Subsidized both by the Chinese government and the US government …
I am talking about housing, of course. And it seems everyone else is too. Starting with the New York Times Magazine.
No wonder. Everyone wants to know what will happen to real estate prices. And to our real-estate centric economy. Particularly now that Treasury yields are creeping up just a bit.
Make no mistake, real estate has boomed over the past few years in part because it has gotten lots of government support.
From China. In order to maintain its exchange rate peg, China has to spend 10% of its GDP a year, give or take, buying dollars - dollars that it then invests in Treasuries. That helps to keep Treasury yields down. And recently, the connection has gotten more direct: the US data suggests that China has stepped up its purchases of "corporate" bonds - widely thought to be mortgage-backed securities. Put differently, in order subsidize Chinese exports, China's central bank has to subsidize American real estate.
And from the US government. Roger Lowenstein reminds us that the US government spends far more subsidizing suburban (and wealthy urban) housing than subsidizing farming - though, for rather obvious reasons, the big suburban (and wealthy urban) dailies tend to editorialize about the ills of agricultural subsidies with more regularity. The mortgage interest tax deduction costs [strike taxpayers] the government $76 billion; agricultural subsidies are a comparative bargain at around $20 billion. [Updated, per the comments section]
(I am taking mandatory spending of the Commodity Credit Corporation as an estimate of farm subsidies - I think that is right, but am not 100% sure)
And just as agricultural subsidies tend to benefit those with bigger farms who produce more, housing subsidies tend to benefit those with bigger houses who borrow more.
Actually that is imprecise. Housing subsidies help those who sell to those who can borrow more as well. And the value of the mortgage tax deduction hinges on your tax bracket, so its biggest beneficiaries are those with high incomes who borrow more - so long as they don't borrow more than $ 1 million.
On either their first OR your second home.
But, then again, the corporate CEOs who cannot deduct interest on their third and fourth home can always try to convince the board to pay their taxes …
And if you have already paid off your mortgage, you can still deduct the interest on a $100,000 home equity loan - a loan that then will be securitized and sold to the People's Bank of China.
I applaud Stephen Roach for drawing attention to the inequities that have been spawned by a global system that relies on asset price appreciation to make up for a the absence of strong growth in wage income (for those not in the economic stratosphere), and in particular that relies on housing price appreciation in the US, Spain and a few other places to generate demand for all the goods China (and others) want to produce.
It is popular but I still believe it is a stretch to call mortgage interest deduction a subsidy. Interests for investment purposes are in general deductible (for individuals and corporations), why not mortgage?
On the other hand, the capital gain tax exemption on home sales is a tax break that only home-owners can enjoy. Though the reasoning is obvious: most people who sell also need to buy another home, so if you have to pay a large tax on the gain you may not be able to afford your next home, which seems rather silly. Some kind of 1031 exchange for home-owners may be the fairest solution, allowing them to defer their gains until they downsize.
Tax policy is not the focus of this post. But I would tell the previous commentator that some of us are old-fashioned enough to believe all income should be treated the same - regardless of source. A thousand dollars will buy a thousand dollars worth of goods, whether it was acquired by selling drugs or real estate or a corporation.
Well said, Brad. And, as usual, Roche hits the mark.
Globalization has not lifted all boats. Nor will it in its present form.
In all honesty, I do not see a way through this, given the current political climate and rather obtuse thinking on the part of so many. Rising disparities of wealth are finally in no one’s interest, not even for those at the top of the food chain with their second, third and fourth homes.
The danger is a misdirected backlash that will pit poor against poor.
We see this occasionally when someone from India or another developing country says “You have yours; now we want to have ours.” Talk like this misses the point entirely.
We hear the same kind of talk from corporate cheerleaders who claim they are really on a rescue mission in China: Economic missionaries who really want to pick all pockets clean.
We deeply need a mechanism that will speak for labor worldwide, not merely for capital. And that simply will not happen.
HZ — those of us who rent are probably less inclined to view housing as an “investment” rather than as a form of consumption — tho right now, clearly, more and more americans treat it as an investment. Still, i don’t particularly see why the current system of offering the largest tax breaks to those with the biggest mortgages and highest tax brackets is the best policy approach. not that it is going to change …
Brad,
I said “investment” because that is the term used on tax returns. I personally view borrowing as leverage. I was not thinking along the line of “investment/consumption”. To be fair I think credit card interest should be treated the same way as HELOC interest: either both deductible or both taxed.
The other reason I would object to the term “subsidy” is because it implies a transfer payment from lower incomes to higher incomes. I don’t think that is reality. When you lower tax rate the higher incomes always benefit more, but it is hardly a subsidy.
I don’t object to further equalizing disposable income but we need to call the kettle black. On average lower incomes get more benefits proportionally than they pay in taxes. The understanding is important because by confusing the issue, the red states’ clamering for lower taxes shot their own citizens in their feet.
Roach’s article is interesting but I think it is misleading to compare income disparity between US and China. There is much more non-monetized income in US in terms of social safety net. I don’t think income inequality in itself is that important an measure. A more important one is to measure whether citzens’ basic needs are met. In China it is a resounding no. In US it is a borderline yes (certainly yes by the global average). I always visualize a London artist living on the dole. He may be poor but he may not be less happy.
Brad,
I’ve 1 question for you. You’ve dismissed rightly the intangible investment argument. As if it could explain de current rising deficits …
Could you and would you go further.
For about 30 years now, people and especially social and economic scientists have witnessed and tried to explain rising schooling time within the society. Ever more people get university diplomas.
There has been rising doubts that this was entirely efficient, many have wondered if there was not too many people studying too long because :
A it was made inexpansive by the government
B the government and no one else had any good idea in how selective the system should be and when there were too many or not enough students
C people wanted to get a relative position in the social stratification and were ready to pay for it a high price, especially when coming from a relative high position already
I came accross this article :
http://www.usatoday.com/money/pe…oans- usat_x.htm
seen it on http://www.cepr.net a good resource.
Think of it, close to a majority of young american adults are carrying huge debt load, because they invested in an “intangible asset” something unseen I think in the history of mankind.
Don’t get me wrong, knowledge is useful, but I think ther’s been some overpricing of it, some speculation…
Just suppose that there are 3 levels in society, say workers, managers and top managers, and that you can pay to become a manager or top manager …
Let’s suppose that part of the price of the studies pay for an increase in human capital and a higher revenue, and part of it pays for your relative position within the society.
If borrowing is made cheap and if you are fooled into believing that there is such a thing as the knowledge economy were everybody can earn huge salaries if they pay very expensive studies, then you end up with having paid a lot just to get access to a relative status.
Right now, instead of having universities, there could be a system that said, if you want to become a top manager, pay a few thousands dollar to ….. why not the government, and borrow the same amount to …. banks or government.
So may be things are not that different that when the governments of feodal europe were selling offices and noble title and tons of money were “uselessly” spent on buying prestige (a relative status).
All this sums up in one simple question :
Is there a world wide schooling bubble ?
This one would be on top of the world housing and stock market bubbles, and on top of the investment bubble in asia and the relative world bubble in commodities price.
My opinion is that the very high level of debt within the US under graduates and graduates is a sign that there is one now.
Mortgage interest is taxed. The holders of MBS have to pay taxes on the interest they receive. If home owners didn’t have the tax deduction, then the interest amount would, in effect, be double taxed. It’s the same argument for elimination of taxes on corporate dividends. Why tax an owner of a company (a share holder) for profits they wish to receive that have already been taxed at the corporate level? It doesn’t seem fair.
I don’t think the housing bubble is as big a problem as reported. I think there’s a bubble, but it’s primarily focused on a few areas (South Florida, California, the Northeast). These areas are starting to see their bubbles correct themselves. Most of the geographic areas of the US have reasonable home prices. The vast majority of homeowners in the bubble areas have lots of equity in their homes and, as long as they remain employed and healthy, can continue to make their mortgage payments.
An excellent Stephen Roach editorial on rising World income inequality from Neo-liberalism globalization. Although the mainstream economics media tends to dismiss the problem, if not addressed, the issue will become politically explosive once the US housing Bubble economy implodes.
http://www.morganstanley.com/GEFdata/digests/20060303-fri.html#anchor0
” What is new is how America’s income distribution has become more unequal in a period of rapidly rising productivity growth — a development that has been accompanied by an extraordinary bout of real wage stagnation over the past four years. Economics teaches us that in truly competitive labor markets such as America’s, workers are paid in accordance with their marginal productivity contribution. Yet that has not been the case for quite some time in the US.
In large part, that has occurred because increasingly broad segments of the American labor market are now exposed to a uniquely powerful competitive force — the IT-enabled arbitrage. Courtesy of the hyper-speed of sharply accelerating Internet penetration, the global labor arbitrage has pushed into areas that historically have been unaccustomed to wage competition.
Inequalities of the income distribution have long been the Achilles’ heel of economic growth and development. In an era of IT-enabled globalization, that seems more the case than ever. History tells us that the pressures of widening income disparities are often vented in the political arena. ”
- Stephen Roach
Why tax an owner of a company (a share holder) for profits they wish to receive that have already been taxed at the corporate level? It doesn’t seem fair.
I don’t agree. Rich people have too much money, besides they always make money by some form of exploitation, this money is better in other people’s pockets and besides that’s the only way to sustainable growth.
So if double taxation bothers you, It may be possible to raise the tax on corporate profits or on revenues … What is important is the overall tax level for the different classes of people (annual revenue and asset worth) and it’s variation.
On overall the USA is a country that taxes rich people very little. Globally the trend this last 30 years has been to tax rich people always less. THis trend has been stronger in the USA.
This has helped the asset bubbles formation and is one of the cause that is leading us into the major depression ahead.
When rich people spend money on speculation instead of paying workers to generate revenue based demand for products, then trouble is ahead. Curbing speculation activities is good.
“Ownership society “= codeword for “the speculating soon to be bankrupted society”
Economist Paul Kasriel of Northern Trust in Chicago on the broad economic impact of a Housing Bubble collapse on the US Economy.
http://www.msnbc.msn.com/id/11658208/
” 1. Jobs. More than 40 percent of new new private sector jobs added in the first several years of the current expansion were related to housing, although that percentage has fallen sharply as the broader job market has accelerated, according to Northern Trust research. Still, a sharp downturn in sales could mean layoffs for construction workers, real estate agents, mortgage brokers and even many employees at Wall Street firms that help provide the capital for new mortgages.
2. Consumer spending. The run-up in housing has boosted consumer spending in two ways - through a psychological “wealth effect” and by allowing owners to turn their homes into giant cash machines, withdrawing equity at a record annual rate of more than $600 billion last year, compared with less than $200 billion a year in the late 1990s. If home prices flatten or turn down, there will be no more equity to withdraw, and consumers who have much of their wealth tied up in a single asset will no longer feel inclined to spend so freely.
3. Problem loans. More than 40 percent of the dollar volume of new loans has been made with adjustable mortgage rates in recent years, compared with less than 20 percent in the early 1990s. As interest rates rise, many owners who stretched to buy a house will find themselves facing higher and possibly unaffordable payments. If housing prices turn down, some owners could find themselves “upside down” on their loans, owing more than the house is worth. A a true housing bust - comparable to the collapse that deflated tech-stock values in 2000 - holds the capacity to “cripple the banking system,” Kasriel said. That would make it difficult for the Federal Reserve to revive flagging growth since banks would be hard pressed to loan money even if rates were falling. ”
- Paul Kasriel
Dave Chiang — sorry to be a bit snippy, but if i mention an article in my post (Steve Roach), even if it is below the fold, I am not sure that it is necessary to paste the same article into the comments section.
DF,
I just don’t agree with your socialist ideas. I believe an economy needs an uneven distribution of wealth to function properly and I certaintly don’t agree that all rich people exploited their way to wealth. Most rich people I know got that way because they worked harder than your average citizen. You need to check your facts about how much each class pays. The wealthy in the US pay a hugely disproportianate amount of taxes. I think there are limits to what they should be expected to pay. I don’t buy into the argument of whatever they pay, it isn’t enough. Also, the interest deduction is limited to $1Million, so the interest deduction that you’re against doesn’t help the super wealthy as much as the average homeowner.
I’ve got a very simple question - What happens to the holders of these securitized mortgages if some large percentage of the mortgages they’re based on go into default? Do they get the keys to the house? Does Freddie/Fannie cover their loss (with money borrowed from ??)? Or is the house liquidated at a lower price and they take a loss?
Charlie, your disagreement of course does not come as a surprise.
I also believe an economy needs an uneven distribution of wealth to function properly.
Even Rawls believes that.
All rich people exploited their way to wealth.
Of course the amount of exploitation varies. Some got rich by birth or lottery, so they’ve not exploited anyone at the start. However in order to get rich, you need to get higher returns on your capital than others. There’s 2 ways of doing it. One is innovation that allows you to provide better and cheaper services while paying your workers contractors the prevailing wage. The other is doing everything to pay workers and contractors less that the market price, and false the market by using your monopsonic monopolistic position. There may be a few rich people who have not done that themselves or invested in companies who did. But a lucky few. Anyway you look at it, being rich is a mortal sin, and it’s also an encouragement to greed, so it’s good for government to reduce wealth inequalities.
The wealthy in the US pay more taxes per head than others. Agreed. However - that does not mean the amount is disproportionate. If you compare the US situation to other countries you find that the rich people pay a smaller percentage of their revenues than in most other advanced countries, that this % has been falling, faster than elsewhere.
I think there are limits to what they should be expected to pay. Agreed. they are just way higher than right now.
Also, the interest deduction is limited to $1Million, so the interest deduction that you’re against doesn’t help the super wealthy as much as the average homeowner.
That’s agreed also. The problem is that under the current state of deregulation the interest deduction has been helping the formation of a major bubble.
The good thing is that speculation in housing prices is driving state and county tax revenue up a lot. People individually think they will gain in taxes, but the agregation of their individual behaviour drives prices up and they end up paying more local taxes.;. Funny ain’t it ?
Anonymous,
There are many kinds of mortgage securities. If it is GSE backed, one of the GSE will insure timely payment of principal and interest. If there is a default, Fannie or Freddie will eventually forclose on defaulted loans. MBS owners’s corresponding tranche will be called. So if you paid a premium on the security you may suffer prepayment loss (as happens to any called securities bought at premium).
And what about a schooling bust ? I mean what if suddenly human capital assets lose a lot of their value, because, say, there’s a massive unemployment in several sectors that used to hire college and master graduates.
What if all those young professional and managers can’t repay their debt ?
I think we’ve been accustomed to assume that schooling and human capital assets always go up. If there’s a slowdown in the labor market, may be universities will take a hard blow, and that means a blow for lots of related jobs.
There is no real mortgage subsidy. Instead the price level has changed to incorporate it. Eliminating it would change the price level correspondingly.
The Flow of Funds tells us about foreign purchases of GSE’s, but what about the rest of the mortgage-backed securities market? Are people just guessing when they make pronouncements about the rising external source of mortgage finance? Given the precariousness of both the housing market and the flows on the capital account, isn’t this something we would really like to know?
“The mortgage interest tax deduction cost taxpayers $76 billion;”
it’s funny to say that it “costs” them, when it “saves” them. Let’s say, “The mortgage interest tax deduction widens the deficit by $76 billions”
OK, but, Brad, do you know how much the recent 40% run up in housing prices has generated in property tax revenues ?
on this site, Dean Baker estimates that back in 2002, the run up in housing prices had already inflated housing wealth by 2,6 trillions. 3 years later, with prices even higher, let’s assume that total to be 4 trillions
http://www.cepr.net/publications/housing_2002_08.htm
What is the average property tax ?
If it is 5% then the housing bubble generates 200 billions in tax revenues each year. In which cases, investing 76 billions in tax deductions, to generate a bubble that generates 200 billions in tax revenues is a wise short term fix.
What do you think ?
In his latest update on the housing bubble, dean baker values the housing bubble at 5 trillions dollars
http://www.cepr.net/publications/housing_2002_08.htm
That makes it even more profitable for property tax collectors.
any one knows the national average rate of property taxes ?
It seems it could be a bit lower than 3%.
ANyway, I find it hard that nobody comments the fact that may be the federal mortgage interest tax deduction, is in fact an indirect transfer of taxes from the federal towards the local government levels, and on top of it, an efficient way to generate more tax than deducted !!!
That means that asset price inflation is efficient as a tax revenue generating device, though probably not as efficient as good prices inflation (the tax on wage revenues is in the 10-30% range, the tax on wealth in assets is in the 2-4%)
“costs taxpayers $76 b was a bad choice of words” — should be costs the government … and saves wealthy tax papers $76b (and yes, it gets factored into property prices, which helps those with property to sell .. and hurts those trying to buy in lower tax brackets (b/c the tax deduction helps them less than most).
DF — interesting point on prop. taxes. so it is a transfer from the federal government to the local governments of blue (high property price) states …
yeah, and it’s also proof that inflation in asset prices boost taxes in the same way as inflation in good prices does.
Suppose that GDP was adjusted not to CPI but to an index of both consumption and production goods, reflecting the demand of both consumers and producers … GDP growth would then look much much smaller.
This is a technical question for you brad if you have the time.
GDP is the sum of all value added.
Investment is not included in the value added, investment is a decision made out of the value added, once wages are paid.
However, some firms produce investment goods.
So if investment goods rise in price, we should see a rise the added value of the companies who produce (should I say build ?) investment goods.
If consumption goods do not rise, this rise will be considered as inflation free, and a true growth.
Why ?
After all, other firms need investment goods, they lose buying power when the price of investment goods rise, yet this fall of buying power is not tracked in the value added !
DF,
Interesting points. Here in California the property tax rate is a bit above 1%. If it were 5% I guarantee we wouldn’t have seen the price appreciations we had. But we also pay the highest state income tax and one of the highest sales tax.
We live in interesting times: people all over the country vote against their own economic interests, at least on the federal income tax.
“In his latest update on the housing bubble, dean baker values the housing bubble at 5 trillions dollars”
The link you provided [ http://www.cepr.net/publications/housing_2002_08.htm ] is to an article from August, 2002. That’s pretty stale. And anyone who didn’t buy a home four years ago due to articles like that are feeling pretty poor…
Here’s a link to this guy’s latest “fear and loathing in housing” article: http://www.tompaine.com/articles/2006/07/31/the_coming_housing_crash.php (which is linked to from the front page of http://www.cepr.net/ )
I guess if he keeps writing this stuff year after year someday he’ll be able to say he was right.