Jul312013
Housing subsidies are detrimental to America
Every homeowner wants to see the resale value of their home go up as rapidly as possible. Since more than half the country owns a house, political pressure mounts to prop up home prices and cause them to appreciate. The result is a plethora of subsidies designed to make houses more expensive.
The result of these subsidies and our ever-present desire for rapid home price appreciation is a great deal of house price volatility. Unfortunately, house prices can’t appreciate faster than the wages go up to support them. Any time prices are artificially pushed higher, they inevitably crash back down with horrendous consequences.
What’s worse is that all this volatility can be avoided. If people accepted that house prices can only rise so fast, then perhaps they wouldn’t get carried away with kool aid intoxication and overborrow to buy real estate as an investment. If governments accepted that some people are better off renting, we wouldn’t get policies designed to make everyone a homeowner whether they can sustain it or not. If homebuilders, realtors, and bankers accepted that some people shouldn’t be given onerous debt loads to buy houses (and generate sales commissions), perhaps we wouldn’t have such powerful lobbying for policies that are the root of the volatility in our housing markets.
The cult of home ownership is dangerous and damaging
By Adam Posen — July 26, 2013 7:28 pm
You would think that the residential property bubble and subsequent crisis of the past decade would make people leery of widespread home ownership, and governments reluctant to pump it up. Yet, here we are again.
Despite the continuing fiscal tightening, the UK coalition government is pressing on with its “Help to Buy” scheme and the US Congress continues its unquestioning protection of the home mortgage interest tax deduction. This is the economic policy equivalent of incurring the individual and social costs of an obesity epidemic while still subsidising maize and beef production ….
I always find it astonishing that when a government policy proves to be a dismal failure, the answer politicians come up with is to do even more of the same. Would anyone characterize the war on drugs a success? The war in Iraq? How about abstinence education? Or quantitative easing to boost the economy?
Things do not have to be this way in the Anglo American economies. Policies to increase home ownership do not necessarily improve the supply or distribution of housing, … and often works against it. The OECD’s Better Life Index shows that no relationship exists between a country’s home-ownership levels and its average housing satisfaction and quality.
Loanowners have their names on title, and if you asked them, they would tell you they own their houses despite the fact they have no equity. Do you think many of them have a high degree of satisfaction with their housing situation?
And there is no iron law that higher-income economies must have higher rates of home ownership: Mexico, Nepal and Russia all have home-ownership rates of more than 80 per cent, while the French, German and Japanese rates are 30-40 percentage points lower. The US and the UK rates sit between them at about 65 to 70 per cent.
One of the main arguments in favor of high home ownership rates is that owners are supposed to have a vested interest in their communities whereas renters are hooligans who cause trouble. Germany and Japan certainly aren’t hotbeds of civil unrest.
The real issue, however, is the harm done by efforts in the UK and US to maintain and increase that rate. Start with the distortion to savings behaviour that mortgage subsidies and high loan-to-value ratios encourage. For many American and British households, their home equity is their primary financial asset. In other words, we incentivise middle-class households to leverage the bulk of their savings into a highly volatile, difficult to price asset, which is subject to disaster risk both idiosyncratic (fire, tree falling on the roof) and general (flood, local industry closure), and which – based on the economic fundamentals – should return at best the average rate of local wage and population growth.
I’ve said it many times that house prices are tied to wage growth. Over the long term, prices can’t go any higher than buyers can push them. In the past, lenders abandoned prudent debt-to-income ratios and “innovated” with toxic mortgage products to push prices up faster than wage growth would allow. The result has been disastrous housing bubbles.
Average individuals cannot calculate, let alone reasonably project, the running costs and financial risks of their housing investment as opposed to renting and putting their savings in more stable, liquid assets. But they constantly hear the misleading mantra that renting “is throwing money away” while incurring mortgage debt “builds equity”. So their savings go into housing,…
This has always been one of the silliest arguments realtors spout when trying to manipulate buyers. When people spend money each month for housing, they can either throw the money away on rent, or they can throw the money away on interest. When the cost of interest, even after the tax subsidy, exceeds the cost of renting — which it does on many Coastal California properties, the owner is the fool. The nonsense about building equity can be obtained by a renter who invests the money saved by not making such an onerous mortgage payment.
Overinvesting in bricks and mortar is a losing proposition for the households involved – but also for the economy as a whole.
The mass movement of voters’ savings into an inherently risky asset also creates demands on policy makers to provide capital gains on housing that their constituents otherwise would not receive.
All housing subsidies offer the promise of appreciation that would not otherwise occur. Once the middle class became over-invested in housing, government policy sought ways of distorting the market to justify this investment. Central bankers consistently lowered interest rates to juice house prices, and the government provides a plethora of subsidies to promote this mal-investment. Rather than causing trees to grow to the sky, it merely inflates unstable housing bubbles that crash with devastating effect on families and our banking system.
As a result, we get a combination of regulatory measures, local stimulus plans, subsidies to property lending and bias towards inflation that promote housing bubbles. And it is housing booms and busts that wreak the most havoc on economies of all bubbles, including through the concomitant destruction of banking systems. This was evident from history even before our current crisis, as my colleague Tomas Hellebrandt and I have shown. …
Great Britain has inflated several housing bubbles over the last forty years. Their housing market is much like California’s. They have severe growth restrictions that create shortages, and they have the same array of government subsidies that causes volatility. (See: What California can learn from Britain’s housing bubbles)
This danger alone would be justification enough to having governments lean against housing price swings, as opposed to pursuing policies that promote real estate speculation by individuals.
The costs of excessive home ownership, however, go even further. The promotion of such ownership is fundamentally regressive. It perpetuates inherited wealth and subsidies of middle-class children. The accumulation of housing wealth benefits those simply lucky enough to have had grandparents who were homeowners. Any policies to promote younger people “getting on the property ladder” will disproportionately benefit those fortunate children who have been given savings, have parental co-signers ….
Someone will argue that having prudent parents or grandparents is an advantage we should encourage. Perhaps it is, but government policy doesn’t need to increase that advantage by inflating house prices beyond the reach of orphans, immigrants, or lower class workers who work and save and want to buy a house but can’t because the inheritor class has inflated house prices too much.
Who has been the biggest beneficiaries of the last 30 years of declining interest rates? Baby boomers. Low interest rates have inflated house prices 30% to 50% from where they would be if interest rates were unchanged.
They come at the cost of spending that money elsewhere, …. They also perpetuate an influential lobby to protect mortgage debt and housing assets from taxes, …
The National Association of Homebuilders and the National Association of realtors consistently lobby for all tax subsidies of real estate, whether they are good for the country or not.
Like all favouritism to the children of the relatively rich, this discourages the development of new talent and competition, and thus is economically harmful.
Home ownership also directly discourages economic flexibility. In new research, my colleague David Blanchflower and Andrew Oswald of Warwick university have found that rises in the home-ownership rate in a US state are a precursor to eventual greater rises in unemployment.
(See: New report may kill the home mortgage interest deduction)
Home ownership damages employment through three powerful channels: decreasing levels of labour mobility, increasing commuting times and diminishing creation of businesses. Their evidence suggests that the housing market can produce negative “externalities” on the labour market.
Of course, in a free society, people who want to own homes and have the means should be able to purchase them, just as they would any other luxury item. But our governments do not need to subsidise that purchase. Increasing home ownership does not increase housing, least of all for the poor.
Numerous studies have shown there is no correlation between government subsidies and home ownership rates.
Increasing home ownership in the US and Britain beyond what the free market would generate does, however, distort capital allocation, put a large share of household savings at unnecessary risk, impede mobility, and creates a powerful lobby for government transfers to the wealthy. And it creates housing bubbles to devastating effect.
Why should anyone care about financial bubbles? The first and most obvious reason is that the financial fallout is stressful. People buying into a financial mania too late, particularly in a residential housing market, will probably end up in foreclosure and most likely in a bankruptcy court.
In contrast, stock market bubbles will only cause people to lose their initial investment. It may bruise their ego or delay their retirement, but these losses generally do not cause them to lose their homes or declare bankruptcy like a housing market bubble does. In a stock market collapse, a broker will close out positions and close an account before the account goes negative. There is a safety net in the system. In a residential housing market, there is no safety net.
If house prices decline, a homeowner can easily have negative equity and no ability to exit the transaction. In a housing market decline, properties become very illiquid as there simply are not enough buyers to absorb the available inventory. A property owner can quickly fall so far into negative territory that it would take a lifetime to pay back the debt. In these circumstances bankruptcy is not just preferable; it is the only realistic course of action. It is better to have credit issues for a few years than to have insurmountable debt lingering for decades.
The real problems for individuals and families come after the bankruptcy and foreclosure. The debt addicted will suddenly find the tools they used to maintain their artificially inflated lifestyles are no longer available. The stress of adjusting to a sustainable, cash-basis lifestyle can lead to divorces, depression and a host of related personal and family problems. One can argue this is in their best interest long-term, but that will be little comfort to these people during the transition.
The problems for the market linger as well. Those who lost homes during the decline are no longer potential buyers due to their credit problems. It will take time for this group to repair their credit and become buyers again. The reduction in the size of the buyer pool keeps demand in check and limits the rate of price recovery.
OCHN rating system
I developed the OCHN rating system to combat the volatility in our housing market. Timing the housing market is important, but it shouldn’t be. We should not need to focus so much attention on real estate prices because of excessive volatility. It shouldn’t matter when you buy. If your income can afford a certain level of housing entitlement, it should always be able to provide the same. As people get periodic salary raises, the cost of resale housing should rise in direct proportion as others who received the same wage increases would also bid up the value of houses. Unfortunately, that’s not the world we live in.
And the reason we have to deal with all this volatility and uncertainty is because housing is too subsidized here in America.
Their timing wasn’t good
The former owners of today’s featured property bought in May of 2005. They paid too much, and they borrowed too much to do it. The couldn’t make the payments, so they quit trying in early 2011. Fortunately for them, the bank let them squat for two years before booting them out.
[raw_html_snippet id=”newsletter”]
[idx-listing mlsnumber=”OC13148155″ showpricehistory=”true”]
58 GREENFIELD #57 Irvine, CA 92614
$394,000 …….. Asking Price
$462,000 ………. Purchase Price
5/26/2005 ………. Purchase Date
($68,000) ………. Gross Gain (Loss)
($31,520) ………… Commissions and Costs at 8%
============================================
($99,520) ………. Net Gain (Loss)
============================================
-14.7% ………. Gross Percent Change
-21.5% ………. Net Percent Change
-1.9% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$394,000 …….. Asking Price
$13,790 ………… 3.5% Down FHA Financing
4.38% …………. Mortgage Interest Rate
30 ……………… Number of Years
$380,210 …….. Mortgage
$120,300 ………. Income Requirement
$1,899 ………… Monthly Mortgage Payment
$341 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$82 ………… Homeowners Insurance at 0.25%
$428 ………… Private Mortgage Insurance
$357 ………… Homeowners Association Fees
============================================
$3,108 ………. Monthly Cash Outlays
($426) ………. Tax Savings
($512) ………. Principal Amortization
$22 ………….. Opportunity Cost of Down Payment
$69 ………….. Maintenance and Replacement Reserves
============================================
$2,261 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$5,440 ………… Furnishing and Move-In Costs at 1% + $1,500
$5,440 ………… Closing Costs at 1% + $1,500
$3,802 ………… Interest Points at 1%
$13,790 ………… Down Payment
============================================
$28,472 ………. Total Cash Costs
$34,600 ………. Emergency Cash Reserves
============================================
$63,072 ………. Total Savings Needed
[raw_html_snippet id=”property”]
Blackstone, Deutsche Bank in Talks to Sell Bond Backed by Home Rentals
Two major Wall Street firms are in detailed discussions to create and sell the world’s first bond backed by home-rental payments, people familiar with the matter say.
Blackstone Group LP BX -0.44% is in negotiations to bundle monthly rental payments on about 1,500 to 1,700 of its homes. The private-equity giant is among the firms that have spent billions buying homes out of foreclosure, an investment strategy that has helped to bolster demand and strengthen the U.S. housing market.
The bond comprised of the Blackstone homes would be structured and marketed to investors by Deutsche Bank AG, DBK.XE -2.03% the people say.
The creation of a new type of security shows that Wall Street’s financial engineering, blamed for deepening the financial crisis, is revving back up.
Some investors and analysts have said they are wary of a bond backed by rental payments, citing the dearth of long-term data on how often tenants living in previously foreclosed homes pay their rent on time.
Also, some investors and analysts have raised concerns about how quickly firms have purchased thousands of homes, and whether they have the management track record and expertise to oversee the maintenance of properties scattered across the country.
Indeed!
Speaking of detrimental…. the dumping of risk has begun…..
Here We Go Again: Step Aside RMBS, Rent-Backed Securities Are Here, And With Them The Beginning Of The End
It appears that since America’s financially innovative elite doesn’t have the patience to wait until housing prices regain their previous all time highs in order to usher in the second great RMBS wave, they looked long and hard at the chart above, and especially the red rental line, and came up with a brilliant idea: “Hey, let’s just securitize rents.”
securitization marked the peak of the last housing bubble. If the Blackstone deal indeed comes to market and prices, and is followed by many more, the end of the second credit and housing bubble is now, mercifully, in plain sight, which for those sick and tired of centrally-planned and manipulated markets is actually good news: the faster this artificial house of cards crashes and burns, the better, so if Blackstone wants to dump its housing exposure to the biggest idiot, more power to it.
Finally, for those who have been on the fence about whether or not to sell their house, this is your warning sign. When the biggest housing bull starts selling, run for the proverbial hills.
http://www.zerohedge.com/news/2013-07-30/here-we-go-again-step-aside-rmbs-rent-backed-securities-are-here-and-them-beginning-
Securitization has been around since the 80’s and this was the plan all along. In the unlikely event that home prices fall, it will make the rental streams more secure and thus, the RMBS more valuable. However, I don’t think the homes will be transferred from Blackrock to the securities, so the biggest housing bull isn’t “starting to sell”. It’s more like Blackstone taking a jumbo mortgage against the rental streams so they can redeploy that capital into more home purchases.
aka.. DUMPING RISK.
I think MR is right. ZeroHedge jumped the shark on this one.
Amazingly refi are still the majority of the market. The purchase index is up, but the purchase applications are down? How is that possible.
Mortgage apps drop 3.7% on falling refi volume
By Brena Swanson July 31, 2013 • 6:01am
Mortgage applications continued their downward trajectory, falling 3.7% from a week earlier for the week ending July 26, the Mortgage Bankers Association said.
“Mortgage rates were little changed last week, but remain roughly one percentage point higher than they were three months ago,” said Mike Fratantoni, MBA’s vice president of research and economics.
Furthermore, the refinance index dropped 4%, while the purchase index inched up 3% from last week.
“Refinance application volume continues to decline, with the refinance index now more than 55% lower than its recent peak, reaching the lowest level in over two years,” added Fratantoni.
“Applications for home purchases dropped for the fourth time in five weeks, but purchase volume is running about 5% higher than last year at this time,” he added.
Overall, the refinance share of mortgage activity remained at 63% of total applications.
The average contract interest rate for a 30-year, fixed-rate mortgage with a conforming loan balance remained unchanged at 4.58%.
In addition, the 30-year, FRM jumbo declined to 4.64%, from 4.66% the previous week.
The average 30-year, FRM backed by the FHA climbed to 4.30% from 4.28%.
Meanwhile, the 15-year, FRM increased to 3.67% from 3.63%, and the 5/1 ARM rose to 3.39% from 3.30% last week.
Ouch!
http://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2013/07/20130731_MBA.jpg
The purchase index actually decreased 3% and Housingwire misquoted the press release.
http://mbaa.org/NewsandMedia/PressCenter/85224.htm
Thanks, now that makes sense.
Cue the Price is Right you lose music.
Mel Watt fails to obtain Congressional vote before summer recess
President Obama’s Federal Housing Finance Agency nominee Rep. Mel Watt, D-N.C., failed to obtain a vote on his nomination to lead the FHFA in time to beat Congress’s summer recess.
Lawmakers break on Aug. 2, Compass Point Research & Trading pointed out. The tight time frame makes a Mel Watt confirmation unlikely this summer.
“We believe this is a significant event as it is reflective of both the continuity of the Republican opposition as well as the unwillingness of Democrats to force the issue on Rep. Watt’s nomination at this point in time,” the research group said. “While the debate will reemerge when Congress returns from its recess on September 9, we continue to doubt that Rep. Watt will become the next FHFA director.”
6% Treasury yields sooner than you think?
The Federal Reserve will lose control of interest rates as the “great rotation” out of bonds into equities takes off in full force, according to one market watcher, who sees U.S. 10-year Treasury yields hitting 5-6 percent in the next 18-24 months.
“It is our opinion that interest rates have begun their assent, that the Fed will eventually lose control of interest rates. The yield curve will first steepen and then will shift, moving rates significantly higher,” said Mike Crofton, President and CEO, Philadelphia Trust Company told CNBC on Wednesday.
“If the great rotation that everybody talks about out of bonds into stocks does happen, and that gains its own momentum, you will see rates begin to back up very quickly; the Fed will not be able to control it,” added Crofton, who argues that for now, “the great rotation” has been more out of bonds into cash, rather than stocks.
(Read more: Goldman Sachs:Treasury yields will hit 4% )
Under this scenario, he sees the yield on the 10-year rising to 3.5-4 percent in a “very short period of time.” Thereafter, he expects yields to move to 5-6 percent over the next 18-24 months. Yields were last seen at 6 percent level over a decade ago, in mid-2000.
Crofton says that as the average investor begins to see that they are losing money on their bond portfolios, this will drive fear into the market that will feed on itself. “More and more bonds will be sold and rates will continue to go up.”
U.S. government bond yields have risen at a faster-than-expected pace in the recent months on expectations that the Fed will begin scaling back its monthly bond buying program later this year.
Earlier this month, 10-year Treasury yields , which move in the opposite direction to prices, spiked to 2.73 percent – the highest since August 2011- from around 1.7 percent in early May.
I picked the wrong day to post this. Mortgage and interest rates are actually going down.
Lender Can-Kicking Reduces Foreclosures over Last 20 Months
Completed foreclosures and distressed inventory continued their downfall in June, CoreLogic reported Tuesday.
Data for last month showed 55,000 homes were lost to foreclosure, down 20 percent from June 2012. The decrease represents the 19th month-in-a-row completed foreclosures have ticked down. However, on a monthly basis, completed foreclosures inched up by 2.5 percent.
Since the financial crisis began in September 2008, about 4.5 million homes have been lost to foreclosure.
The level of foreclosure inventory also came down in June. According to CoreLogic’s estimate, about 1 million homes were in some stage of foreclosure, which represents a 28 percent annual decrease and a 2.9 percent decline from May 2013. The yearly decline marks the 20th consecutive month inventory has trended down.
Serious delinquencies are also posing less of a threat to distressed inventory.
“So far this year, distressed inventories have fallen dramatically, down 14.4 percent, and serious delinquencies are down 15.9 percent,” added Dr. Mark Fleming, chief economist for CoreLogic. “In the first six months of 2013, the stock of seriously delinquent mortgages has dropped by 412,000.”
Anand Nallathambi, president and CEO of CoreLogic, described June’s improvement as “broad-based,” noting 49 states have posted annual declines in foreclosure rates.
The one state to see a slight increase was Arkansas, where the foreclosure rate rose 0.1 percent from a year ago.
“The housing market is clearly on the mend, but we expect the ultimate conclusion of the present housing down cycle to be another several years away,” he added.
In June, Florida continued to lead as the state with the highest number of completed foreclosures over the last year after 107,000 homes were lost to the process.
California followed, with 72,000 completed foreclosures, while Michigan (63,000), Texas (48,000), and Georgia (44,000) rounded out the top five, which account for almost half of all completed foreclosures nationally.
Again, Florida led with the highest foreclosure inventory rate, at 8.6 percent, which is more than three times the national rate of 2.5 percent.
Also in the top five were New Jersey (6.0 percent), New York (4.8 percent), Connecticut (4.2 percent), and Maine (4.1 percent).
All of a sudden, DUMPING RISK has become en-vogue with ‘insiders’. Again.
Tic…tic…tic…
Freddie Mac Introduces ‘Risk-sharing’ MBS
Freddie Mac has begun marketing a new product, dubbed Freddie Mac Structured Agency Credit Risk (STACR) securities, designed to offload the “first-loss piece” of certain government-guaranteed MBS into the private capital markets.
http://confoundedinterest.wordpress.com/2013/07/18/freddie-mac-introduces-risk-sharing-mbs-credit-scores-between-601-and-839/
Thanks for the great article. I plan to visit your blogs more for Real Estate news and articles.
“…Why should anyone care about financial bubbles? The first and most obvious reason is that the financial fallout is stressful. People buying into a financial mania too late, particularly in a residential housing market, will probably end up in foreclosure and most likely in a bankruptcy court…”
And even in the “best case” scenario where bubble buyers were prudent like us and don’t “lose” the house, it’s arguably more harmful. Our neighbors bought new in 2007 next door to us. They were one family of many in our neighborhood that “lost” their house because they couldn’t afford it and the were underwater. However, they were able to live rent-free for a year and walk-away from the mortgage and related property debt. They gained ~$35k in imputed rent. The only price was a lower credit score for a few years.
We, on the other hand, have paid our mortgage and are trying to sell now. If we sell for an amount near comps, I calculate our purchase and 6-year stay will have cost us ~$75k (after accounting for monthly costs above rental parity, tax adjustments, money spent on improvements, and sales commission).
This is why we should try to discourage wild swings in housing prices. It rewards deadbeats and punishes the prudent.
“This is why we should try to discourage wild swings in housing prices. It rewards deadbeats and punishes the prudent.”
Well said.
When you see the real-world impact of these subsidies and the volatility of house prices it creates, it’s hard to argue in favor of keeping them.
There’s not much we as individuals can do to change government policy. Therefore, the best method to combat this is by refusing to overpay for a house and by taking advantage of the wild swings by timing purchases near troughs, or if you do choose to overpay, look at your purchase as a consumer decision rather than an investment.
Agreed. Nearly every American loses 50% on their a car purchase every few years, and we think nothing of it. Buy an Accord for $25k, four years later trade it in for $12k, and buy a new one. Rinse. Repeat.
We’ll likely lose ~11% of our townhouse’ purchase price. Not devastating considering everything, but still a pretty large number.
We can all agree we’re at a peak or just past one though right? I mean, if this isn’t it, what is?
I don’t think the Fed will let up until prices have exceeded the 2006/2007 peak by a little bit, which at the current rate of increase isn’t too far off.
We were right on pace in early 2013 to exceed peak prices in our neighborhood within the year. Then mortgage rates spiked 100 bps, inventory built-up, and now nothing is moving.
Fed recommits to current pace of MBS purchases
http://www.housingwire.com/news/2013/07/31/fed-recommits-current-pace-mbs-purchases
I think the big news out of Fed is Moderate to Modest. Slowly walking back from the Taper. Or unless Bernanke wants to dump the responsibility on someone else.
They’re committed to the same gross dollar amount of purchases, and the total dollar volume of MBS is declining. Rates rose and dramatically reduced refi activity. Hence, billions less mortgages being originated and sold each month, but the Fed still purchasing the same gross amount – a much larger percentage of available MBS.
An unbelievable swing in MBS and mortgage rates today!
Do you think the Fed is going to Taper? I have no idea.
I’m now conviced that at the 11th hour, they’re going to maintain the status quo. Either that or they begin to taper, watch the meltdown begin, and start buying again.
We all saw what the HINT of a future taper did to bonds, MBS, and mortgage rates.
At this point, they are going to taper.
It’s already priced-in; ie., rates are up >100bsp roughly MoM and holding.
What is NOT priced-in is the ‘sell-off’ that commences just prior to the announcement that they’re going to taper. That one is gonna sting/leave a mark.
PS: no need for anyone to save this post because MelloRuse has already done so.
I’m just convinced that whatever I decide to do, I’ll lose.
If I stop renting and buy a house – the market will crash
If I continue to rent – house prices continue to rise
Jay, link please?
http://www.mortgagenewsdaily.com/mbs
I’m a total communist, and I heartily agree with this statement.
What the hell are these people thinking?
It’s probably all political survival: a price collapse would hurt whoever happens to be in the White House and on The Hill at any given time, so it is never allowed to happen.
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