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.

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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
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