The Problem With Housing Bailouts: Arithmetic, Not Ideology
Many of my friends have asked my why I oppose the housing bailout schemes that many progressives are pushing to keep moderate income homeowners in their homes as homeowners. The answer is simple: they are bad deals for homeowners – or least homeowners in bubble inflated markets.
I always thought that progressives were trying to improve the plight of low and moderate income people. These bailout plans are likely to make them worse off, compared to a scenario in which they returned to renting. At least that’s what the numbers show, and given the choice of relying on DC policy wonks or arithmetic, I’ll go with arithmetic every time.
Here’s basic deal. In many bubble inflated markets, the ratio of the sale price of a home to a rental of comparable unit still exceeds 20 to 1. This means that the cost of owning can easily be twice as much as the cost of renting.
To make this concrete, let’s take a family that earns $50,000 a year. They can either own a home that sells for $200,000 or rent a comparable home for $10,000 a year.
Suppose they opt to own. If they are very lucky, they will get a 6 percent mortgage (these are families with questionable credit so they can easily pay 2 percentage points more). Including the principle payment, this will cost them about $13,700 a year. They can also expect to see property taxes approximately equal to 1 percent of the home’s value. That adds another $2,000, bringing the total to $15,700. Then throw in maintenance and insurance, also at least 1 percent of the sale price, which raises total costs to $17,700.
This analysis is of course crude, but it gives the basic story. There is no deduction for taxes, because this family most likely will not find it worthwhile to itemize. If they did, it would change the picture little. A larger flaw is that it does not factor in utilities, some of which are almost always included for rental units (e.g. water, sewage, and garbage pick-up) and are almost always paid by owners. And of course, the ratio of sale price to rent is actually greater than 20 to 1 in many bubble areas.
So there you have it. Our great bailout plan will have this family pay $17,700 a year for housing costs, rather than $10,000 a year if they rented. The $7,700 difference comes to 15.4 percent of their income. We’ll call that the “ownership tax.” This is money that could go to pay for the family’s health care or to provide quality child care, but instead it is going to cover unnecessary housing costs.
But, what about the equity that the homeowners accrue? Well, they won’t accumulate any equity. The problem is that prices in these bubble markets are falling. They are likely to end up selling their house at a loss. The economists who didn’t see the housing bubble might dispute this assertion, but we can only spend so much time arguing with the economists’ branch of the flat earth society.
There are two other points about these bailout schemes that are worth noting. Some people push them with the idea that they will keep house prices from falling. This may be a reasonable goal in depressed markets like Detroit and Atlanta, but why on earth would any progressive want to keep the bubble from deflating in places like San Diego and Boston. High house prices mean that young families are less able to afford to buy homes. I thought that progressives were in the business of trying to make homeownership more affordable for moderate income families, not less affordable.
The other important point to note about these plans is that the one clear winner in these plans is the banks. The banks win in two ways. First, they will almost certainly get more for their mortgages than if we just left things to the market. They may take write-downs on these mortgages, but the write-downs will be much smaller because of the helping hand of the government.
The other way the banks win is that the new mortgages being issued will all come with fees. In fact, because some of the schemes are rather complicated, involving certificates that could potentially cover the banks’ losses, the fees could be substantial. At the very low end, the fees will be at least 1 percent of the value of the mortgages issued. They could easily exceed 2 percent at the high end. If the plan involves $300 billion in new mortgages, as some have proposed, then we are talking about $3 billion to $6 billion in fees for the banks. The latter figure is almost enough to cover the proposed expansion of State Children’s Health Insurance Program for a year.
Okay, so we’re going to have moderate income families pay more for their housing, price young people out of homes, and give lots of taxpayer dollars to the banks. Exactly what about these plans is progressive?
The entire scheme of bailouts - for both banks and homeowners - has a larger deleterious effect for America: it provides financial incentive for bad decisions and worse leadership.
This was the easiest possible catastrophe to see coming. Single family middle class homes shouldn't have been going up 38% a year while wages increased 2%. America's banks deliberately allowed a feeding frenzy by lowering the requirements for loans. Eventually, it all collapsed.
Gosh, so complex! A million bucks for a one bedroom condo didn't make sense. Who knew?
Now, the idiots involved want my money to bail them out. I have an alternate plan. The government should give ME $10,000 as a reward for making responsible financial decisions.
It won't happen. Here in Dick Cheney's America, we actually pay cash bonuses to people who ruin the nation's economy.
The countries that provide incentives for making GOOD decisions will win in the 21st Century.
April 6, 2008 10:50 PM | Reply | Permalink
Dean's "Let them rent" solution strikes me as so novel and effective that it's a sin that I only read about it at TPM.
My only beef is that renting is a ripoff. You pay every day and you get nothing more than shelter. When the hot water goes out you have to deal with a landlord who is reluctant to spend money to help. You're at the mercy of that landlord who might ask for more money every time the lease is up.
Worse, over the course of your life, you'll spend far more on rent than the place you're renting is worth and yet even if you pay a million dollars in rent for a place that will never be worth a million dollars, you can be kicked out on your butt at almost any time.
I like Dean's solution because it keeps people in homes and prevents urban blight. But we really need a solution that doesn't keep people IN their homes, we need one that keeps them OWNING their homes.
Because renting, even on the best of terms, is a ripoff.
April 6, 2008 11:11 PM | Reply | Permalink
Renting may be a "rip-off", but borrowing can be an even bigger rip-off. In a market like this one, that's currently the case. Interestingly enough, even if you can afford to pay cash for a home, it currently might make more financial sense to rent. If you were to invest the money that it cost for a new home in something other than a house, the ROI would be higher than what it would be costing you in rent.
These analyses are all based on the assumption that the value of the house is not increasing or is increasing slowly. If this changes back to historical trends, it could make sense to invest in purchasing a home again.
April 7, 2008 8:51 AM | Reply | Permalink
Exactly what about these plans is progressive?
$20 million in campaign contributions buys a lot of progressives: Dodd, $5,796,000; Bayh, $1,582,000; Schumer, $6,162,000.
April 7, 2008 1:10 AM | Reply | Permalink
$20 million in campaign contributions buys a lot of progressives
Aren't you the saucy wench...
Only a minority of senators, particularly those with smaller pieces of the campaign-cash pie, dissented. "That is socialism!" railed Sen. Jim Bunning (R-$452,000). "And it must not happen again."
Leave it to a mental defective to misunderstand socialism.
Socialism would be the Treasury buys Bear for $2 per share, accruing any imputed income derived from the 30 billion bailout for the taxpayers who are bailing.
April 7, 2008 2:32 AM | Reply | Permalink
. . . a mental defective . . . .
Hey! Let's give a pre-FA guy a break, can't we? And too, he did chalk up 23 career shutouts.
April 7, 2008 9:16 AM | Reply | Permalink
give a pre-FA guy a break
Too late.
He's already on Arricept...
(o/t-now that there's a blood test for oncoming alzheimer's, can we insist on screening for Congress, Prez, and Cabinet?)
April 7, 2008 3:36 PM | Reply | Permalink
"My only beef is that renting is a ripoff. You pay every day and you get nothing more than shelter. When the hot water goes out you have to deal with a landlord who is reluctant to spend money to help. You're at the mercy of that landlord who might ask for more money every time the lease is up."
I disagree: Dean's is a very well written post and makes an excellent case against the current bail-out plans. Renting is only temporary. You rent until you have saved up enough money for a down payment. Given the inflated housing prices we presently have, renting is a smart move. Also, there is such an oversupply of homes that I think there would be an effective lid on rents.
Moreover, we are almost certainly headed into a period of much higher interest rates, which means a long term decline in housing prices. Anyone who got locked into a new mortgage, even at a reduced price, might still find himself a loser. Renting is not a bad option at all.
It also has to be said that many people who are currently "homeowners" in fact put little or nothing down on the home; so they would be out only the payments and fees they have already made. The subprime loans should never have been made in the first place.
The one principle should be that the "homeowner"-victims come out relatively unscathed.
There are two options that ought to be investigated:
1. There is a lot of private money on the sidelines now which would be delighted to swoop in and buy up the distressed mortgages, if only a "fair value" for them could be determined. What is needed is a clearing house that would auction off these mortgages in some way that would give protection to the current "homeowners". i.e. a way for them to stay in the home as renters, perhaps with a long term lease.
2. Another option is to allow foreclosures but turn evictions over to the local courts, which would have authority to determine fair rental values, and to look out for the occupants. If local taxes are not paid by the mortgage holder, the homes could be taken by the taxing authorities and rented out to the current occupants.
The question, then, is how to resolve the current crisis in a way that does not throw millions of people out onto the streets, or further exploit individuals, and destroys cities and towns. That cannot be done under the current administration, or while the Republicans have veto power in the Senate.
Hint: Greenspan, one of the chief architects of the current mess, has endorsed McCain, who says he does not understand economics. George Soros, has endorsed Obama.
April 7, 2008 7:04 AM | Reply | Permalink
Renting is not necessarily a ripoff, it is a financial strategy that is appropriate at some times. Keep your costs down, maybe even save!! (Wouldn't it be nice if people built up some capital?) If you can, buy when the market is more in line with incomes so that you actually CAN own a home.
You can't find a way to keep people 'owning their own homes' when they never owned anything to begin with. (See: "Record No of Americans Pretending They Own a Home" - http://www.satirewire.com/news/0106/dream.shtml ) It's not fair to apply some sort of moral imperative to owning a home if the economics don't make sense. If we keep underwriting risk for businesses and individuals, we'll never get back to 'normal,' whatever that is.
April 7, 2008 7:16 AM | Reply | Permalink
Dean,
I have a basic problem with your initial numbers for renting. 10,000 for a 200,000 comparable? Don't know what market you can get that in but I'd love to see those figures. That number more realistically is closer to 15,000 for a 200,000 comparable. In some markets the renting will be even higher. However, even if I would agree that your numbers are correct some issues on the ground would send you back to ownership and having families stay in those properties. Though, I have to say most of the argument is moot since there have already been so many families dumped to the curb of this problem.
If families are allowed to stay these are the automatic benefits to the areas effected and us as a whole.
1. Allowing them to stay will keep families together. Moving to renting and the consequent internal family pressures drive family breakups.
2. Home ownership improves the quality of neighborhoods from house upkeep to local schools.
3. It keeps more volume to hit the housing market. We are already at historic inventories that are still rising. To work through what is there is going to take the rest of the year if this thing turned around tomorrow. The last thing we all need is more product in this market.
4. The empty houses in neighborhoods now are being stripped bare by salvage hunters. In Cleveland its rampant and low income areas like Slavic Village are being torn asunder by people poaching in a "natural disaster" sort of way.
This situation is going to cost us dearly no matter what the resolution. I would rather spend our tax dollars in keeping families together and neighborhoods flourishing. Renting just people back behind an obvious eightball that they will never get around. My "personal responsibility" friends will say we are just supporting bad behavior. However, I would argue that this situation was thrust on a lot of these folks by unscrupulous lenders. It is inherent on us to decide how we are going to treat people. Tent cities or housing?
April 7, 2008 9:43 AM | Reply | Permalink
There's more than one market involved here. What happens to the renter's market when 2 million former homeowners are put out of their homes and must find a place to rent? I can guarantee that apartments/homes are going to be harder to come by, the competition will be fierce, and the rents will be fiercer. It is utterly naive to prate about the low cost of rent in such a comparison. If we persist in refusing to help these families stay in their homes, the rental market will be the next housing bubble. How many bubbles do we need to experience before we conclude that they are a crappy deal for everyone but the very rich?
Yes, no doubt there are some "owners" who would be better off financially if they were renting instead. I'll bet there are far, far more who would be better off right where they are, if they were getting a fair shake from their lender. And their lenders would be better off too. Supporting, and yes, subsidizing, these owners would also in effect be supporting and subsidizing the lenders. And, no it's not just rewarding the bad behavior and bad judgement of the lenders, and owners. We, the rest of us who are not personally involved in one of these mortgages or investments will most assuredly pay for the mis-judgements of the rest, one way or the other. The question is, can we limit the cost and the damage? This is the only appropriate way to prevent the major destruction of our economy that is looming on our horizon. We can't save all of the homeowners, nor can we bail out all the banks, but if we work on trying to save both we are more likely to succeed than with a bailout only targeted to the banks and investment houses. This is not an either/or situation, where there's only enough room in the lifeboat for one or the other. This is a situation that requires that we balance the lifeboat with BOTH owners and lenders. Without a sufficient number of both the lifeboat will tip and founder. Bailing out only lenders still leaves millions of ex-owners homeless and bankrupt, without the resources to float the economy that the lender bailout is supposedly saving, as well as leaving potentially hundreds of thousands dependent on the charity of taxpayers, further stressing an already stressed system. Suggesting that all those owners who are in danger of losing their homes would be better off renting is pure rationalizing hogwash.
April 7, 2008 10:51 AM | Reply | Permalink
Your logic reveals one of the fundmental flaws in people's thinking about economics -- the tendency to view markets, supply and demand, as static instead of seeing them as intricately related things that have a reciprical affect on each other.
Yes, demand will go up for rental properties with people being put out of their homes, but likewise so will supply of rental properties for two reasons. One, any significant increases in price will tend to spur investment in the construction of apartment complexes that can take advantage of that and in fact, I believe that this has already started to happen. Second, at least some of the houses left on the market unsold were held by speculators who now find they cannot sell them or they are held by banks that foreclosed and cannot sell them. So they will instead rent them out, which is in fact exactly what just happened with the house right next to mine. So supply will increase to meet demand.
Now, I guess, it's possible this could become a bubble if the market responds by overbuilding to meet supply, but there's zero evidence that this is happening or likely to happen given that the credit crunch is likely to put some restraint on this.
April 7, 2008 4:46 PM | Reply | Permalink
A couple of quick points. First, on the origins of my numbers, read the cited paper. The data on rents and housing prices comes from HUD and the Census Bureau, respectively.
The fact that sale prices and rents are hugely out line should not be surprising. In real terms, sales prices rose by more than 70 percent from 1995 to 2006, while rents rose by about 8 percent. In the bubble markets, real sale prices rose by more than 100 percent, while rents may have risen by 20 percent. Given that there was little change in the ratio of sale price to rent for most of the prior post-war era, it should evident that this sudden surge in sale prices will cause an imbalance.
We don't have to worry about former homeowners sending rents soaring. First, the rental vacancy rate is at a near record level nationwide indicating that there is considerable slack in many markets. But, the other part of the story is that ownership units can become rental units -- especially if out friends in Washington can think clearly about the problem.
Instead of throwing money at the banks, Congress could use a few billion to facilitate the conversion of some number of foreclosed units into good rental housing. It would make for much better housing policy.
April 7, 2008 11:13 AM | Reply | Permalink
I'm curious if any of the figures for home/rent increases over the period of time you indicate here have factored in all of the properties that were formerly rental units which were closed down and rebuilt as condos. Only now, with the bubble burst and owners sitting on empty properties, are some of these conversions being reintroduced into the rental market. But they are very expensive options in an already expensive market.
I live in West Hollywood (which is probably not the best place to look for the national average) and over the past 5+ years rents climbed pretty steadily (especially once rent control was trashed several years ago) and many many buildings in the area were either converted to condos or more often demolished in order to build condos from the ground up. In both cases the number of units available for rent dropped pretty noticeable and the prices for those units left climbed noticeably as well. Many people I knew were force to move to greater distances, like to the valley, in order to find apartments that were within their budgets and thus were forced into the horrible LA commute. And now with gas prices rising rapidly that too is now squeezing them. They feel like they're running out of options at this point.
I personally rent because the LA market for housing has been and continues to be obscene. In addition I refuse to get sucked into the dreadful commuter lifestyle (the frustration takes years off your life, you're not paid for the hours spent doing it, and it's horrible for the environment). I've been lucky enough to have my own business located only a few blocks from where I live and that is important to maintain for me. But now I've been in the same apartment for 8+ years and while I'd like to move to a newer or better apartment, my options are limited and the price increase I will have to pay is not insignificant...so I'm currently staying put.
April 7, 2008 7:18 PM | Reply | Permalink
Does anyone know if these "homeowners" will actually be able to pay, even if their mortgages are renegociated? Some number of people falsified their incomes & assets, with banks turning a blind eye. Does it make sense to try to keep someone with a $50,000 income in a $750,000 house?
http://www.nytimes.com/2008/04/06/business/06gret.html
April 7, 2008 11:17 AM | Reply | Permalink
The census data must be 8 years old by now, bearing very little relation to our current reality. And doesn't HUD average rental prices from different cities with widely divergent rental markets? To suggest that former homeowners should be able to find a rental for $10,000 ignores that averaged number, which is likely to be wildly out of step with most given rental markets. And neither the census nor HUD numbers touch the obvious fact that with somewhere around 2 million owners potentially flooding the rental market in the space of a year or 2, rental prices would skyrocket. Rental prices have already been on the rise, and occupancy rates are already increasing. So is homelessness. You can't pretend that away.
April 7, 2008 1:00 PM | Reply | Permalink
Two comments.
Like several above I place greater value than Dean on keeping more home owners in their homes.
Certainly not with a schemes creating fees for the banks. Our taxes should be used solely for direct assistance to home owners.(The lenders would be indirectly by having their mortgages continue to perform).
Why not a scheme in which the Government-with some sort of lien- partically subsidizes "reasonable" mortgage payments for "responsible" home owners , in exchange for the lender subordinating its claim to the Government's ?
Clearly the devil would be in the "details".
April 7, 2008 2:42 PM | Reply | Permalink
The data on median house sale prices are for 2006 (the American Community Survey) and were adjusted up for the last year using the Office of Federal Housing Enterprise Oversight's House Price Index.
April 7, 2008 7:49 PM | Reply | Permalink
Dean is correct that home-rental costs and home-buying have diverged since the beginning of the decade (especially since 2004). But he is exaggerating the spread.
I've posted this before, but I will post it again. I live in S. Florida, one of the ground zeros of the bubble. Our landlady bought our house (a 45 y.o. three br/2bt) for 250K in early 2006, more or less height of bubble. We pay 1600 a month in rent. That isn't 20 to 1. That isn't even 10 to 1. And yes, the only valid comparison is between what any single given house would rent for vs what it's worth on the market. Otherwise it's apples to oranges. Nor is there anything out of the ordinary about this situation: anyone who wants to check the numbers need only look at our real estate and rental ads (excluding the multi-million dolar mansions on the Intercoastal, which skew our average home prices sky high, and which are almost never rented). You'll find that rent and house prices are within the ballpark I've mentioned above. Renting is seriously cheaper than buying, just not as much as Dean claims, at least not hereabouts.
April 7, 2008 7:51 PM | Reply | Permalink
I am pleased that Dean has recognized that "I always thought that progressives were trying to improve the plight of low and moderate income people." Dean has not gone far enough in demonstrating that a bailout program will not work. Personally, I don't think that any subsidy program actually helps the poor. Subsidy programs include: low interest loans and tax breaks for mortgage interest payments.
The common logic is that these programs "help" the poor by making housing affordable. The problem is that any program which "cheapens" the value of money drives up price. Think of it this way, if somebody gives you a free dollar you may be willing to pay more for a product than you would otherwise.
Also the poor would be in competition with those who are richer for housing. There would be little ability of the poor to outbid those who make more money then they do.
Many people also have a misconception concerning the equity in their house. In many respects when a house increases in "value" many people believe they are making money. In fact they are not, the value of the house is simply adjusting for inflation. The price of candy bar in the 1970s was around a dime, now over fifty cents. My example, of course is simplistic, but my point is that a house is not a free money machine.
Many people don't seem to realize that a house is an investment that can rise and fall in value as a result of market demands. You can't simply buy a house and assume that it will go up in value. As with any investment, the buyer needs to research before buying.
As to the question of renting versus buying. There are many cases were renting can be a superior choice. The ability to move is easier for renters, the cost of entry and exiting is lower, and there may be opportunities to invest in other financial instruments that would give you a better return than home ownership.
April 7, 2008 10:28 PM | Reply | Permalink
Indeed, this is something that I never saw anyone else bring up in Utah's "school voucher" wars last year. (The referendum vote went against vouchers in the end, so it is now kind of moot.) Anyway, I had predicted that if the voucher idea passed, the effect would be that private school prices would rise by approximately the amounts of the vouchers.
April 8, 2008 2:34 PM | Reply | Permalink
Jonf311,
Not to quarrel with your landlady, but house sale prices on average have increased in real terms by more than 70 percent since 1995. Rents have increased in real terms by less than 10 percent. If we originally had a balance of around 15 to 1, then we would be well over 20 to 1 as an average and much higher in bubble markets, like Miami, SF, SD, Boston, etc.
April 7, 2008 10:32 PM | Reply | Permalink