Mar092013

If the housing market is doing so well, then why all the subsidies?

There are so many subsidies, handouts, and tax deductions that have a powerful affect in the housing economy and it’s quite surprising when you list them all.  I wanted to create this list as the media is cheering the “Return of the Housing Market”.  However, look at the factors, for example like low mortgages rates it’s a type of handout.  The average American should be concern with these policies because it affects them everyday life they just don’t know or understand how.  The bottom line is why should citizen A’s tax money be used to purchase citizen B’s house.   This is not some public assistant program, so if citizen B wants a house they should use their money to purchase it.  The ability to purchase a home is passage of responsibility but it’s been corrupted into a right.

FHA

FHA was first time home buyer program for low cost homes developed in the Depression, but now it’s turned into the low down payment mortgage insurance company. FHA insures low down payment loans and charges a mortgage premium to the borrower.  However, FHA is in financial trouble because they were used after 2007 to insure low down payment lows and low down payment subprime loans.  These changes to it’s original mission will lead to a $150 billion bailout and current 17% delinquency rate.  This bailout is trying to be prevented by increasing the mortgage insurance premiums, but too late for the program.

Mortgage Interest Tax Deduction

Estimates range from $80 billion to $100 billion of taxes that are not collected due to this deduction.  It’s very simple, mortgage interest is deducted against your gross income changing it to adjusted gross income.  Even State governments allow mortgage interest deductions against their state income taxes.  This is transfer of taxes from people that have no mortgages or renters to owners who still owe on a loan for their homes.  However, is it really necessary and vital to the health of the housing market?  Most people would purchase their home with or without the deduction, it’s a consumption choice.  The deduction also increases the cost to purchase real estate because the buyers could afford a larger loan and greater purchasing power, so they bid up home prices.

Ironically, this deduction was designed to be used by the lower income home owner as an encouragement to purchase homes and stimulate the economy, but it’s mostly used by the families whose income is more than $114,000.  Those families under $114,000 mostly use the standard deduction.  Since, it’s not working as designed it should just be phased out over a 20 year time frame in my opinion.  You can even keep it revenue neutral by lowering the income tax rate as the deduction is phased and lower tax rates tend to help the economy as a whole better than the mortgage deduction.

Quantitative Easing and the Zero Interest Rate Policy (ZIRP)

Quantitative Easing is the printing of US dollars used for the purchase of US Treasury Bonds and Mortgage Backed Securities.  It increases the price of these securities and lowers the interest and mortgage rates.  It’s a subsidy to the banks because it allows them modify underwater mortgages to keep them from defaulting.  It increases the purchasing power of the buyers and kept home prices from falling lower.  Banks that foreclose or short sale mortgages could recoup more of their funds they lend out.  Even existing home owners can refinance their existing mortgages are a lower rate   However, this is not a free ride and comes at a price.

By printing money you are creating inflation with a decrease in purchasing power of your current dollars and it taxes future and current generations.  It can also cause a death spiral of money printing.  You need to print more and more money to keep these rates low.  This causes ever increasing inflation.  You will see when you go the grocery store, gas station, and when you purchase durable goods.  Is this subsidy to the banks’ bond and stock holders that are trying to avoid losses worth a decrease in your purchasing power?

Freddie Mac and Fannie Mae

Freddie Mac and Fannie Mae packages mortgages into mortgage backed securities with guarantee to the investor that it will insure some losses encase of default of the mortgage by the borrower.  The guarantee is backed the US government.  This guarantee under-prices the default risk that should be charged to the borrower because the US is seen as credit worthy country as a backstop.  In 1992 the US government encouraged the agencies to originate riskier mortgages without increasing the insurance premium, again like a subsidy.  This was expansion of the role just like FHA 6 years ago. In 2008, when a series of economic events occurred, the US government had to take over Fannie Mae and Freddie Mac at cost of over $200 billion.

Current State

There are numerous news articles that state housing is back and turns a corner like the bubble never occurred.  However, when you factor in FHA, Mortgage Interest Tax Deduction, Quantitative Easing, ZIRP, and GSE these policies, agencies, and subsidies have maintain home values against market forces.   How long can these policies go is anyone guess, but they are coming under fire.