Thursday, February 24, 2011

Home is Where You Wear Your Hat

-- Posted by Neil H. Buchanan

Last Friday, I revisited the owning-versus-renting question in housing. With the Obama Administration taking a surprising stance that home ownership might not be the be-all and end-all of housing policy -- that it might actually be better for some people to rent -- it is natural to ask who might be included among those who should not rent. My answer (based in large part on the idea that people's financial well-being should not be tied up in a single asset that can precipitously lose value): There is a rebuttable presumption that no individual should own his or her own home.

As a first step (one that is much more aggressive than anything the Administration is proposing), I suggested that public policy should at least not artificially encourage people to own homes. Even changing the current pro-ownership policy regime would only be the first step in this process, of course, because of the widely and deeply held belief that owning one's own home is evidence of having "made it." Changing such attitudes is not easy, but eliminating the current pro-ownership policies would rather quickly undermine many people's taste for risking everything on a house.

What are those policies? The list really is too long to discuss in any detail in a blog post, but it includes federal mortgage guarantees (the focus of the Administration's concern in promulgating its recent proposal), the deductibility of interest on mortgages, the deductibility of state and local property taxes, the exclusion from taxable income of the gain on the sale of a home (which would otherwise be taxed only at preferential capital gains rates, anyway), the homestead exemption in bankruptcy (which has been abused in states like Florida, where bankrupt litigants put all of their money into lavish homes), and so on.

As I mentioned this past Friday, however, there is a huge matter of fairness involved in changing the underlying rules that favor home ownership: People who bought their homes under the current regime would take potentially enormous losses if the legal incentives changed. This is true of any legal change, of course, but it is an especially large problem in housing, simply because so many people are involved. Moreover, while the losses from any legal change can possibly be justified by saying that there are no guarantees in life -- that, for example, people who buy Microsoft stock do so knowing that their investments would lose value if the government takes a more aggressive stance on antitrust law -- the home ownership situation presents a much stronger case for mercy. Having spent decades convincing everyone that owning a home is not only financially savvy but practically required for entry into Heaven, it would be especially unfair for policymakers now to channel Otter from "Animal House" and say, in essence: "You f#cked up. You trusted us!" [Movie fans will notice that the title of this post is from another favorite from my youth: "The Adventures of Buckaroo Banzai Across the 8th Dimension." I'm still waiting for the promised sequel.]

The problem, of course, is not that the housing stock should intrinsically be worth less in the hands of corporate owners who rent to individuals than in the hands of individual owners. If anything, the economies of scale involved in coordinating maintenance (repairs, snow removal, grass mowing, and so on) could lead to a combination of lower net costs to live in a house and higher property values. The potential losses come from the removal of public policies that directly and indirectly commit public funds to inflating the price of houses. Most obviously, if we believe that the mortgage interest deduction's value is included in the price of a house (making a person who would have been willing to pay $500,000 for a house willing to go to $600,000), then the removal of that subsidy will result in an immediate loss to current homeowners.

The textbook response to such a problem would be to compensate current owners for the policy change with a one-time lump-sum payment, making them whole and then letting the market go forward without policy-driven incentives to own. This would be enormously difficult, however, for the same reason that lending standards can be so easily manipulated: valuation is imprecise. Just ask any appraiser how easy it can be to make up a number. In the early 2000's, mortgage originators gleefully encouraged over-valuations, because they ultimately did not pay the price of those misjudgments. In a buy-out regime, with the federal government on the hook for the estimated losses, it would be especially tempting to game the system. (It would not be impossible to police this -- by, say, requiring look-back rules on subsequent sales under which federal payouts could be recaptured -- but I would not want to be the Inspector General for such a regime.)

The underlying goal here is to spread losses. (Arguably, however, some of the current rules should be changed in a way that concentrates losses, such as the homestead rules mentioned above. Taking this seriously would complicate matters even further.) The one-time buyouts would spread those losses by having the federal government initially cover the losses, which would thus be passed through to current and future taxpayers. If, however, we are not willing to concentrate the losses on homeowners, but we are too worried to nationalize the losses through the government, the next obvious place to look is shareholders. If there were a way to get the new corporate owners/managers of the housing stock to pay current prices for houses to make families whole, then to reduce the value of the housing stock by eliminating all of the subsidies later, the losses would show up in the form of reduced shareholder value. This would still cause pain to individuals (through, for example, reduced values of retirement and pension funds that have invested in real estate stocks), but the pain would presumably be more diffuse, with no one losing as large a chunk of their life savings because of the policy change.

Forward-looking investors, however, could unravel such a plan rather quickly. If the policy were announced in advance, the prices offered by corporate owner/managers would reflect the anticipated change in legal rules (adjusted for time value of money and risk), at least in the aggregate. The only alternative would be to pretend that no such plan was in the offing -- that the subsidies would continue for ever. That kind of clever plan would be nearly impossible to pull off, however, and it would also be subject to renegotiation under intense pressure from the new stakeholders.

If we are not willing to explicitly raise taxes to pay for the transition, and we are unwilling to make current homeowners pay, and we are not able to make future corporate owners pay, what is left? It is not enough to say that continuing the current regime is the cost-free alternative. We know from recent, bitter experience that the current system is not cost-free. The costs are hidden until it is too late (foreclosure crisis, financial bailouts), and they are sometimes worse than they need to be, because of market overreactions and the all-in character of too many families' financial investments in their homes.

The alternatives, therefore, are to adjust the rules to allow the current regime of subsidized home ownership to continue (with the adjustments designed to minimize the risks of concentrated losses and systemic crises), or to unravel the current regime slowly enough that the pain is tolerable. Nearly every politician favors the former, while I strongly prefer the latter. (The remaining political divide, of course, is driven by disagreements over how widely the subsidies should be made available, and how honest we should be about the implicit federal guarantees against systemic failure. Nearly all politicians, however, leave unchallenged the idea that home ownership is a high calling -- at least for most people.)

How boring is this? In the end, I am arguing for a radical re-ordering of society, to be carried out over decades in an orderly fashion. And I do so, knowing that it all could be reversed at any time. (In my defense, however, we are talking about undoing policies that have been in place for decades.) Surprisingly, the place to start might be where I began in one of my first DoL posts about the housing crisis: Point out to people that -- even with the pro-ownership subsidies in place -- owning one's home is not the financial boon that it is made out to be. Much of the current problem stems from people's belief that ownership is not only morally correct but financially wise. If we can disabuse people of that idea -- a process that will take time to unfold -- then the costs of future policy changes will almost surely go down.