Saturday, May 21, 2005

"Too Little Too Late" For Greenspans' Bubble Talk

The economic world is commenting on Alan Greenspans' remarks about the housing bubble yesterday. The LA Times has some quotes. "'Affordability is a serious issue,' said Esmael Adibi at Chapman University in Orange. 'The fact is that more people are trying to buy more housing than their incomes can justify.'"

"By letting short-term interest rates hit rock bottom, the central bank helped drive down mortgage rates. That in turn created an exaggerated demand for housing, Adibi said. 'The Fed caused some of the problem, no question,' said Adibi, who believes local housing prices may start to fall by the end of the year."

"Adibi and others suggested that Greenspan might be trying to reduce the impending shock of a slowing housing market. But Greenspan's remarks may be 'too little, too late,' said Christopher Thornberg, a senior economist at the UCLA Anderson Forecast who has been among the few economists to emphatically describe California's housing market as a bubble."

"People have been freely spending 'because they feel wealthy' thanks to soaring home prices, he said. 'When the market cools, it will have implications beyond real estate,' Thornberg added."

15 Comments:

At 11:05 AM, Anonymous Anonymous said...

Chapman University analysis is near worthless except for a laugh.

They are behind the "Orange Curtain" of unfounded optimism and the new economy ideals.

They are firmly in the realtor/new money camp as they primary activity seems to be fund-raising to increase the endowment with newly minted real estate millionaires money.

I have a rich older friend that is actively being courted by the foundation for "estate planning" with Chapman at the head of the list. No fiduciary obligation conflict of interest there.

 
At 11:06 AM, Anonymous Anonymous said...

One thing I don't understand is why the federal government and federal reserve don't co-ordinate their monetary and fiscal controls more carefully.

For example, if monetary policy needs to become very accomodative because of a slowdown and threat of a recession, why can't fiscal policy automatically adjust to prevent this new liquidity being overinvested in the wrong asset classes.

If the taxation laws are designed carefully enough, tax incentives and rebates can adjust automatically without the need for the passage of new laws.

For example, the interest paid on a 30 year fixed rate mortgage where the rate is over 7.5% should be fully tax deductible. If the rate is 7-7.5%, only 80% deductible, if 6.5-7% only 60% deductible, if 6-6.5% only 40% deductible, if 5.5-6% only 20% deductible, if less than 5.5% not deductible at all. This will make refinancing less attractive and dampen the effects of loose monetary policy on housing affordability reducing the chances of overinvestment in real estate.

A similar tax scheme could be designed for other mortgage types e.g. 15 year fixed, various kinds of ARMs, IO etc. - where full tax deduction is applied when the rate (either fixed or averaged for the tax year when variable) is at or above the long-term average and is diminished on a sliding scale when it dips below the average.

Of course, the range of the bands and the tax deduction applicable to those bands is open to debate, but it would be a way to discourage reckless investment in housing when monetary policy is accomodative.

 
At 11:18 AM, Anonymous Anonymous said...

Anon 11:06 AM

Respectfully, please tell me that you are kidding.

The picture I made in my mind when I read your post, of thousands of beauracrats bustling around like the floor of the NYSE frantically adding and subtracting incentives and disinsentives by the millions of pages to the already several million page IRS tax code caused me to have fits of laughter.

 
At 11:21 AM, Anonymous Anonymous said...

Along the same lines, capital gains on real estate should be taxed just like those on all other asset classes.

If this seems too harsh, one could allow for a certain proportion of the capital gain to be tax-free - in particular that part which is pure inflation.

e.g. if you bought a home in 1990 for $100K and the cumulative compound CPI is 70% from 1990 to 2005, then the first 70% of $100K of your capital gain i.e. $70K should be tax-free. So if you sell for $350K today, you should have to pay regular capital gains tax on the other $180K of your capital gain.

Another useful tax policy to dampen housing overinvestment during a period of stimulative monetary policy is a federal property tax which is inversely proportional to prevailing mortgage rates in a given tax year.

All these tax policy suggestions should be designed to be revenue-neutral i.e. in years where they increase revenue, income taxes etc. should be lowered to compensate.

 
At 11:24 AM, Anonymous Anonymous said...

Anon 11:18 AM,

If you are a believer in simplifying the tax code, let's just do away completely with the mortgage interest rate deduction and the real estate capital gains exemption.

I would be in favor of that but some will regard it as unfair so I imagine some sort of complicating compromise will be needed along the lines I mentioned.

 
At 11:47 AM, Anonymous Anonymous said...

Anon 11:24

If you did the original post, sorry, I really thought you were kidding.

I am for simplification of the tax code, but I am not for cherry picking just the deductions and cap gains out as a one sided way of simplifying the tax code, and I rent and get no deduction, although I have in the past, my principles have not changed.

To remove the cap gains would be a massive tax increase. Many older citizens that have paid into the system and built there retirement plan around the cap gains deduction could be destroyed.

As far as the interest deduction, I am not a fan of removing it, but would consider supporting the idea as long as it was part of a real universal tax code simplification package.

But I believe Government/Fed/CentralBank, meddling, taxing, allowing some deductions and not others, interest rate manipulation and money supply control are the regulatory reasons that we are in this mess.

As for regulation described above by virtue of taxing every different RE transaction differently would have to be outsourced to India, even the US doesn't have that many beauracrats.

 
At 11:50 AM, Anonymous Anonymous said...

Why not introduce a punitive RE short-term capital gains tax to soak flippers and speculators - say a flat 98% CGT rate due at sale of any property held for less than 3 months, 90% CGT if property held for <6 months, 80% CGT for property held <9 months etc?

 
At 12:08 PM, Anonymous Anonymous said...

Anon 11:50

I just don't believe that tax increases and government intervention is the answer.

Otherwise, why not also punish short term traders the same way in every other market, bonds, stocks, heck even saving accounts.

A certain amount of speculation provides liquidity in any market. I prefer to regard the "housing Bubble" as a debt bubble that manifested itself in housing. And I believe that it has because of the Government, in this case, backing shaky loans through Fanny and Freedie, which is supported eventually by the tax payer. I sure as heck didn't sign up to take the risk. Again, governement intervention.

 
At 12:08 PM, Anonymous Anonymous said...

Anon 11:47 AM,

If you did the original post, sorry, I really thought you were kidding.

I am for simplification of the tax code, but I am not for cherry picking just the deductions and cap gains out as a one sided way of simplifying the tax code.


It is not one-sided - it is simply removing unjustifiable tax advantages that RE has over other forms of investment that encourage overinvestment in RE - according to the Economist magazine, over a TRILLION dollars of overinvestment in this latest housing boom alone.

To remove the cap gains would be a massive tax increase.

I already said that any changes to the tax code should be revenue-neutral i.e. they would be compensated by a decrease in other taxes like income tax.

Many older citizens that have paid into the system and built there retirement plan around the cap gains deduction could be destroyed.

This was the reason why I proposed that the part of their capital gain that was pure inflation should not be subject to taxation.
OTOH, older citizens should not benefit tax-free from windfall profits arising from a housing bubble at the expense of first-time buyers.

As far as the interest deduction, I am not a fan of removing it, but would consider supporting the idea as long as it was part of a real universal tax code simplification package.

In the UK during the late 80s a royal commission was set up to investigate the economic impact of the mortgage interest deduction - their conclusions were that it transferred wealth from the government and home buyers to mortgage finance companies. The only people in favor of the mortgage interest deduction were lobbyists for such companies and against their protests, the UK government abolished the mortgage interest deduction.

But I believe Government/Fed/CentralBank, meddling, taxing, allowing some deductions and not others, interest rate manipulation and money supply control are the regulatory reasons that we are in this mess.

If they're going to meddle, they should do so in a co-ordinated fashion that distorts markets less and is less likely to inflate bubbles.

As for regulation described above by virtue of taxing every different RE transaction differently would have to be outsourced to India, even the US doesn't have that many beauracrats.

Every stock transaction is taxed differently - there are short term and long term gains, ESPP purchases, options purchases, purchases of restricted stock, purchases and sales within various tax-advantaged accounts like IRAs and 401Ks etc. There are probably thousands more stock transactions per year than RE transactions which are all large and lumpy (.e. involve large quantities of money).

Bureaucrats are only needed for enforcement - most of the filing can be automated.

 
At 12:14 PM, Blogger goleta said...

Since most recent home buyers will be hit with AMT, I'm trying to figure out
how renting compares to owning for families that can actually afford a home at current level.


Assuming a well-to-do family with household income of $250K is buying a $1.25M below median price home in Santa Barbara.

With $250K down payment and a $1M 30-year fixed rate mortgage, the monthly mortgage payment is around $5,700 or
a yearly payment of $68K. The property tax would start around $13K. Local and state income taxes would reach $20K.
With the AMT tax rate of 26 to 28% and only the primary mortgage interest can be deducted. The family would have to pay $54K AMT tax after mortgage interest is deducted.

So we have $68k+ $13K +$20K +$54K=$155K and that doesn't include social security or medicare taxes that can be over $15K for a family of 4.
So just taxes and mortgage alone would be $170K. Maintaining the home, association fees, and utilities can easily reach $10K.
If they put $30K in 401K, company stock investment, and/or IRA accounts, then they will only $40K left for tuitions, food, cloths, cars, fuel, medical expenses not insured and not deductible, etc. Hardly any money to waste and they have to assume they can keep their jobs.


If they rent the same home, they'd pay $2,500 in rent and $300 in utilities a month. AMT would be $67K.
So annually, they will pay $33K (rents+utilities)+ $67K (AMT)+$20K ( state and local taxes) +$15K (social security + medicare taxes)=$135K. With the same $30K in retirement funds. They would have annual $85K disposable income (more than twice of $40K if they own) and still save the $250K cash ( the down payment if they own ) for better investment.

Owning a home doesn't make any financial sense at all even for the top 5% families that can afford the median price home. If the economy deteriorates and the family loses part or the whole income, they can rent a less expensive home and still have enough cash to live normally for many years to come.

But if they bought the home and a recession comes that even if thy only lose 50% of the income, they can no longer afford the mortgage and have to sell the home at likely 50% or more loss. They will end up with $375K of debt.


So whether a recession comes or not, you can't win being a home owner.

 
At 12:17 PM, Anonymous Anonymous said...

Anon 12:08

"I already said that any changes to the tax code should be revenue-neutral i.e. they would be compensated by a decrease in other taxes like income tax."

Didn't catch that, but if you start with that statement, I surely have my ears open.

I agree that it is not fair to allow tax advantages to one group over another, but it is there now and would have to carefully be unwound.

But tax simplification would be a good thing, we could put all those bean counters to work doing the work we are sending overseas.

Good conversation, gotta go to a basketball game.

 
At 12:35 PM, Anonymous Anonymous said...

Anon 12:08 PM said:
I just don't believe that tax increases and government intervention is the answer.

Otherwise, why not also punish short term traders the same way in every other market, bonds, stocks, heck even saving accounts.

A certain amount of speculation provides liquidity in any market. I prefer to regard the "housing Bubble" as a debt bubble that manifested itself in housing. And I believe that it has because of the Government, in this case, backing shaky loans through Fanny and Freedie, which is supported eventually by the tax payer. I sure as heck didn't sign up to take the risk. Again, governement intervention.


Firstly, the last thing the US residential real estate market needs right now is speculators artificially boosting demand - what's the harm of taxing them out of existence in the current market?

Secondly, if you believe that the root cause of the housing bubble is a debt bubble then for heaven's sake, let's at least stop providing tax incentives to borrow heavily (i.e. let's eliminate the mortgage interest tax deduction). To stay revenue-neutral, we can provide tax incentives for saving e.g. stop taxing interest income on savings accounts.

 
At 12:58 PM, Anonymous hobbes said...

(I just don't believe that tax increases and government intervention is the answer.)

I agree. Speculative activity is the lifeblood of markets. And speculators frequently get their commeuppance if they bet wrong. The difference right now with housing is that speculators are preying on The American Dream (homeownership) and many Americans are unwittingly playing right along not realizing that have entering the lion's den.

That's unfortunate.

But much of the root of this is not the lack of government intervention, but the presence of it.

From "guaranteeing" Freddie Mac and Fannie Mae, to the home mortgage exemption, to the ability to sell tax-free, etc. No other sector gets this kind of kid-glove treatment. So housing in many ways has been ripe for this kind of speculation for some time now.

I'm not a fan of "social" tax programs---those tax benefits that are intended to steer citizens towards a goal that is supposedly "good" for society, like owning a home.

Does anyone truly believe that no one would be interested or willing to own a home, put down roots, become part of the fabric of their community if it weren't for the tax breaks?

Gimme a break.

The problem now, of course, is that these "breaks" are assumed to be sacrosanct. That's why government intervention is so insidious. It's very easy to pass a law, but very difficult to "unpass" one.

Protecting people from themselves is a slippery slope. We have very good laws on the books for criminal behavior, but these only take effect after the crime has been committed.

But it's very dangerous to pass laws that anticipate unhealthy behavior (or speculation) and regulate it before it occurs.

Given the current housing market, I fully expect many thousands of Americans will find themselves in very difficult financial circumstance. But perhaps they will learn a lesson: no free lunches, never swim with sharks, etc. All government should do is monitor the water. If sharks are sighted, put up a sign saying, "Sharks in water. Swimming inadvisable." If people still choose to swim, they have the right to be chomped.

 
At 3:18 PM, Anonymous Anonymous said...

I'm back from the ballgame...

"From "guaranteeing" Freddie Mac and Fannie Mae, to the home mortgage exemption, to the ability to sell tax-free, etc. No other sector gets this kind of kid-glove treatment. So housing in many ways has been ripe for this kind of speculation for some time now."

Great point, and I like the shark metaphor.

An earlier post mentioned removal of the interest deduction. I rent now, but in the past have had benefit from it. And although it gives tax advantages to some and not others, to remove it would also destroy some financially and not others.

Objectively, I wish it never had existed. And it makes me angry to see some owning two homes, claim one as their primary while living in the other, thereby getting the cap gain advantage without being there.

Anytime the Gov regulates, there are ALWAYS unintended consequenses that allow abuse.

That is why I think it is better for them to just do what the Constitution allows them to do and nothing more. No where have I seen in the Constitution "specualtors shall be punished for short term investments".

The market will take care of that, if the Government keeps its nose out of it.

 
At 11:53 PM, Anonymous Anonymous said...

Very simple...eliminate ALL taxes except for a progreseive income tax. 15% tax on all capital gains. 80% of the tax to Federal Govt. and 20% to State Govt.(negotiable). They both have to allocate some portion to local services through a General Fund. Eliminate ALL tax deductions except (possibly) for charitable contributions. There...problem fixed! :) There is honestly no need for mortgage int. deduction. None. This would also make greed a bit less profitable.

As far as the housing bubble; as many have posted here before, lenders should require 20% down, with a 33% back-end debt-to-income ratio. Income must be proven. That would eliminate most of the speculation. As far as getting "lower income" people into housing, there should be a set number of grants or coupons (down-payment assistance) which can be awarded to a limited number of families each year. They must qualify based on financial need and must meet minimum standards regarding financial and social responsibility, clean criminial record, and clean drug test, etc. If we are going to give them money, they should at least be worthy of the gift. The limited number of these "coupons" (very limited) would ensure the market is not flooded with first-time buyers who will distort the market (as is happening now).

 

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