Are higher home prices really the answer to the housing crisis?
Looking back at 2009 we saw unprecedented support for the housing market in terms of government subsidized interest rates, tax credits, foreclosure moratoria and loan modifications that make subprime lending look safe. Clearly the drop from the dizzying heights homes prices reached in 2006 was staggering, and just as clearly the drop would have been far worse without this intervention. To justify this intervention one has to assume that higher home prices are in our best interest. But are they really?
Like an athlete using performance-enhancing steroids, should we be willing to risk our economic health and future for a remarkable, but likely unsustainable, performance now? Is it really reasonable to expect our current steroid induced housing market won’t come back to haunt both our personal finances and our national economy in the future?
Looking back to our previous foreclosure crisis in the 1990’s, we worked our way out of that one with housing steroids as well. We started with the Taxpayers Relief Act of 1997 that incentivized every homeowner to flip-that-house with tax-free gains on real estate. As we entered the millennium the housing steroid cocktail was enhanced with a loosening of regulations and an extended period of low interest rates. This stimulus led to the greatest housing bubble in our history, the aftermath of which we will continue to deal with for years to come.
As with steroid use by athletes, there are short term artificially induced gains followed by serious negative side effects. The gain was stratospherically higher but unsustainable home prices. The side effect has been negative equity, foreclosure and recession as the steroids wore off and homes prices returned to earth. As we once again embark on injecting a powerful cocktail of stimulus into the housing market let’s look at the winners and the losers of housing on steroids.
Who are the winners and losers of housing on steroids?
Winners
- Government: Higher property values mean higher property taxes and higher government revenues.
- Title & Escrow companies: Higher prices mean higher transaction fees.
- Realtors: Higher prices mean higher commissions.
- Insurance Companies: Higher prices mean higher premiums.
- Sellers: Anyone who flips, sells, downsizes, or simply cashes out – assuming they get the timing right.
Losers
- Homeowners: Periods of artificially inflated values only mean inflated taxes, insurance premiums and unpredictable future value potentially leaving them stuck in an underwater prison-of-debt during the inevitable busts.
- Realtors: While the highs are great, the busts are devastating – not only to their own income, but also to their reputation among those who trusted their mantra that “now is a good time to buy” at the peak.
- Retirees: And other fixed-income investors who can’t get a decent return on investment thanks to artificially low interest rates. It’s hard to get those 5-10% returns your retirement plans are counting on during a period of near zero interest rate policy.
Is the solution to our housing crisis really more housing steroids in the form of government intervention? Might we better off by kicking the habit and returning to a sustainable market, realistic growth that keeps pace with inflation, and prices that reflect actual incomes? Ask yourself a few questions:
As a homeowner, which would you prefer?
- Artificially inflated home values that eat at your income with higher taxes and insurance premiums while not otherwise benefitting you so long as you still need a roof over your head , or
- Confidence that the value of your home will remain stable and keep pace with inflation as you build equity by paying down the mortgage.
As a Realtor, which would you prefer?
- An unstable and dysfunctional boom/bust housing market with periods where commissions can be hard to find, or
- A stable housing market with continuous sales bringing a consistent stream of commissions.
As a citizen, which would you prefer?
- Covering up the real problem (too much debt) by artificially inflating home prices using tax payer dollars we don’t have (creating more debt) while still leaving our consumer-driven economy weak because too much income is going to mortgage payments, or
- Addressing the negative-equity problem and allowing prices to return to levels supported by reasonable incomes and loan terms.
The reality is that housing prices aren’t too low; it is our debt that is too high. Rather than continue to waste tax dollars we don’t have on temporarily inflating home prices, perhaps its time to “Just Say No” to the housing steroids that got us in this mess to start with.
Excellent post. The only thing missing is the interests of home-builders (and the narrowly-skilled workmen they employ) who have their own unique stake in prices. Right now, their industry is in a severe depression and it looks like new building will be strongly suppressed for many years. The latest numbers indicate that building may be only around 20% of its peak level only a few years ago. That is an enormous decline in a major sector of our economy.
While higher prices might mean higher profits per home sold (depending on land, labor, and material costs), home building activity will be suppressed so long as:
1. Excess inventory remains and discounted distressed existing homes dominate sales, and
2. Household numbers continue to decline through doubling-up, subletting, room-mating, etc…
As a (probably idled) builder thinking about the long-term stability of my company after this crisis, I would want policy makers to set the stage for an extended period of sustainable business activity. I would need the payment-to-income ratio to decline enough to encourage new household creation, stimulate demand, spread confidence in consumers that prices have indeed “bottomed”, and clear all the distressed and excess inventory out of the system.
When that equilibrium is eventually met, then I’ll be able to finally emerge from the depression and start building and renovating again at a level consistent with the natural pace of economic and population growth. Until then, conditions will be profoundly dreary.
[Side note: Hello Mr. O'Toole. Sent my resume in and hope your human resources person will be able to take a look at it should any opportunities arise.]
While I agree with much of what you say, I disagree that the Tax Relief Act of 1997 encouraged “flipping.” To me, flipping happens within 1 year or less, not after a minimum of living for 2 years as your primary residence in the property. Perhaps a minor point. But the law also came at a time when sellers were extremely reluctant to make a move because of the potential capital gains they faced if they didn’t purchase a home for at least the same or more money than the last one. In fact, it could be argued that the TRA of 1997 actually loosened up the market without encouraging higher prices. Remember, you could take your tax-free $250,000 or $500,000 gain and go rent for the rest of your life if you wanted to with no penalty–and you still can. Before, you had to keep deferring your gain by purchasing another more expensive home. The only escape from the eventual tax was death or if some really creative conversions of primary home to investment properties were accomplished.
It was when the loosened lending rules were made risk-free by the securitizing of “toxic” or subprime mortgages that the bubble really began some 5 years later, at least in my Los Angeles neighborhood.
Great point about debt, though.
Sean,
Great post as always! As a real estate broker, I would prefer to see our government not get involved with market manipulation. It’s bad enough that our government today seems to have their hands in everything.
The beauty about the real estate markets is that it’s imperfect and constantly ebbing and flowing. With our government being more involved, the real estate market becomes more like Wall Street, and that’s not a good thing.
The government has entirely overreacted with the banking, financing, and housing sectors (as a small example). I would prefer to have available and sound lending practices return for homeowners and investors, and let’s allow the buyers and sellers dictate the real estate market.
Interesting post! I agree with you for the most part that what happened to the market previously could effect us again forever. The main issue to me is that Americans as a whole will not live within their means. We are a country full of people wanting more and of that more we always want it bigger and better. Until we learn to be less wasteful and demanding as an entire nation I don’t know when everything will change.