The Mortgage Lender Implode-o-Meter now stands at 91. That’s 91 major US lender and mortgage companies that have gone bankrupt, closed their doors, or otherwise gone belly-up since Dec. 2006. More than a few have managed to get themselves indicted too.
Tell me, is this how the “invisible hand of capitalism” makes everything right as long as the pesky government backs off and doesn’t interfere in business? Well, the government didn’t interfere, the vultures went mad with greed, and now it’s all blown up into pieces.
Government intervention will be required to try to fix the mess they made. But, I’m guessing free marketeer greedheads won’t turn down government bailouts -while no doubt continuing to loudly protest how the government should keep its hand out of business.
“Tell me, is this how the “invisible hand of capitalism†makes everything right as long as the pesky government backs off and doesn’t interfere in business? Well, the government didn’t interfere, the vultures went mad with greed, and now it’s all blown up into pieces.”
I hate to say this (because I didn’t want to believe it at the time), but “Business Week” claimed several years ago that government intervention was causing a housing bubble, which would be in danger of bursting. Government intervention, you say? Indeed, they claim (not entirely without merit) that our tax code encourages home owership and speculation by giving massive deductions and exclusions for ownership of first and second homes that are not available to other types of investment.
Do they have an axe to grind? Sure. All those dollars went into the housing market at the expense of the stock market. Does the argument make sense? Yes, to a point. Show me any other investment that you can borrow money to buy, deduct the interest from your taxes, and (under certain conditions) exclude a half million dollars of gain from your income!
While that doesn’t justify predatory lending, it sure sets the scene for such scams. (Alliteration unintended.)
But the mortgage interest deduction has been going on for decades without bubbles like this one occurring. Or did they add a new deduction? And was this for the benefit primarily of homeowners or for investment banks and the monied class?
The main change in the tax law was to exempt $500,000 in gain every two years on a couple’s primary residence. Prior to this “simplification” in 1997, gain could be rolled forward (i.e. postponed but not exlcuded), and was subject to a one-time exclusion after age 65 (or something like that). But since 1997, there’s virtually no limit on the tax free gains. This has encouraged speculators to buy homes, live in them for two years, fix them up, and sell them for tax-free profits. It has also encouraged house-hopping, finding ways to make a secondary residence primary so it can be sold tax-free, and so forth. And of course when you’re looking at trading up, it makes a lot more sense if you can use the profits from your current house tax-free.
As to the deductibility of home mortage interest, prior to 1986, ALL inmterest was deductible, so home mortgage interest did not get any special treatment. You could use your credit card to buy stocks, and the interest was deductible.
When the rules changed in 1986, mortgage interest was deductible only to the extent of the cost of the residence, cost of any improvements, and certain medical and educational expenses. In other words, if your home gained in value and you borrowed on the equity, that interest was deductible ONLY if you put the money back into the home as improvements (or spent it on medical care or education). If you used the money to pay down your credit cards, sorry, no deduction. Now, the law says you can deduct interest on up to $1,000,000 in debt to acquire your home, and up to $100,000 in home equity debt (used for any purpose at all)– but never have I seen a tax preparer or CPA ask a taxpayer whether the interest reported on their Form 1098 exceeded these limits.
It should also be noted that the interest rules were linked to the capital gain rollover rules until the latter were repealed in 1997. Thus, starting in 1997, there was a significant skewing of the tax laws in favor of real estate over other types of investment.
When interest in real estate increased because of tax benefits, prices went up. When prices went up, homeowners found ways to speculate on second homes, often using the (questionable) equity in their primary residences. You may be aware (you may even have reported) that in some markets, up to 40% of real estate sales in the past couple of years were as second homes or investment properties. Many of those homes sitting empty in Las Vegas were not primary residences, but were bought by homeowners speculating for the first time. And of course would-be first-time homeowners were struggling to get into the game, too.
This created an enormous demand for debt, creating an unprecedented debt market. Where there’s a need, someone will fill it– and not always someone with scruples.
Don’t get me wrong, I benefitted from those tax laws (as you probably did too). But some people argued that the tax laws were creating a bubble– long before the rest of us recognized that one existed.
It may not be a bad thing to encourage home ownership, which the tax code was certainly designed to do in the case of home ownership. Talk to people who bought houses before WWII (if you can find any still alive) to hear about the problems with a max of a three-year mortgage.
The subsidy, if we strip away all the appendages that DJ has nicely detailed, is not really in the ownership of real estate. That is, if we pool our assets and buy a shopping center, no one looks askance and strangely if we deduct for interest and the like. It is, after all, a capital asset that requires expense to maintain. The difference between a commercial investment and a home investment is that you get untaxed income from investing in a home. If we taxed the homeowner for the benefit of the “free” housing he receives from his asset, all would be equalized. (You can see this by comparing the balance sheet of two people who buy identical houses but one of them lives in the house and the other rents it out and pays rent to live elsewhere.)
I’m not suggesting we tax the imputed income from the main residence, though it makes sense to take it from second residences since the need for such a subsidy is, to me, anyway, far from apparent.
Typically the principle in U.S. taxation is that “ordinary and necessary” expenses related to generating income are deductible, personal expenses are not. So deduction for home ownership is an exception.
Typically, ALL income is taxable in one way or another, less the expenses to generate the income. Excluding the gain from sale of a primary residence is a BIG exception to this.
I’m not saying it’s wrong to encourage home ownership. But I am saying that the change in the tax code in 1997 created increased demand for property (sending prices higher) and debt (encouraging more lenders to enter the market). Combined with the stock market crash of 2000-2001 which caused people to pull their money out of sticks and mutual funds and look for something else to invest in, pushing real estate prices in an upward direction, perhaps we created the “perfect storm.”
BTW, these first time homebuyers who are now getting hosed probably did not get any benefit at all from the aforementioned tax breaks. They didn’t sell a home in order to buy a new one, and if (like us) their mortgage interest wasn’t high enough to deduct on Schedule A, they got no tax benefit. So (in very simple terms) these tax breaks that drove up the real estate market benefitted middle class folks like Bob & me, but did nothing for the entry-level buyer who’s now taking the fall.
(There are plenty of middle-class investors who overextended and are taking the fall, too, but that’s the result of stupidity, and while I empathize, IMO they should have known better.)