THE BEAR'S
LAIR Time
to dump on housing By Martin
Hutchinson
The US National Association of
Homebuilders Housing Market Index jumped to 46 on
Monday, its highest level since May 2006, just
before the peak in house prices. In Britain,
especially in southeast Britain, house prices
remain inordinately high in terms of wages, rents
and purchasing power. In the United States house
prices are subsidized by innumerable tax and other
benefits, including an effective government
guarantee of most home mortgages.
In both
countries, house prices are subsidized by interest
rates that have been inordinately low for over
four years. In both countries, government budget
deficits threaten the stability of the financial
system and the economy generally. Overall, it's
time to
put housing policy into
reverse and to reclaim some of the subsidies from
the housing sector.
Housing subsidies are
largely a product of politicians' sentimentality.
In both the United States and Britain before 1980,
house prices were affordable in terms of average
incomes and housing finance operations like Jimmy
Stewart's Bailey Building and Loan (It's a
Wonderful Life, 1946) made mortgage loans to
middle-income people who had saved a sufficient
down-payment.
It's likely this idyll could
have continued forever but for the inflation of
the 1970s, which caused interest rates to rise in
both countries so that in Britain mortgages (which
generally carried floating interest rates) became
unaffordable and in the US the losses on
fixed-rate mortgages destroyed the balance sheets
and cash flows of the savings and loan
associations.
The inflation of the 1970s
also affected the public's attitude to housing. In
both countries, houses ceased being simply places
to live and became investments. From this point,
the better-off ceased worrying about the upkeep
costs of a large house and began to extend
themselves in the mortgage market, hoping to
maximize their investment profits.
The
result was a massive run-up in prices in
fashionable areas like London, New York and most
of California, which took both housing and local
jobs well out of range of ordinary people. I am by
most standards quite wealthy, at least in terms of
income, but I could no more afford to live
comfortably in today's London than I could afford
a luxury yacht and its attendant upkeep and crew.
The ideal we should aim at is Germany,
where thanks to the admirable Bundesbank there has
been little inflation, so home ownership is
limited. Only around 43% of the population owns a
home and finance is available for at most 80% of
the purchase price, normally less. German house
prices have been flat or slightly declining in
nominal terms for two decades, and only recently,
as euro monetary policy has been by German
standards excessively lax and euro interest rates
have been held down below German inflation, has
there been a bump of maybe 10-15% in prices.
It's not a coincidence that Germany has
the most successful industrial sector in Europe.
Because of its lower house prices less of its
savings is wasted in home purchase, even though
the rich, like the Victorian British, are
substantial investors in rental properties. (They
invest little in equities, substantially in bonds
and not at all in hedge funds or other worthless
excrescences of the Anglo-American capital
markets.) Houses are affordable, either to buy or
to rent, yet staff are mobile when they need to
be, since only the oldest and longest established
own their homes.
In short, the German
housing and house finance market is a good
template, and our policies should be aimed at
mirroring that market.
In the United
States, the home mortgage interest tax deduction
should be abolished, providing a sizeable US$60
billion annually towards closing the $1 trillion
federal budget deficit. If as is likely a populist
president and congress wimp out of most of the tax
increases in the "fiscal cliff", abolishing the
home mortgage interest deduction will at least
provide a modest move towards fiscal sanity, even
though that particular tax break is not as
egregious as the "carried interest" treatment of
private equity profits or the tax break for
charitable donations, both of which actively
encourage economically destructive behavior.
The most egregious housing subsidy in the
US system is the effective federal guarantee of
home mortgages through Fannie Mae and Freddie Mac.
This grew up almost accidentally, resulting from
the development of mortgage securitization
techniques in the 1970s and 1980s. It has resulted
in the death of the Jimmy Stewart model, and its
replacement by a gigantic bureaucracy, which makes
the mortgage process far more difficult than it
needs to be.
In addition, the Federal
Housing Administration (FHA) guarantees mortgages
itself, a duplication of effort if ever there was
one, and has exhausted its capital, having
loosened its lending restrictions in 2008 just as
everyone else was tightening them. The FHA now
supports 15% of all mortgages, up from 5% in 2008,
and its stated purpose of enabling the indigent to
get mortgages has been stretched to include a
maximum guarantee limit of no less than $729,000.
We were informed this week that Fannie Mae
has expanded its staff by over 1,000 since its
bankruptcy in 2008, although Freddie Mac has cut
back slightly. In addition, a nominal 15% decrease
mandated by congress in the value of mortgages
bought directly by the entities has been
effectively ignored.
This subsidy has gone
on long enough. With housing recovering, these
entities need to be shut down, not over a period
of a decade or more but within a year. The US
banking system is eminently capable of making home
mortgages itself, as it did for decades before
1970, and if the cost of housing finance increases
somewhat, so what? It will push people towards
lending and away from excessive leverage, both
favorable developments for the overall economy.
There are other subsidies that also need
to be removed. Under the Basel banking
regulations, mortgages are given preferential
treatment in banks' capital calculations compared
with other loans. Experience since 2006 worldwide
has shown the risk assumptions behind this to be
faulty, as are the even more egregious subsidies
given to holding government paper. Changing this
is simple; the housing sector does not deserve
such consideration.
The final subsidy to
remove is that of ultra-low interest rates. These
favor investment in long-term assets of limited
volatility, such as home mortgages, thereby
allowing banks to load up on mortgage assets on a
highly leveraged basis while neglecting the far
more economically valuable activity of lending to
small business.
Low interest rates have
de-capitalized both the United States and Britain;
they have also driven British house prices up to
inordinate heights, and will do so again in the US
if the current housing recovery is allowed to
fester.
Remove these subsidies, and house
prices in Manhattan, the fashionable bits of
California and South East England will collapse,
halving or more in the Russian Mafia-dominated
purlieus of central London. That will have a
number of beneficial effects.
It will
cause losses to the more foolish and spendthrift
rich, who have overinvested in housing. It will
deter young successful people form overinvesting
in housing, thereby increasing their investment in
equities and especially small businesses. At a
less exalted level, it will remove the bias
between renting and home ownership, thereby
increasing workforce mobility, so that families
will tend to buy houses only when they are well
established with children, perhaps in their 40s.
Naturally, to get Germany's housing
market, the authorities in Britain and the United
States will need to adopt Germany's monetary
policy (or rather, that of the Bundesbank before
1999). For Britain, this will not be all that
difficult; the traditions of the Bank of England
include the wholly admirable Montagu Norman and
Rowland, Lord Cromer. While there are few if any
of the current staff left from the period of those
worthies, there is at least no institutional bias
against sound money.
In the United States,
it will be more difficult. Paul Volcker lasted
only eight years and was immensely lucky; one can
imagine the fate of his sound policies when
matched against a president George W Bush rather
than Ronald Reagan. The legislation governing the
Federal Reserve needs rewriting, with the "dual
mandate" to cover unemployment removed, and
provision made so that Fed policy is adequately
"Volckerized" in spite of political pressure.
Mere independence is not enough; we have
seen in the past few years the damage that can be
done when an independent Fed is run by a chairman
more populist than Huey Long. Historically,
however, even the Gold Standard Fed of the 1920s
proved prone to meddling in the wrong direction,
creating a surge of speculation in the 1920s
followed by an orgy of debt deflation in the early
1930s. Criteria must be set so that future Fed
chairmen are forced to govern by monetary policies
that mimic a true "free banking" Gold Standard, in
which money creation is automatic and central bank
policy meddling minimized.
That's for the
long term, and after this month's election results
not immediately feasible. However, removing the
multiple egregious subsidies to housing is
currently feasible and forms a major element in
the lengthy and difficult task of restoring the US
and British economies to full health.
Martin Hutchinson is the author
of Great Conservatives (Academica Press,
2005) - details can be found on the website
www.greatconservatives.com - and co-author with
Professor Kevin Dowd of Alchemists of Loss
(Wiley, 2010). Both are now available on
Amazon.com, Great Conservatives only in a
Kindle edition, Alchemists of Loss in both
Kindle and print editions.
(Republished
with permission from PrudentBear.com.
Copyright 2005-12 David W Tice &
Associates.)
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
