A very interesting article.

Maybe the old rules of thumb are the best. A property that rents for $1,700 just might not be worth a $57,000 down payment, a $3,200 monthly morgage payment and condo fees. Purchasing decisions like that are unsustainable.  Can a correction be far behind?    

LaPerriere points to increased productivity as a reason to hope the coming correction is going to be soft and not a crash. The reason increased productivity is generally considered a good sign is that it has traditionally been predictive of coming increases in employment as managers try to sustain the growth fueled by the increased productivity.  Increased employment has traditionally lead to increased wages. Increased wages have fueled growth. All up to a point where , traditionally, we have suffered a necessary correction (hard or soft)  which lead to increased productivity etc. Have wages been rising in America? I don't think so. I do note that there has been significant wage inflation in China.  Hummmm.

America is no longer anything close to a closed economic system.  Once the equity money runs out and the bills come due, what you gonna do when the trustee comes for you?  What are we all going to do?  

Ron Byers

Something to consider here is a news story that broke today that reports that 40 percent of home sales last year went to second homes. 

Jim Anderson

www.lighthouseonline.net

Jim, at least the aging boomers have some money.  Actually the report that 40% of home sales went to 2nd homes would indicate the market is weaker than we thought. It won't take long for the boomers to decide to sell their first hones as they retire and move to Florida or Arizona. That could create a glut of used homes in working cities coast to coast.  

Ron Byers

It is not my blog so this is not exactly blog-whoring, but the most comprehensive discussion of this topic I have found is on Calculated Risk Now in my view Calculated over estimates the risk and certainly put the popping of the housing bubble too early at least for most people in most markets. But if you were leveraging yourself to the hilt last year to buy condo units in Las Vegas last year you really really should have listened to CR back then. And the level of commentary is at a pretty advanced level.

I wrote an article about this subject last month, and based on what I know, I doubt this is going to be a big political issue. Yes, there will be a lot of foreclosures -- but they'll happen in slow motion, over several years. That will mute the political impact, unfortunately.

Christopher Cagan, a research analyst for First American Real Estate Solutions, wrote a definitive report (warning: PDF file) on mortgage resets and the resulting delinquencies and foreclosures.

Basically, if you got a mortgage in 2004 to 2006, and you have less than 15 percent equity, and your introductory rate was 2.5 percent or less, you're in danger of losing the house to foreclosure when the rate is reset. Imagine the outcry in California and along the east coast if regulators had tried to restrict such loans in the last three years.

This brings up a sort of interesting point about progressive taxes. Because people tend to accumulate wealth until retirement or shortly thereafter, progressive taxation in no small part represents a transfer of money from 60-year-olds to 25 and 85 year-olds.

There's a pretty good case that progressive taxation would help us avoid a lot of bubbles - after all, capital needs a market, and speculation is most intense when people build up a good bit of capital they have to invest somewhere. That's the hard sell.

The nearly impossible sell is this. Mortage regulation would have helped keep the lid on some of the worst excesses of lending. But the basis of the real estate bubble is the vastly oversized mortgage exemption that drives money out of stocks, bonds and plain old savings accounts and into real estate markets (and thus allowed real estate to absorb a large number of workers whose skills wouldn't have gotten them that far in other industries). The mortgage exemption is as much a third rail as Social Security, and while it was originally intended to be progressive, it has gradually become an incentive for the well-to-do again, as house prices soar out of reach for most families. Some have suggested that a quick fix would be to simply lower the cap on the total value, but that sort of income threshold almost always draws ire and cheating as people cross some static threshold. In my view the deduction needs to be scaled back to down to point where only people of modest means really want it. That ought to get the rich putting their money back where it belongs: in capital markets.

If the goal is to make houses affordable, what we must do is make land affordable. The materials for houses are readily available, and so is the labor to build, in most places in America. No particular scarcity of either of those inputs. What is scarce is land, at least land in places where people want to live.

How do we change that? Nudge those who are sitting on more land than they really need to give up their excess land that they aren't putting to good use. After all, they can't claim to have created it themselves, and everyone is in need of a piece of land to live on, and, having been created equal, we are all entitled to a place to live.

What form does the nudge take? Simple. Increase the millage rate on land value. If you want to stay revenue neutral, reduce the millage rate on buildings. Or reduce the dumb taxes, like Philadelphia's wage tax (do you know how far west Philly's suburbs are sprawling? listen to the traffic reports on XM) or the sales taxes in some counties in Alabama, which run as high as 11%, on products as essential as milk and bread, or the tax.

That higher millage rate on land will have at least two effects.

First, it will be capitalized into the price of land, driving it down, just as, when interest rates rise, sellers don't receive as much for their property as they did when interest rates are lower.

Second, it will light a gentle flame under those who have well-located land that they aren't putting to good use. This will cause them to do one of two things -- either they will be motivated to put it to better use themselves, in order to earn enough income to pay the higher land tax, or, equally desirable, they will lower their asking price, making the land available to someone who is ready to put it to good use. Either one works for me.

They'll stop thinking of that underused lot as a fine nest egg to leave their grandchildren, and start to think of it as something they need to put to good use, can't afford to carry as a vacant lot.

Further, there seems to be a rule of thumb that, whatever a builder pays for a piece of land, to maximize his profits, he must build a house that will sell for roughly 4 times that amount. I don't yet understand the economics behind it, but I've got a bunch of articles that cite it. This may well explain why so many McMansions are being built. If a spec builder can't make money by putting a modest home on the lot, he'll build an expensive one, even if the market would really rather have a more modest home. But if he pays less for the land, because it comes with a somewhat higher land tax bill, maybe he can put a more modest and affordable home on it.

lvtfan

http://www.wealthandwant.com ... if you'd like to see an end to poverty

Prof Warren - as it relates to the problems of the property market, this jazz about "liberals" and "conservatives" is worse than irrelevant. It's a huge distraction from the very real problem, and very real solution to that problem, faced by every family with school-age children in this country. Namely, the good school districts are rapidly becoming too expenisve for all but families earning >$200k per year. In other words, by stifling competition in the education market, we are inadvertently creating a two-tiered public education market that's segregated not by race but by income. Fairfax County VA, Palo Alto, Highland Park TX: these school districts might as well be considered private schools because the cost of entry is a mortgage of a million dollars or more.

Why not just dispense with the fiction that our public schools offer equal access to a good education, admit that the system's broken and hideously unfair, and support vouchers for all?

At the risk of over-simplifying, may I propose a solution to the problem? Suspend judgment for a while and think about this one.

You wrote,

This phenomenon feeds itself: as home prices in the elite school districts rise, more and more families conclude that it's stupid to spend money on private schools and live in a cheaper area when they could have excellent public schools for free and pour the savings into mortgages... which only accelerates demand for the expensive and scarce housing in those school districts, and on and on we go.

Try this for size. Most places finance education through some combination of a property tax, a sales tax and an income tax. This sometimes is known as the "three-legged stool" approach, which makes it sound wise and solid, even eternal and necessary. Wrong!

Think about the effect of public spending. Start with public schools (from K, and below, through high school, college and university level), because they're a big chunk of the budget, but the logic extends to many other kinds of public spending at the local and state level and arguably even much federal spending (think earmarks, think Section 8, think defense that is really defense, think FEMA if FEMA did what it should, etc).

When we-the-people spend our public funds well and effectively, we produce certain benefits. Good schools in a particular school district drive up property values there. Tenants are willing to pay landlords more for an apartment there than they would pay for a comparable unit in a neighboring school district. Buyers are willing to pay sellers more for a piece of land in that district than they would pay a seller in the neighboring district, and this is true whether the piece of land is vacant, has a 50 year old cottage or a brand new McMansion on it. What they want is to live in that location rather than another location.

The effect of effective public spending is to drive up property value, more specificly, land value. (There are other mechanisms which drive up land value, too*)

Once we understand that, why on earth would we use taxes on anything other than land value to finance such public spending? If we use, say, a sales tax to finance schools and other spending, we are asking those who own poorly located land, or a tiny amount of land or who own no land at all to finance public spending which drives up the value of the well-located sites. So not only do they pay twice (because they pay rent to someone who owns one of those good sites since they need both a place to live and a place to work, and then have to pay again through a sales tax), someone else reaps the financial benefit.

Similarly, when we finance such things through a tax on wages (have you been to West Philadelphia lately?), we ask those who work to pay for services that ultimately benefit those who own land.

What a spiral that creates: things get better and better for the lucky ducks who own the best land, who get to behave as if they somehow created the land and its economic value, and at the same time, things get worse and worse for those who own poorer land or no land at all, and who must work for a living. Who owns the best land? Corporations, REITs, family trusts, foreign corporations, foreign families.

Why on earth should we set things up in such a way that those who own the best land are enriched by our public spending, and the rest of us who have to work for a living are impoverished in the process.

The alternative, of course, is to tax land value. Don't tax buildings. Don't tax wages. Don't burden sales. (Do you know that there are counties in Alabama where the sales tax on milk and bread is 11%? But they keep the property tax very low, because that's what works for the state's wealthy interests. This is also known as Jim Crow taxation. Last week they reduced the income tax on the folks at the bottom of the income spectrum, and thereby lowered spending on public education by 2%. The wealthy folks' kids won't be affected.)

Today's property tax is two taxes, and they are like a badly matched couple. The two spouses are the tax on land value and the tax on the improvements. As long as the two are married, when a town needs more revenue, they must raise both millage rates. Taxing land values has very desirable effects; taxing buildings has undesirable effects. The trick is to divorce these two. Let them go their own ways. Reduce the tax on buildings, or even eliminate it. Increase the millage rate on land value. The land can take it. It won't leave town, and its owner cannot hide it or pretend that it isn't there, or that a valuable site is really not worth much. When we tax its value, the owner who is underusing it will be motivated to use it better. Using it better creates jobs. If he is too weary to use it better, he will be motivated to lower his asking price, and someone else will come in and know that he can make a profit on that land by putting it to good use. This will cause the downtown to be more dense, and the fringe sites to be maintained as agricultural or single-family residential.

I've wandered a bit. Let me bring this back to the schools issue. Houses in places with good schools appreciate faster than houses in places with inferior schools, and that appreciation far exceeds the taxes that their current owners pay. [I am speaking imprecisely here: houses do not appreciate. Houses depreciate, but the sites they sit on appreciate at varying rates depending on things like the quality of the schools, access to various other amenities, etc.]

Taxes in wealthy towns with good schools are often rather low, while taxes in poorer towns with inferior schools are often higher.

If we were setting up a just society, wouldn't we simply tax land value evenly across all towns, and then use those funds to meet the needs of all our children?

As we do things right now, rich towns only tax themselves lightly and have enough to meet their residents' expectations for good schools and other services. But Scarsdale and Greenwich are desirable not just because they have good schools, but because they are close to NYC. Good highways (paid for not by local taxpayers, but by federal spending) and public transportation (ditto) and access to airports (ditto) make these locations valuable. Shouldn't we-the-people collect back in locational-value-taxes most of that benefit? The residents of Scarsdale and Greenwich didn't make those sites valuable.

Tax the land value. Collect most of the economic value of the land as our common treasure, and use it to educate our children -- all our children. Dare I say it? According to their need, not according to the wealth of the folks in their own town. Collect that economic value, and let those who want to live in the highly desirable towns pay not the sellers of the land but we-the-people.

Doing this would deflate the selling PRICES of sites Palo Alto, Cupertino, Highland Park, and Fairfax County. But it would not reduce the VALUE of those sites, because much of it is based on their proximity to high-paying jobs and views and other things that wealthy people value. Their mortgages would be lower, but their land tax would be higher. So people would stay in those places while they had jobs and were raising children, and free up those homes for others when they moved into another stage of their lives. (Sort of the flip side of California in the Proposition 13 era, where artificially low taxes on land value have produced sky high appreciation and housing affordability rates in the teens -- which has led to higher-than-elsewhere homeownership among California's elderly and among the lowest homeownership rates in the whole country among folks under about 55.)

*Other mechanisms which drive up land value:

• population growth, be it through increased fertility, increased longevity, immigration;
• technological progress: the invention of elevators made urban land more valuable; commuter trains made suburban land more accessible and therefore more valuable; air conditioning made southern land more valuable; fiberglass boats made waterfront land more valuable; and so on
  
• natural amenities, such as waterfront, attractive views, appealing climate, cooling breezes, etc
  
• cultural amenities, such as theater, museums, -- as long as enough people have sufficient leisure and discretionary income to enjoy them
  

Can one of us claim preferential rights to those benefits, or should we all benefit equally from them? It seems to me that we have some documents we hold dear that say "we hold these truths to be self-evident, that all men are created equal," and that the truest expression of that is not to let some of us behave as if we created land or land value, while others, needing access to land in order to live and to work, must pay them for it.

For a bit more on this, take a look at this page http://www.wealthandwant.com/docs/Gross_Rent.html

and for more about the three-legged stool fallacy, see

http://www.wealthandwant.com/docs/Batt_3legged.html

LVT fan -- that's Land Value Taxation

http://www.wealthandwant.com ... if you'd like to see an end to poverty