mistaken about how the world works, given the human desire to be free.

  • Matthew Slyfield

    Harry,

    I don't disagree with any of that. You are completely correct on the near collapse time line.

    That said, "For the previous two years, credit standards for homebuyers loosened for political and ideological purposes." this is exactly what Fannie Mae was created to do in 1938 and has been doing with gusto ever since.

    Barney Frank's crime is that oblivious to the fact that this strategy was doomed to fail eventually he pushed for more and more right up to the collapse. Even worse, having spent the months after the collapse working feverishly to absolve Fannie, Freddy, and the government of any blame and trying lay it all on the private banks and free market failure he has gone right back to his original play book.