Posts tagged ‘home ownership’

Single-Minded Obsession on Home Ownership

This article from the LA Times confused me greatly:

Advocates for borrowers took such comments to mean that the banks would prioritize debt write-downs on first mortgages, which banks resisted before the [$25 billion] settlement. Now, with nearly all the promised relief handed out, it is clear that the banks had other ideas.

The vast majority of the aid to borrowers, it turns out, came in the form of short sales and forgiveness of second mortgages. Just 20% of the aid doled out under the national settlement went to forgiveness of first-mortgage principal, the kind of help most likely to keep troubled borrowers in their homes. In terms of borrowers helped, just 15% of the total received first-mortgage forgiveness.

The five banks collectively delivered twice as much aid using short sales, in which owners sell their homes for less than the amount owed and move out, with the shortfall forgiven.

In all, the lenders sought credit for nearly $21 billion related to short sales and $15 billion related to second mortgages. That compares with $10.4 billion in write-downs on first mortgages.

Critics on the Left (example) are calling this a failure of the program, that most of the relief went to short-sales and 2nd mortgage forgiveness rather than first mortgage forgiveness.  The original article has this quote:

"It just shows you that the banks are running the government," Marks said. "There's virtually no benefit to borrowers, and yet you give the banks credit for short sales and getting second liens wiped out — something they were going to have to do anyway."

Hmm, well I am not the biggest fan of bankers in the world, but short sales and second lien forgiveness are principle forgiveness as well, just of a different form.  If they wanted a settlement that was first-lien forgiveness only, they should have specified that.

In fact, both short sales and second lien forgiveness have tremendous value to individuals if one considers individual well-being one's goal rather than just this obsessive fixation on home ownership.  

For many people, the worst part of their negative equity is that it created a barrier to their moving.  Perhaps they could find a job in another part of the state or country, or they wanted to move into a home or apartment with less expensive payments but were stuck in their current home because they could not afford to bring tens of thousands of dollars to closing.  In such cases, a short sale is exactly what the homeowner needs and facilitating and expediting this likely helped a ton of people  (It is also an example of just how unique our mortgage rules are in the US -- in almost any other country in the world, the amount of the negative equity in a short sale would get hung on the seller as a lien that must be paid off over time.  Only in the US do buyers routinely walk away clean from such situations).  Given that first mortgage loan forgiveness more often than not does not save the loan (ie it eventually ends in foreclosure anyway), short sales are the one approach that lets lenders get away clean for a fresh start.

As for second mortgages, I can tell you from personal experience that it is virtually impossible in the current environment to restructure or refinance a first mortgage with a second lien on the house -- even in my case where everything is performing and the underlying home value is well above the total of the two liens.  Seriously, what is the point in reducing principle in the first mortgage if there is a second mortgage there, particularly when the second mortgage is likely far more expensive?  For people with a second mortgage, forgiveness of that is probably the first and best gift they could get.  They may end up still losing their home, but they can't even begin to discuss a restructure or refinance without that other mortgage going away.

I Have A Better Idea: Let's Just Kill It

Kevin Drum thinks the mortgage interest deduction is unfair because people with bigger mortgages get bigger deductions.  In particular, he is concerned that people with smaller deductions get no incremental benefit because these deductions are seldom larger than their default personal exemption.

But tax deductions are always going to be like this in a progressive system -- the rates are progressive and the fixed personal exemption is extremely progressive, so the combination of the two mean that tax deductions are going to preferentially help the rich more.  This reminds me of the arguments in Colorado when tax law required a tax reduction and Democrats in the state legislature complained that people who don't pay taxes would be getting no benefits from this.

He tries to posit some silly alternative tax credit system, but why bother?  Haven't we had enough of distortive tax breaks that favor a single industry and/or shift investment alarmingly into a particular pool of assets (thus increasing the risk of bubbles).  Isn't the whole notion of tax-subsidizing home ownership but not rentals inherently regressive, no matter how the deduction or credit is calculated?  Doesn't the labor market rigidity of home ownership most penalize lower income workers who get trapped in a certain geography by their home and cannot migrate for better wages, as blue collar workers have done in past recessions and recoveries?

Why wouldn't a good progressive like Drum be advocating for an elimination of the deduction altogether?  Is this one of those coke-pepsi party things, where the Republicans have taken over the issue of limiting deductions so Democrats have to reflexively defend them, even if ideologically it would make more sense for them to promote their elimination?

My Tax Proposal

1.  Eliminate all deductions in the individual income tax code

2.  Eliminate the corporate income tax.

3.  Tax capital gains and dividends as regular income.

4.  Eliminate the death tax as well as the write-up of asset values at death

 

I don't have any idea if this revenue positive or negative (I suspect it would be short-term positive, and long-term very positive), but I don't care.  This would:

  1. Substantially reduce the government's ability to play preference games and give crony special help in the tax code.
  2. Completely eliminate the huge unproductive drag of corporate tax law expenses and substantially reduce the cost of individual tax preparation.
  3. Eliminate the enormous unproductive drag of estate tax planning
  4. Eliminate forced sales of family farms and businesses at death in order to pay the taxes (taxes are paid instead on capital gains when sold).
  5. Substantially reduce government-induced distortions on flows of capital  (e.g. current promotion of home ownership over renting, of corporate debt over equity financing, of capital gains over income, etc).
  6. Eliminate most double taxations in the code, since there is now only the individual income tax.

I would be happy to make this revenue neutral (even if it required an individual income tax rate hike) and sell this to the Tea Party and Occupy Wall Street alike as a plan to reduce waste, corporatism, and crony meddling.  The OWS might be upset about 2 & 4, but corporate profits eventually show up as either capital gains or dividends, so they will eventually get taxed on the individual income tax return.  Ditto death taxes - currently they are largely offset by the ability to write-up asset basis at death and aggressive tax planning.  And anyway, the death tax is a trivial sources of government revenues.

 

Postscript:  I know there is all sorts of literature that supposedly promotes a lower capital gains tax as an economic positive.  Frankly, I don't trust it any more than any other literature genned up to promote special tax breaks to any group because that group is supposedly economically more important.  In my mind, a lower capital gains tax rate (which means a higher regular income tax rate) is just another way of government expressing an artificial preference for one economic activity over another.  Specifically, a lower capital gains rate creates a preference for real estate and stock investors over business owners.   Currently, I invest in a second home and flip it for a profit and I get a tax break on the capital gains.  But if I invest in a business instead that pays off with regular income, I get no tax break.  Why?  Why is one type of investing better than another?  The answer is that it is not, but the people who buy and sell equities and real estate in large quantities have more political clout than small business owners.

Postscript #2:  And Medicare taxes have to go up, at least until the program is restructured. 

Postscript #3:  This is a great example of what I want to make go away.  I consider it far more destructive in the long run than a percentage point rate change.  In case it is behind a paywall, here is a bit of it (these giveaways to the rich were in the very same bill that was supposed to be to soak the rich):

Thus Michigan Democrat Debbie Stabenow was able to retain an accelerated tax write-off for owners of Nascar tracks (cost: $78 million) to benefit the paupers who control the Michigan International Speedway. New Mexico's Jeff Bingaman saved a tax credit for companies operating in American Samoa ($62 million), including a StarKist factory.

Distillers are able to drink to a $222 million rum tax rebate. Perhaps this will help to finance more of those fabulous Bacardi TV ads with all those beautiful rich people. Businesses located on Indian reservations will receive $222 million in accelerated depreciation. And there are breaks for railroads, "New York Liberty Zone" bonds and so much more.

But a special award goes to Chris Dodd, the former Senator who now roams Gucci Gulch lobbying for Hollywood's movie studios. The Senate summary of his tax victory is worth quoting in full: "The bill extends for two years, through 2013, the provision that allows film and television producers to expense the first $15 million of production costs incurred in the United States ($20 million if the costs are incurred in economically depressed areas in the United States)."

You gotta love that "depressed areas" bit. The impoverished impresarios of Brentwood get an extra writeoff if they take their film crews into, say, deepest Flatbush. Is that because they have to pay extra to the caterers from Dean & DeLuca to make the trip? It sure can't be because they hire the jobless locals for the production crew. Those are union jobs, mate, and don't you forget it.

The Joint Tax Committee says this Hollywood special will cost the Treasury a mere $248 million over 10 years, but over fiscal years 2013 and 2014 the cost is really $430 million because it is supposed to expire at the end of this year. In reality Mr. Dodd will wrangle another extension next year, and the year after that, and . . . . Investing a couple million in Mr. Dodd in return for $430 million in tax breaks sure beats trying to make better movies.

Then there are the green-energy giveaways that are also quickly becoming entitlements. The wind production tax credit got another one-year reprieve, thanks to Mr. Obama and GOP Senators John Thune (South Dakota) and Chuck Grassley (Iowa). This freebie for the likes of the neediest at General Electric GE -0.82% andSiemens SIE.XE +0.20% —which benefit indirectly by making wind turbine gear—is now 20 years old. Cost to taxpayers: $12 billion.

Cellulosic biofuels—the great white whale of renewable energy—also had their tax credit continued, and the definition of what qualifies was expanded to include producers of "algae-based fuel" ($59 million.) Speaking of sludge, biodiesel and "renewable diesel" will continue receiving their $1 per gallon tax credit ($2.2 billion). The U.S. is experiencing a natural gas and oil drilling boom, but Congress still thinks algae and wind will power the future.

Meanwhile, consumers will get tax credits for buying plug-in motorcycles ($7 million), while the manufacturers of energy-efficient appliances ($650 million) and builders of energy-efficient homes ($154 million) also retain tax credits. Manufacturers like Whirlpool love these subsidies, and they are one reason that company paid no net taxes in recent years.

Cargo Cult Social Engineering

Once upon a time, government officials decided it would help them keep their jobs if they could claim they had expanded the middle class.  Unfortunately, none of them really understood economics or even the historical factors that led to the emergence of the middle class in the first place.  But they did know two things:  Middle class people tended to own their own homes, and they sent their kids to college.

So in true cargo cult fashion, they decided to increase the middle class by promoting these markers of being middle class.  They threw the Federal government strongly behind promoting home ownership and college education.  A large part of this effort entailed offering easy debt financing for housing and education.  Because the whole point was to add poorer people to the middle class, their was a strong push to strip away traditional underwriting criteria for these loans (e.g. down payments, credit history, actual income to pay debt, etc.)

We know what happened in the housing market.  The government promoted home ownership with easy loans, and made these loans a favorite investment by giving them a preferential treatment in the capital requirements for banks.  And then the bubble burst, with the government taking the blame for the bubble.  Just kidding, the government blamed private lenders for their lax underwriting standards, conviniently forgetting that every President since Reagan had encouraged such laxity (they called it something else, like "giving access to the poor", but it means the same thing).

A similar bubble is just about to burst in the college loan market, and this time it will be much harder for the government to blame private lenders, since the government effectively nationalized the market several years ago and for years has been the source of at least 90% of all college loans.  In the Wall Street Journal today, it was reported that student loans are now the largest component of consumer debt, and growing

Further, a Fed report yesterday said that student loan diliquencies have jumped substantially of late

The scary part was found by Zero Hedge in the footnotes of the report, which admit that this number is understated by as much as half, meaning the true delinquency rate of student debt may be north of 20%.

The Journal article linked above explains why this is:

Nearly all student loans—93% of them last year—are made directly by the government, which asks little or nothing about borrowers' ability to repay, or about what sort of education they intend to pursue.

President Barack Obama championed easy-to-get loans during the campaign, calling higher education "an economic imperative in the 21st century." A spokesman for Education Secretary Arne Duncan said the goal is "to make student loans available to as many people as possible," and requiring minimum credit scores would block many Americans

Any of this sound familiar?  I seldom learn much from anecdotes in new stories since it is too easy to craft a stirring anecdote on either side of just about any issue.  But I was amazed at the story of the woman who was issued $184,500 in student debt to send her son to college when her entire income is a $1600 a month disability check.

Is This Really Political Discourse? My First and Last Experience with the Debates

I wasn't planning on watching the debates, but my wife made me watch the first 20 minutes.  Is this really what passes for political discourse in this country?  I was particularly struck by the appeals to unnamed authorities -- both candidates said something like "I saw a study the other day [unnamed] that said my plan was great" or "your plan was bad."  Seriously pathetic.

And, after the corporatism and cronyism of the last 8+ years, the fact that Romney could not explain why it made sense to cut tax rates but eliminate deductions just convinced me he deserves to lose.  He was losing to class warfare rhetoric on tax cuts, when he should have been taking the high ground, even with the occupy wall street folks, saying that it was time to stop tilting the tax code towards special interests and populist fads at least one of which -- the tilting of the tax code to home ownership -- helped drive the recent economic downturn.

I blog and don't tend to debate in real time, because I always think of great quips hours later, but even I had the perfect rejoinder for Obama in real time when he said, "I think we should return to Clinton era tax rates, when the economy was great and growing."  Romney should have said, "If I am President, I will happily work with Democrats to do just that, as long as they agree to return to Clinton era spending levels.   After all, if government policy during that era was really so perfect for the economy, then spending levels must have been appropriate as well."

I don't plan to watch any more of this garbage until and unless they include someone other than the Coke and Pepsi candidates.   I'd like to see Gary Johnson but heck, even adding a Marxist would probably help.

Land Use Regulation and Income Inequality

I don't have time to comment or peruse the study in depth, but this looks interesting.  From Randal O'Toole:

Harvard economists have proven one of the major theses of American Nightmare, which is that land-use regulation is a major cause of growing income inequality in the United States. By restricting labor mobility, the economists say, such regulation has played a “central role” in income disparities.

When measured on a state-by-state basis, American income inequality declined at a steady rate of 1.8 percent per year from 1880 to 1980. The slowing and reversal of this long-term trend after 1980 is startling. Not by coincidence, the states with the strongest land-use regulations–those on the Pacific Coast and in New England–began such regulation in the 1970s and 1980s.

Forty to 75 percent of the decline in inequality before 1880, the Harvard economists say, was due to migration of workers from low-income states to high-income states. The freedom to easily move faded after 1980 as many of the highest-income states used land-use regulation to make housing unaffordable to low-income workers. Average incomes in those states grew, leading them to congratulate themselves for attracting high-paid workers when what they were really doing is driving out low- and (in California, at least) middle-income workers.

As Virginia Postrel puts it, “the best-educated, most-affluent, most politically influential Americans like th[e] result” of economic segregation, because it “keeps out fat people with bad taste.” Postrel refers to these well-educated people as “elites,” but I simply call them “middle class.”

I have not read the study, but I think the word "proven" in the first sentence likely goes to far.  Economic systems are way too complex to absolutely show one variable among millions causes another.  I am convinced that the way we have regulated the housing market and promoted home ownership has reduced labor mobility.

Cargo Cult Social Engineering

Glen Reynolds has a great observation on government social engineering.  I hadn't thought about it this way before, but in many ways government drives for things like home ownership are like a cargo cult

The government decides to try to increase the middle class by subsidizing things that middle class people have: If middle-class people go to college and own homes, then surely if more people go to college and own homes, we’ll have more middle-class people. But homeownership and college aren’t causes of middle-class status, they’re markers for possessing the kinds of traits — self-discipline, the ability to defer gratification, etc. — that let you enter, and stay, in the middle class. Subsidizing the markers doesn’t produce the traits; if anything, it undermines them

So What?

Via Glen Reynolds, from Keith Jurow at Business Insider

There is a far-reaching change occurring now which threatens housing markets around the country. A survey conducted by Harris Interactive for the National Apartment Association in May 2010 found that 76% of those surveyed now believe that renting is a better option than buying in the current real estate market, up from 71% in 2008.  Especially sobering was the fact that 78% of those surveyed were homeowners.

David Neithercut, CEO of Equity Residential, the nation's largest multi-family landlord, believes that there is a "psychology change" in the mind of consumers.  In a June address to an industry conference, he declared that there is "a change in one's thought process about the benefits or wisdom of owning a single-family home."

When an author uses the word "threatens" to describe a trend, you know he doesn't like it.  While a home may be  a good place to put excess cash for some people, as a leveraged investment it is insane.  It is a dead asset, producing no cash flow or future value.  While the land under it may be a scarce asset, particularly in some areas with strict growth limits and zoning laws, the house itself is a depreciating asset as much as your car is (trust me, I just replaced an air conditioner and spent weeks repairing dry wall cracks).

Renting pays a lot of benefits, not the least of which is the mobility it adds to the labor market.  Individuals with leases are less tied to a certain spot, so have more flexibility to leave a given area to seek better opportunities elsewhere  (this actually triggers a thought I had not had before -- I wonder if government promotion of home ownership, particularly at the state and local level -- can be seen as a modern form of serfdom, with politicians attempting to tie people to the land so they cannot move and take their tax money elsewhere).

So home ownership is a fine option for many (I own a home and prefer that status in my present circumstances) but there is no law that says it has to be the norm or the default.  Many people have switched from whole life to term, from buying individual stocks to mutual funds, from defined benefit pensions to 401k's.  The way we achieve goals evolve over time, and there should be nothing surprising about a change in how people wish to access housing.  And certainly nothing in this trend which should occasion government intervention to prevent.

Comparing College to Home Ownership

Sorry, an unfinished version of this post may have shown up earlier today in your feed readers.  This one is the completed version.

For years, America has pushed home ownership.   Mortgage interest is one of the few personal expenses that is tax deductible, giving people a strong financial incentive to shift from renting to owning.  The Federal Reserve has pursued a policy of keeping interest rates low, further decreasing the cost of owning.   Congress passed a myriad of laws and created numerous organizations to help insure that anyone who wanted to buy a home could probably get credit.  And every politician, talking head, "expert", etc. who ever got in front of a camera tended to advise everyone regardless of circumstance to try to buy a home.  It was not just home ownership, it was The American Dream Of Home Ownership.

Hayek could have told us years ago that there was a fundamental problem with this.  In short, 300 million people do not have the same situation and needs and preferences.  Take just one example.  Does it really make sense to encourage a worker who has a risky income stream (e.g. is vulnerable to layoffs or reduced hours) to buy a house?  Leasing provides much greater flexibility to adjust fixed housing costs to changing circumstances.  Rent, get your hours reduced, move to a smaller apartment.  Buy, get your hours reduced, default, ruin your credit.

The result of our full-court press for home ownership has been rising home ownership rates ... and rising foreclosure and bankruptcy rates.

OK, none of the above is new information.  But I was having a conversation with my dad about education, and it struck me that we may be doing the exact same thing with four-year college liberal arts degrees.  Every talking head, from talk show hosts to politicians, push kids to go to college.  Along with home ownership, the BA is described as a keystone to the American Dream.  As with home ownership, we subsidize college education with state-run schools and government loan programs.  Just as the government tries to make sure everyone can own a home, they try to make sure every kid can go to college.

Returning to Hayek for a moment, is it really likely that spending four years getting a college liberal arts degree is really the best possible course for every single person?  Sure, one can argue that the state offers community colleges and other alternatives to the standard 4-year degree, as do private companies like the University of Phoenix, but I get no sense that politicians and the intelligentsia are really promoting this kind of nuance and choice.  I think the message clearly is "four year liberal arts degrees are the goal, everything else is second best."

State university systems that were originally founded to help teach scientific agriculture to farmers wouldn't be caught dead having anything so pedestrian show up in their marketing brochure today.  They want to have Nobel prize-winning faculty and be influencing public policy and be doing (and getting grants for) state-of-the-art research.   Teaching students a useful trade?  That's so ... uncool.  Let 'em go to DeVry if they want that.

To some extent this is the result of the takeover of most campuses by the faculty, who wield most of the power nowadays (just ask Neil Rudenstein and Larry Summers at Harvard).   Academics are a special class of folks who work as much for, or more for, prestige among their peers as for money.  Those incentives are great when you want someone to focus in 120 hours a week on inventing a new type of superconducting material.  But in a university, it tilts the entire institution towards a focus on teaching interesting things vs. teaching useful things.

So what has been the result?  Well, college has an equivalent to foreclosure and bankruptcy, and it is called drop-out rates.  And drop-out rates seem to be rising, at least reading articles anecdotally.  The only actual figure I can find was this one:

Just 54 percent of students entering four-year colleges in 1997 had a degree six years later "” and even fewer Hispanics and blacks did, according to some of the latest government figures. After borrowing for school but failing to graduate, many of those students may be worse off than if they had never attended college at all.

I can't prove there is a trend, because I just can't find a good online source, but 46% non-graduation rate strikes me as pretty high.  And I would argue that there is, in addition to drop-out rate, a second figure one must consider.  How many of those that did graduate could actually do with their degree what they thought they could?  How many have a 4-year journalism degree from Michigan and now are working at Starbucks, either by choice or necessity?  I call this the soft drop-out rate, the rate of, for lack of a better word, underemployment of one's education investment.

I know that education leaders can all give a nice speech about how important a liberal arts degree is to the health and functioning of the polis, but the fact of the matter is that it is a luxury.  It is an incredibly rich world that can have its youth in their strongest and most productive years studying Italian Renaissance poetry or Portuguese literature for four years.  And I am not talking about this as a luxury for garbage collectors or auto mechanics, but a luxury even for future white collar workers, who need basic skills like these but are, based on my hiring observations, graduating from college without them:

  1. A strong sense of personal responsibility and a commitment to excellence in one's work
  2. The ability to break down a task and organize work towards its completion
  3. The ability to write a well-organized five paragraph persuasive essay or letter
  4. The ability to do basic computational math
  5. The ability to manage personal finances and make smart financial decisions
  6. The ability to understand basic accounting terms and concepts
  7. The ability to interact with other people honorably and on the basis of a reasonable level of self-awareness
  8. A reasonably well-developed sense of ethics and responsibility

To illustrate this further, I want to end with something I have observed over the past year.  During the last election, I sensed something in the average 20-something Obama supporter that went beyond just frustration with the incumbent President and the normal level of youthful flirtation with progressivism.   I sensed a real anger that somehow some promise had not been kept to these folks.  One interpretation of this is that these folks were all promised that a 4-year liberal arts degree would be the guaranteed ticket to success, and that their college degree would make them future leaders and the world would soon tremble at their pronouncements (seriously, just go read the marketing literature from any college).  Having gotten this "promise," they suddenly find the world doesn't really hang on the every word of a 22-year-old who has never really been out of the womb, and the employers of the world are not beating the doors down to hire a gender studies major who wrote a really well-received thesis on the role of women in the Paraguayan post-modernist movement.

The Washington Post had a great profile on such folks (though written with far more sympathy than I would have mustered).  Here is an example from that article:

Armed with a Georgetown University diploma, Beth Hanley embarked in her 20s on a path hoping to become a professional world-saver. First she worked at nonprofit Bread for the World. Then she taught middle school English in central Africa with the Peace Corps. Finally, to certify her idealism, she graduated last spring with a master's degree in international relations from Johns Hopkins University.

But now the 29-year-old faces a predicament shared by many young strivers in Washington's public interest field. After years of amassing so many achievements, they struggle to find full-time employment with decent pay and realize they might not get exactly what they set out for. Hanley, a think tank temp who dreams of aiding the impoverished and reducing gender discrimination in developing countries, is stuck.

TJIC had some classic comments on this article, and I added some more.

Which brings me finally, of all places, to Michelle Obama.  She said something that I thought was relevant to this post:

Despite their Ivy League pedigrees and good salaries, Michelle Obama often says the fact that she and her husband are out of debt is due to sheer luck, because they could not have predicted that his two books would become bestsellers. "It was like, 'Let's put all our money on red!' " she told a crowd at Ohio State University on Friday. "It wasn't a financial plan! We were lucky! And it shouldn't have been based on luck, because we worked hard."

You can see the whole piece here, but she is a pretty clear example of what I am talking about.  She got a Princeton liberal arts degree and is just amazed that it did not automatically pay off for her.  Somehow, some promise to her has been broken.

Just as she is an example of this phenomenon, she is now endeavoring to be part of the problem, working hard to further confuse the expectations of young people.  Her message to them is -- go get an expensive education, but whatever you do don't do anything money-making with it:

"We left corporate America, which is a lot of what we're asking young people to do," she tells the women. "Don't go into corporate America. You know, become teachers. Work for the community. Be social workers. Be a nurse. Those are the careers that we need, and we're encouraging our young people to do that. But if you make that choice, as we did, to move out of the money-making industry into the helping industry, then your salaries respond." Faced with that reality, she adds, "many of our bright stars are going into corporate law or hedge-fund management."

I have no particular problem with people taking on these occupations, as long as I don't have to pay for it.  And I am proud that my university, Princeton, is one of the few that has changed its financial aid rules to allow students to graduate debt-free and have the financial flexibility to pursue careers that are not high-paying (making Ms. Obama's comments doubly ironic since this is her alma mater as well).

But the general expectation here is just unrealistic.  Here is how I responded previously to Ms. Obama's comments on her education:

This analogy comes to mind:  Let's say Fred needs to buy a piece of earth-moving equipment.  He has the choice of the $20,000 front-end loader that is more than sufficient to most every day tasks, or the $200,000 behemoth, which might be useful if one were opening a strip mine or building a new Panama Canal but is an overkill for many applications.  Fred may lust after the huge monster earth mover, but if he is going to buy it, he better damn well have a big, profitable application for it or he is going to go bankrupt trying to buy it.

So Michelle Obama has a choice of the $20,000 state school undergrad and law degree, which is perfectly serviceable for most applications, or the Princeton/Harvard $200,000 combo, which I can attest will, in the right applications, move a hell of a lot of dirt.  She chooses the $200,000 tool, and then later asks for sympathy because all she ever did with it was some backyard gardening and she wonders why she has trouble paying all her debt.  Duh.  I think the problem here is perfectly obvious to most of us, but instead Obama seeks to blame her problem on some structural flaw in the economy, rather than a poor choice on her part in matching the tool to the job.

And this is what it is all about when you cut through all the misty-eyed Utopian notions about education:  For most people, it is a tool.  And the tool needs to fit the circumstance, the goals, the capabilities, and the budget.  Its time to stop advocating (and subsidizing) and one-size fits all college education program.

Random Thought on Home Ownership

I'm thinking of the three major consumer purchases that are probably at the base of the hierarchy of needs:  Fuel, food, and shelter.  Its interesting how very different the media and public perception is of price changes in these areas.

The reaction to fuel price increases is easy to predict - they are always portrayed as bad.  Rising prices hurt everyone, producers are evil, and speculators who make bets on rising prices are even more evil.

The reaction to rising food prices is more mixed.  That's because we have come to the collective decision that producers of food are sympathetic figures whereas producers of oil are unsympathetic.  So media laments about rising food prices are often tempered by good news stories about rising farm profitability.

And then there is shelter.  For this category of consumer expenditure, everything is flipped on its head.  Rising prices are good, and falling prices are bad.  One might argue that housing is different, because consumers often take an equity position in shelter that they do not take in food or fuel.  But all this means is that home buyers are speculating on the price of shelter, going long on bets that prices will rise.  They could easily just rent, and pay for their shelter month-to-month like they pay for their food or fuel, but many consumers bet on rising rents and shelter prices by buying shelter futures (ie purchasing a home).  In a real sense, home buyers are all speculators (using margin accounts at that!), but this is one case where we encourage speculation, and even have tax subsidies for it.

If the reader finds this a funny way to think of home ownership, here is a thought experiment.  Let's say at the age of 30 I wanted to take an equity stake in my current and future fuel needs.  I take out a loan to buy enough Exxon stock such that the annual dividends will cover my fuel purchases for the year.  If fuel prices go up, the dividends likely go up as well, so I am sheltered from the vicissitudes of worrying about my monthly fuel bill, and all I have to do is pay off a regular and predictable mortgage on my Exxon stock.  In 30 years, when the note is paid off, likely I have a big capital gain in my Exxon stock, which I could cash in at retirement if I want to downsize to less driving and fuel use.  Or I can pass it on to my kids.

The only difference I can come up with, economically, between this example and how we do housing is that in my example, consumer capital is invested in productive enterprises rather than dead real estate.

Government and Regulation

One argument about regulation that seems to be gaining traction through the recent financial crisis is "See, private action and enterprise is not infallible.  They can make mistakes that have costs for everyone.  Therefore they need to be regulated." 

I don't have time for the full refutation of this, but a few thoughts:

  • No one ever said that private actors in the economy are infallible or even universally honest.  However, no one has ever been able to make the case that government employees are any more infallible or honest. 
  • There are a couple of reasons government regulators are going to be demonstrably worse than the marketplace in making decisions.  The first is information -- a few actors in Washington can never have the same access to information as thousands of actors across the country or around the world.  The second is incentives -- while regulatory hawks cite private greed as a bad incentive in the marketplace, bureaucratic incentives can be at least as problematic.
  • Governments are subject to all sorts of rent-seeking initiatives, not to mention regulatory capture, that undermine regulatory effectiveness.  Just look at the bailout bill. Wooden arrows?

For some reason, the argument "private actors screwed up" seems sufficient justification for regulation.  The burden of proof should instead be "the government could have done better."

Here is a nice example of how regulation really works, from an interview with Warren Buffett:

QUICK: If you imagine where things will go with Fannie and Freddie, and
you think about the regulators, where were the regulators for what was
happening, and can something like this be prevented from happening
again?

Mr. BUFFETT: Well, it's really an incredible case study in regulationbecause
something called OFHEO was set up in 1992 by Congress, and the sole job
of OFHEO was to watch over Fannie and Freddie, someone to watch over
them. And they were there to evaluate the soundness and the accounting
and all of that. Two companies were all they had to regulate. OFHEO has
over 200 employees now. They have a budget now that's $65 million a
year, and all they have to do is look at two companies. I mean, you
know, I look at more than two companies.

QUICK: Mm-hmm.

Mr.
BUFFETT: And they sat there, made reports to the Congress, you can get
them on the Internet, every year. And, in fact, they reported to
Sarbanes and Oxley every year. And they went--wrote 100 page reports,
and they said, 'We've looked at these people and their standards are
fine and their directors are fine and everything was fine.' And then
all of a sudden you had two of the greatest accounting misstatements in
history. You had all kinds of management malfeasance, and it all came
out. And, of course, the classic thing was that after it all came out,
OFHEO wrote a 350--340 page report examining what went wrong, and they
blamed the management, they blamed the directors, they blamed the audit
committee. They didn't have a word in there about themselves, and
they're the ones that 200 people were going to work every day with just
two companies to think about. It just shows the problems of regulation.

The problem, of course, is that Fannie and Freddie were doing exactly what Congress wanted them to do -- systematically lowering mortgage underwriting standards.  They won't put it that way now, but that is  what spreading home ownership to lower income families really amounted to.

I'm Sure This Is Not In Any Way Relevant To Recent Events

Via Carpe Diem, comes this September 30, 1999 NY Times story:

In a move that could help increase home ownership rates among
minorities and low-income consumers, the Fannie Mae Corporation is
easing the credit requirements on loans that it will purchase from
banks and other lenders.

The action, which will begin as a
pilot program involving 24 banks in 15 markets -- including the New
York metropolitan region -- will encourage those banks to extend home
mortgages to individuals whose credit is generally not good enough to
qualify for conventional loans. Fannie Mae officials say they hope to
make it a nationwide program by next spring.

Fannie Mae, the
nation's biggest underwriter of home mortgages, has been under
increasing pressure from the Clinton Administration to expand mortgage
loans among low and moderate income people and felt pressure from stock
holders to maintain its phenomenal growth in profits.

In
addition, banks, thrift institutions and mortgage companies have been
pressing Fannie Mae to help them make more loans to so-called subprime
borrowers. These borrowers whose incomes, credit ratings and savings
are not good enough to qualify for conventional loans, can only get
loans from finance companies that charge much higher interest rates --
anywhere from three to four percentage points higher than conventional
loans.

''Fannie Mae has expanded home ownership for millions of
families in the 1990's by reducing down payment requirements,'' said
Franklin D. Raines, Fannie Mae's chairman and chief executive officer.
''Yet there remain too many borrowers whose credit is just a notch
below what our underwriting has required who have been relegated to
paying significantly higher mortgage rates in the so-called subprime
market.''

Demographic information on these borrowers is
sketchy. But at least one study indicates that 18 percent of the loans
in the subprime market went to black borrowers, compared to 5 per cent
of loans in the conventional loan market.

In moving, even
tentatively, into this new area of lending, Fannie Mae is taking on
significantly more risk, which may not pose any difficulties during
flush economic times. But the government-subsidized corporation may run
into trouble in an economic downturn, prompting a government rescue
similar to that of the savings and loan industry in the 1980's.

''From
the perspective of many people, including me, this is another thrift
industry growing up around us,'' said Peter Wallison a resident fellow
at the American Enterprise Institute. ''If they fail, the government
will have to step up and bail them out the way it stepped up and bailed
out the thrift industry.''

Those heartless free marketing guys at the AEI -- always predicting doom every time we open our hearts to poor people.  Bailout?  What ridiculous scare-mongering.

Thoughts on the Lehman Bankrupcy

While I am not happy to see a historic company go bankrupt, and have vague but unspecific worries about some kind of general cascading financial problem, I am happy to see the government let Lehman go bankrupt without any sort of special intervention or bailout for a number of reasons:

  • Bailouts create awful incentives for other large companies managing their risk portfolios
  • I know many small business people who have gone bankrupt, and I once lost my job in a company bankruptcy.  There is no reason Lehman equity holders and managers should be immune from the same process just because their company is large and old. 
  • Lehman's management has failed to get a positive return from the assets in their care.  A bailout only keeps these assets under the same management.  A bankruptcy puts these assets in the hands of new parties who hopefully can do a better job with them. 
  • I strongly suspect that the hole in Lehman's balance sheet from underwater assets like certain mortgages is large compared to its equity but small compared to its total assets.  If this is true, equity holders will end up with nothing, but most creditors should come out close to whole when everything is unwound.

Like Megan McArdle, I found Obama's recent reaction to the Lehman bankruptcy to be wrong-headed but unsurprising.  Obama is blaming recent financial problems on an overly laissez faire approach by GWB in general (LOL,that's funny) and a lack of strong enforcement by the SEC in particular. 

But one has to ask, what laws were not enforced?  My sense is that these are all perfectly lawful portfolios of mortgages in which the one mistake was systematically being too generous in giving out credit.  Mr. Obama's party has always been a strong advocate of pushing banks to be more generous with credit, particularly to the poor, and of promoting home ownership as a national goal.  If anything, financial institutions are struggling because they were too aggressive in these goals.  McArdle writes:

This was not some criminal activity that the Bush administration should
have been investigating more thoroughly; it was a thorough, massive, systemic
mispricing of the risk attendant on lending to people with bad credit.
(These are, mind you, the same people that five years ago the Democrats
wanted to help enjoy the many booms of homeownership.) Lehman, Bear,
Merrill and so forth did not sneakily lend these people money in the
hope of putting one over on the American taxpayer while ruining their
shareholders and getting the senior executives fired.  They got it
wrong.  Badly wrong.  So did everyone else.

It appears from further Obama statements talking about lack of enforcement for predatory lending laws that the Democrats want to get back on the rollercoaster of whipsawing banks between charges of redlining (you are not lending enough to the poor) and predatory lending (you are lending too much to the poor).

Postscript:  While in retrospect there may turn out to have been laws broken, in situations like this, particularly when a management team is trying to head off a liquidity crisis, these tend to be of the reporting and disclosure ilk.  We saw back during the Enron failure that people tend to assume law-breaking of some sort to be the cause of a major bankrupcy or collapse, and to satisfy this notion the government aggresively pursued Enron executives.  But nothing for which Enron was prosecuted had anything to do with their failure -- all the violations were about disclosure and accounting methodologies.  The company would have still crashed, probably faster, without these violations.

Update:  More here

Re-Evaluating Home Ownership

Mark Perry has had a series of posts of late presenting the hypothesis that high rates of home ownership in the US may be detrimental as it reduces labor mobility.  The argument goes that homeowners have a harder time moving for new jobs than renters do.

Homeownership
impedes the economy's readjustment by tying people down. From a social
point of view, it's beneficial that homeownership encourages commitment
to a given town or city. But, from an economic point of view, it's good
for people to be able to leave places where there's less work and move
to places where there's more. Homeowners are much less likely to move
than renters, especially during a downturn, when they aren't willing
(or can't afford) to sell at market prices. As a result, they often
stay in towns even after the jobs leave. And reluctance to move not
only keeps unemployment high in struggling areas but makes it hard for
businesses elsewhere to attract the workers they need to grow.

The argument makes sense on its surface, but I am having a bit of trouble buying into it (though I will admit that as an American, I am steeped in decades of home-ownership-boosterism, so I may not be approaching the problem without bias).

On the plus side, the selling a home and buying a new one certainly has more costs than switching apartments, particularly if you add in a moving premium for home owners who can accumulate a lot more stuff than apartment dwellers and the switching costs due to emotional attachment to the current house.  Also, on its face, the argument is similar to criticisms of the economy of the antebellum south, where too much capital was invested in land and assets tied to the land.

However, I see a couple of problems with it.  First, its hard to find an increase in structural unemployment rates in the past decades to correlate to the increase in home ownership.  Second, the costs to change homes has been falling of late as the government-protected Realtor monopoly is finally being broken by technology and commission rates are falling.  Third, my sense is (though I can't dig up the data) that the average time in a home is dropping, meaning homes flip owners more frequently, again indicating a decreasing barrier to moving.

I would, however, be willing to accept that in a high home ownership regime, falling home prices and lengthening for-sale times could exacerbate an economic downturn by slowing mobility and thereby slowing the correction.  I would have argued in the past that this was offset by home equity as a savings tool and a source of cash in difficult times, but that could be different this time around as mortgage policies have tightened, drying up the ability to convert equity to emergency cash.

Crowding Out Private Alternatives

Due to the very nature of political pressures as well as poor accounting, a lot of government services are provided to the public below their true cost or market clearing price  (there are exceptions, like intra-city mail, but in these cases the government must pass laws to prevent private competition in order to maintain its market share).  When the government provides these below-cost or below-market-price services, it tends to crowd out private options.  So I am wondering why Kevin Drum is so surprised:

I guess rescuing them was the right thing to do. I'm still a little
taken aback by the apparent fact that American banks are now almost
flatly unwilling to make mortgage loans unless they're backed by Fannie
or Freddie, but that seems to be the case whether it takes me aback or
not. So rescue them we must. I suppose my next question is whether it's
worth thinking about how to restructure the American home mortgage
industry so that it can operate efficiently even in the absence of
massive levels of government backup. Or is Fannie/Freddie style backup
just the way the world works these days and there's no point fussing
over it?

As evidenced by the current bailout (and their huge accretion in market share over the last several years), Fannie and Freddie were under-pricing the service they were providing.  So of course, all things equal, bankers will demand the Fannie/Freddie backing because that will be a more profitable product and will be less work for the banker.  This seems like a "duh" kind of thing.  Like the "mystery" of why in Massachussetts, while everyone is obligated to sign up for health insurance, only the ones who were eligeable for free coverage did so.

I have written before of a similar phenomenon in business loans, where loans with SBA backing have crowded out everything else out there, such that a small business really can't find a lender who will make small business loans except with SBA backing.  Bankers are people too, and they can get lazy.  They have come to rely on these government programs, but certainly the lending function would still exist in a robust form if these programs did not exist.  Bankers would have to find other risk-mitigation tools, or else the loans would be more expensive, reflecting that the banks could not get rid of all the risk and had to price that into the loan.

By the way, don't you love the technocratic hubris of "thinking about how to restructure the American home mortgage
industry so that it can operate efficiently even in the absence of
massive levels of government backup."  Why do I, or Drum, or anyone outside of banking have to think about this at all?  I don't personally know the best private alternative to government mortgage gaurantees.  So what?  The financial field has been rife with innovation over the last several decades.  Just remove the government backup and let the the banks figure it out.  And let them go bankrupt when they figure wrong.

Postscript: As an ironic aside, the bank that holds my SBA loans was closed by the FDIC last week, my guess is due to a bad mortgage book in the Las Vegas area.  This doesn't have a lot of impact on me except that as I have paid down my loans, they became wildly overcollateralized, and I was in the process of trying to renegotiate some of my collateral out of the deal.  That will have to be put on hold, I guess.

Update:  More on government crowding out private options, in an entirely different industry:

Basic
dental care in Britain is free to those under 16 or over 60, the
unemployed, students, military veterans and some low-income families.
For others, government dentists offer lower prices than private
practitioners.

However,
the government does not cover cosmetic dentistry, and a recent
reorganization of the way dentists work has prompted many to leave the
public sector. Katherine Murphy, a spokeswoman for The Patients
Association, an advocacy group, said it was proving increasingly
difficult for Britons to get anything beyond basic dental care from
Britain's National Health Service.

Update #2: More on Fannie and Freddie, again via Rick Perry:

The
Fannie Mae-Freddie Mac crisis may have been the most avoidable
financial crisis in history. Economists have long complained that the
risks posed by the government-sponsored enterprises were large relative
to any social benefits.

We
now realize that the overall policy of promoting home ownership was
carried to excess. Even taking as given the goal of expanding home
ownership, the public policy case for subsidizing mortgage finance was
weak. The case for using the GSEs as a vehicle to subsidize mortgage
finance was weaker still. The GSE structure serves to privatize profits and socialize losses.
And even if one thought that home ownership was worth encouraging,
mortgage debt was worth subsidizing, and the GSE structure was viable,
allowing the GSEs to assume a dominant role in mortgage finance was a
mistake. The larger they grew, the more precarious our financial
markets became.

Capitalism Rorschach Test

The current failures in the subprime mortgage market, both of borrowers and lenders, has become one of those classic Rorschach tests where people self-identify by what description they apply to the market fallout.  Views on capitalism, free interchange, and individual responsibility are all tied up in the choice between:

  1. Businesses recognized an opportunity to expand the mortgage market by offering mortgages to poorer, riskier borrowers and managing the risk by securitizing these loans and reselling them in the increasingly robust institutional market for such loan packages.  While certainly in it for the profit, this move was consistent with the long-term trend in the US to wider home ownership.  It turned out, however, that almost everyone involved were working off some poor assumptions.  Borrowers over-estimated their ability to pay and counted too much on the continued upward trajectory of real estate values.  Lenders made a number of bad credit decisions, something not wholly surprising in a new market.  And institutions and other investors under-estimated the risk in these packages, particularly the systematic risk associated with falling housing prices.   The sub-prime market will likely re-emerge, but with everyone smarter the next time around.  Huge losses give lenders and institutions all the incentive they need to change their behavior in the future.
    -- OR --
  2. Unscrupulous lenders created the sub-prime market as a way to make a quick buck off of naive and inexperienced borrowers.  They tricked these borrowers into taking on more debt than they could handle in order to get large up-front fees.  Institutions were not arms-length investors, but were explicitly knowledgeable and "in on" this con.  Their goal was to sell worthless bonds to unsuspecting investors.  The fact that the lenders and institutions are taking the biggest losses in the market collapse is not a sign that they are innocent, but that the market fell apart faster than they expected, so they had not had the chance to unload the securities on duped individual investors.  Without regulation, lenders and institutions will continue committing these same crimes and poor people have proven that they need outside help to make good decisions with their money.  Congress needs to step in and prevent poorer borrowers from being offered mortgages in the future, and institutional investors need to be held financially accountable when borrowers take on more debt than they can handle.

Update:  There are several comments that say "can't it be both?"  Surely there can be simultaneous examples of both in the same market, but, as an example, proponents of #2 talk as if theirs is the dominant explanation, and are proposing legislation on that basis. 

Recognize that you have to really believe #2 all the way to even consider some of the draconian measures that Congress is entertaining.  There is legislation that is being seriously considered at this moment
that will fundamentally change the entire mortgage market, not just the
sub-prime piece, for the worse.  In particular, Congress is considering making financial institutions that invest in securitized batches of mortgages liable for any illegal lending practices of the originator.  This will effectively kill the securitization process.  Many of you younger folks won't know what that means, but in effect it will send us back to the mortgage process of the 1970's, which I promise you really, really sucked.  This will make it much harder for everyone to get mortgages.  Since securitization, there are an order of magnitude more mortgage competitors, the mortgage approval and application process take about 1% of the time it used to, rates are lower, and there is much more flexibility in mortgage design.