Reality dawns in real estate
Wednesday, 8 October 2008
Christopher Caldwell
On Wednesday, Barack Obama, the US Democratic presidential candidate, urged a solution to the finance crisis "that protects American taxpayers and our economy without rewarding those whose greed led us to this point". That evening, President George W. Bush warned that economic ruination loomed if Americans chose to "stand back and allow the irresponsible actions of some to undermine the financial security of all".
The two see eye-to-eye on a key point - that there is some group of identifiable malefactors behind the recent turmoil, even if Mr Obama considers them greedy and Mr Bush merely irresponsible. The public agrees, if we are to judge from its enthusiasm for "clawbacks" of any market gains made through sharp practices.
The problem is, responsibility is more widely spread. Few Americans are innocent of the cardinal sins of this crisis: extravagance, leverage and complexity. The high-rollers who ran the banks have made a terrible mess. But the common man, had he been given a bank of his own, would have responded in the same way. We know this because, in effect, Americans were given banks of their own: their houses. Thanks in large part to tax laws that allow homeowners to deduct the interest on their mortgages, homes became investment engines - rickety ones.
The mortgage interest tax deduction was part of the original US income tax passed in 1913. It allows homeowners to exempt interest on mortgages up to $1m (£550,000, €680,000), plus $100,000 in home equity loans. Almost 40m homeowners claim it, for a tax saving of roughly $80bn a year. The measure has been much attacked - by conservative flat- tax advocates on the grounds that it sucks investment into residential property and by the left on the grounds that it is unfair. The level of regressivity varies with the property market. But in recent decades the richest 10 or 12 per cent of the people claiming the deduction have got about half the benefit.
The gimmickry and the unfairness interact in a mischievous way. The deduction is almost designed to overheat the housing market and push people towards "more house than they can afford". That is because you cannot get this deduction for borrowing against an existing mortgage, aside from the $100,000 mentioned above. You can only get it on your "acquisition loan" or "first lien". If you bought a house for $300,000 that appreciated by $700,000, you need to sell your house and move into a new one to unlock the full deductibility.
Why do that? For access to inexpensive capital to reinvest. Speculating with one's house was considered a sensible strategy not just by day traders and stock touts but by respectable investment counsellors. Forbes magazine, in a 2004 article called "Hock Your House", urged homeowners to "leverage up and invest". In New York, the combined federal and state income-tax rate for the richest is about 40 per cent, Forbes noted. So when a New Yorker took out a $1m, five-year adjustable-rate mortgage at 4.9 per cent, his effective after-tax rate was 2.9 per cent. You need not be especially cocky to believe you can turn a profit if you are given $1m at below market rates. And the principle is the same even if you are on step one of the leverage ladder, in a $109,000 trailer home with a $100,000 mortgage.
Treating one's house as an investment bank was logical under the circumstances. The incentive was to keep equity as low as possible. "Interest-only" mortgages proliferated. People did not even feign wanting to pay off their mortgages one day. But at heart it contradicted the rhetoric - about "fulfilling the American dream" and the civic benefits of widespread homeownership - that is used to justify the mortgage deduction. Americans often brag about their 69 per cent rate of home ownership. Mr Bush hailed the millions of first-time home- buyers in his speech on Wednesday. But at these levels of debt, is "ownership" the right word for people's relationship to their houses? It might be better to describe them as renters with an option to buy, even if they call their rent a "mortgage".
An important underlying question is whether incentives created a hollowing-out of home ownership that nobody would have wished for in an undistorted market, or whether people simply care less about having equity in a house nowadays. Mr Bush's frequent invocation of an "ownership society" implies that many socially desirable things result when people own their own homes - stability, virtue and wider citizen participation. In Thomas Jefferson's time, having as many property-owning yeomen as possible was a democratic aspiration and we claim to cherish it still. There are unquestionably cases in which encouraging home ownership - as in the case of the widespread privatisation of council homes under Margaret Thatcher - can bring people out of the social shadows.
But to most of us, the belief that full membership of society hinges on property ownership sounds like an 18th-century prejudice. It is against the spirit of our age. We have no sentimental attachment to anything. Everything gets steadily more disposable and short-lived - razors, news stories, jobs, marriages. Education, too: recent reports that Sarah Palin attended five colleges in six years showed her to be flighty, but not atypical. Why should property be immune to this trend? What sense do 30-year mortgages make in an age of migration and retraining? Being not so good a fit with the institutions of our time, the privately owned house has been fitted to a less sentimental use. People have been allowed to collateralise huge loans with an asset that, when push comes to shove, they care less about than popular mythology assumed. The system worked well for a while. While it did, a lot of people were able to move into their dream houses. Now they are moving into their reality houses.
............
Internet
On Wednesday, Barack Obama, the US Democratic presidential candidate, urged a solution to the finance crisis "that protects American taxpayers and our economy without rewarding those whose greed led us to this point". That evening, President George W. Bush warned that economic ruination loomed if Americans chose to "stand back and allow the irresponsible actions of some to undermine the financial security of all".
The two see eye-to-eye on a key point - that there is some group of identifiable malefactors behind the recent turmoil, even if Mr Obama considers them greedy and Mr Bush merely irresponsible. The public agrees, if we are to judge from its enthusiasm for "clawbacks" of any market gains made through sharp practices.
The problem is, responsibility is more widely spread. Few Americans are innocent of the cardinal sins of this crisis: extravagance, leverage and complexity. The high-rollers who ran the banks have made a terrible mess. But the common man, had he been given a bank of his own, would have responded in the same way. We know this because, in effect, Americans were given banks of their own: their houses. Thanks in large part to tax laws that allow homeowners to deduct the interest on their mortgages, homes became investment engines - rickety ones.
The mortgage interest tax deduction was part of the original US income tax passed in 1913. It allows homeowners to exempt interest on mortgages up to $1m (£550,000, €680,000), plus $100,000 in home equity loans. Almost 40m homeowners claim it, for a tax saving of roughly $80bn a year. The measure has been much attacked - by conservative flat- tax advocates on the grounds that it sucks investment into residential property and by the left on the grounds that it is unfair. The level of regressivity varies with the property market. But in recent decades the richest 10 or 12 per cent of the people claiming the deduction have got about half the benefit.
The gimmickry and the unfairness interact in a mischievous way. The deduction is almost designed to overheat the housing market and push people towards "more house than they can afford". That is because you cannot get this deduction for borrowing against an existing mortgage, aside from the $100,000 mentioned above. You can only get it on your "acquisition loan" or "first lien". If you bought a house for $300,000 that appreciated by $700,000, you need to sell your house and move into a new one to unlock the full deductibility.
Why do that? For access to inexpensive capital to reinvest. Speculating with one's house was considered a sensible strategy not just by day traders and stock touts but by respectable investment counsellors. Forbes magazine, in a 2004 article called "Hock Your House", urged homeowners to "leverage up and invest". In New York, the combined federal and state income-tax rate for the richest is about 40 per cent, Forbes noted. So when a New Yorker took out a $1m, five-year adjustable-rate mortgage at 4.9 per cent, his effective after-tax rate was 2.9 per cent. You need not be especially cocky to believe you can turn a profit if you are given $1m at below market rates. And the principle is the same even if you are on step one of the leverage ladder, in a $109,000 trailer home with a $100,000 mortgage.
Treating one's house as an investment bank was logical under the circumstances. The incentive was to keep equity as low as possible. "Interest-only" mortgages proliferated. People did not even feign wanting to pay off their mortgages one day. But at heart it contradicted the rhetoric - about "fulfilling the American dream" and the civic benefits of widespread homeownership - that is used to justify the mortgage deduction. Americans often brag about their 69 per cent rate of home ownership. Mr Bush hailed the millions of first-time home- buyers in his speech on Wednesday. But at these levels of debt, is "ownership" the right word for people's relationship to their houses? It might be better to describe them as renters with an option to buy, even if they call their rent a "mortgage".
An important underlying question is whether incentives created a hollowing-out of home ownership that nobody would have wished for in an undistorted market, or whether people simply care less about having equity in a house nowadays. Mr Bush's frequent invocation of an "ownership society" implies that many socially desirable things result when people own their own homes - stability, virtue and wider citizen participation. In Thomas Jefferson's time, having as many property-owning yeomen as possible was a democratic aspiration and we claim to cherish it still. There are unquestionably cases in which encouraging home ownership - as in the case of the widespread privatisation of council homes under Margaret Thatcher - can bring people out of the social shadows.
But to most of us, the belief that full membership of society hinges on property ownership sounds like an 18th-century prejudice. It is against the spirit of our age. We have no sentimental attachment to anything. Everything gets steadily more disposable and short-lived - razors, news stories, jobs, marriages. Education, too: recent reports that Sarah Palin attended five colleges in six years showed her to be flighty, but not atypical. Why should property be immune to this trend? What sense do 30-year mortgages make in an age of migration and retraining? Being not so good a fit with the institutions of our time, the privately owned house has been fitted to a less sentimental use. People have been allowed to collateralise huge loans with an asset that, when push comes to shove, they care less about than popular mythology assumed. The system worked well for a while. While it did, a lot of people were able to move into their dream houses. Now they are moving into their reality houses.
............
Internet