The Capitalist Maven

A recent article in the soon to be defunct Boston Globe caught my eye today.  “Low mortgage rates, falling prices, and a tax credit are luring first-time buyers into homes they can afford” reads the headline.  I made it through the first page without laughing as it was pretty reasonable.

“I wanted to snap something up,” said Rehman, a psychiatry resident at Brigham and Women’s Hospital in Boston. “It might get lower, but I still feel good about my decision.”

This guy seems to have reasonable expectations.  He admits prices could go lower but he wants to buy now due to a pending marriage.  Completely reasonable.

Then I clicked over to page 2 and read about this guy:

“The $8,000 credit is definitely huge,” said Jamerson, who sells plumbing supplies. “We are looking to buy cheap and in four to five years make a nice profit.“

Seriously dude, 2004 called, they want their irrational exuberance back.  Even those optimistic on real estate prices are predicting an L shaped recovery or the proverbial “dead cat bounce.”  When prices finally do stop falling, they are likely to flatline for 5 or more years.  If this guy is expecting any “profit” let alone “nice profit” in 5 years he is going to be severely disappointed.  For what it’s worth I think it’s extremely telling that the particular development in which he is buying, 5 of the 6 buyers are “first time.”  This means the builder has convinced 5 households with no experience in actual homeownership to buy into his development.  Why was he not able to convince more previous homeowners on the value of this particular piece of real estate?  I’m guessing a combination of taxes and  association fees make this a less than stellar proposition but without the benefits of experience these people don’t know any better.

Surprisingly this kind of article is common.  Stories about people convinced it’s a good time to buy and doing so.  Quotes from realtor’s stating how the combination of low prices, low rates, and incentives make it a great time to buy.  But what’s missing?  Articles about experienced landlords and investors buying.  Where are those stories?  Stories about people with a track record of making wise real estate decisions?  I won’t be convinced we have hit bottom until we start seeing stories about those people.  If it’s a such a great time to buy, where are the investor’s?

Jon Economy

For a long time, the very mention of renting as a wise financial manuever would get you snickers at best and passionate opposition at worst.  Homeownership is the American dream of course, so any mention to the contrary borders on unpatriotic.  Recently it has become clear that the homeownership issue is not as cut and dry as it once seemed.  You know mentality has changed when a newspaper actually publishes an article criticizing homeownership as I found recently in the Boston globe.  A large part of a newspaper’s revenue comes from real estate listings, so publishing such an article is akin to biting the hand that feeds you.  Nonetheless it’s good to see some validation in print of what I have believed for a while.  From the article:

Owning a home is not right for everyone, they say: In some ways it’s overrated, and it can even have harmful effects for individuals and society. It is now glaringly clear that buying a home is a financial risk, not the surefire investment it is often perceived to be. Widespread homeownership may also have a negative impact on the economy, because, among other reasons, displaced workers can’t easily relocate to new jobs. And some of the alleged rewards of homeownership, such as greater self-esteem, health, and civic engagement, have been called into question by research.

I’ve made the personal decision to rent my home until prices fall sufficiently to make purchasing a logical financial decision.  Even my own mother questions what I am doing.  “Homeownership is the American dream”, she tells me.  “That doesn’t make it right”, I respond.  I can understand where she is coming from.  In metro Pittsburgh, I estimate that it costs $1500 a month to rent $150,000 of house.  The same $1500 a month rents $300,000 of house here in metro Boston.  In the end, when I explain how messed up the math is here, she understands my logic.  Even with recent price reductions, it’s still not a good time to be buying property in metro Boston.

Some analysts propose abolishing or limiting the mortgage interest tax deduction, which provides substantial tax breaks for homeowners. Others favor greater security for renters - such as laws making eviction more difficult - or tax deductions for renters, which a few states, such as Massachusetts, already offer.

The government has worked hard to push homeownership to these currently unreasonable levels.  Between the mortgage interest deduction and the capital gains exemption, the government is giving up billions in revenue.  Most of the revenue the government is giving up is going straight to the wealthy.  Yes both the mortgage interest deduction and capital gains exemption primarily benefit the wealthy, both are regressive taxes.  The wealthy can afford more house and therefore will stand to have larger gains when they sell.  The wealthy are also much more likely to itemize deductions to actually benefit from the mortgage interest deduction, while the mortgage interest on a modest home might not even be enough for a middle income person to exceed the standard deduction.

I really like the part of this article where the author disputes the psychological and societal benefits of homeownership:

A recent study, which aimed to avoid the problems of previous research, suggests that homeownership confers no real benefits. The study examined self-respect, perceived notions of control, time spent with friends and family, volunteer activities, and enjoyment of the neighborhood, among other things. On all of these measures, after controlling for income, health status, and home value, the study found no significant advantage for homeowners. In fact, homeowners were on average 12 pounds heavier, and they spent less time with friends.

The evidence is mixed on whether homeowners are more civically engaged than renters. But to the extent that they are, their influence in some cases has undesirable societal repercussions. Since houses are the major asset for so many families, homeowners naturally want to protect their property values. This often leads to zoning laws that make it difficult to construct commercial or additional residential buildings. Such laws erect barriers to entrepreneurs and reduce overall housing affordability.

A homeowners self interest may actually cause them to support laws that go against free market economics.  Here in Massachusetts, we don’t need to look very far to find examples of this extreme anti-development.  A prime example is Carlisle, MA (within 25 miles of Boston) which has a population density of 317 per sq. mile.  Such a low density would classify Carlisle as an “exurb” but being 25 miles from the center of Boston it is geographically a suburb.

So what would happen if we leveled the playing field between renting and owning?  My guess is that home prices would drop to levels where it makes economic sense to own.   So areas like most of the midwest, where renting is more expensive would see little change, while both coasts would see sales prices drop and rents rise.  It would be more expensive to rent, for good reason.  Renting is a convenience that you are paying your landlord to provide.  If we keep the playing field level, people will gravitate to the decision that makes most sense for them.

Jon Economy

Oil prices are back on the upswing again, having hit $54 a barrel today.  I expect to see a rush to push through an increase in the gas tax while prices are still low.  The National Commission on Surface Transportation Infrastructure Financing has recommended a 10 cent increase in the federal fuel tax to help pay for repairs to deteriorating roads.  $1.89 vs. $1.99 is alot easier to stomach than $3.99 vs. $4.09, so I think we’ll see this happen before prices hit those high levels again.  Here in Massachusetts, the governor has been pushing for a 19 cent increase in the state gas tax and again is trying to push it through while prices are low.  Again $3.99 vs. $4.28 is difficult to stomach.

So we’ve got some new taxes conspiring to push up prices at the pump.  What else is happening?  US commodies markets are predicting a huge jump in inflation of the US dollar.  The fed has been pumping alot of money into the system to replace the money supply lost through decreased lending.  This helps to stabilize the economy and is probably a good thing to do.  The problem however, is when lending picks up again, it’s unlikely they’ll be able to pull that money back out very quickly or easily.  More money in the system = more inflation.

Then we’ve got the stimulus, uh spending, package. While named a stimulus, it’s been widely reported that by the time the money from this bill actually gets spent the recession is likely to be over.  So we’ve got the government spending huge amounts of money in an already growing economy.  It doesn’t take a rocket scientist to figure out this will be inflationary.

Next, we’ve got the post recessionary economy.  When we do pull out of this recession, people will naturally start jumping in their cars, flying on airplanes, and powering around on boats just like 2 years ago.  The world didn’t have enough supply then, it’s unlikely to have enough supply a year from now either.

So we’ve got higher taxes, inflation, and supply constraints, every element of the perfect storm to send fuel prices back through the roof.  Even the cheap gas while it lasts…

Jon Economy

Outrage is the new word of the moment.  Chances are you, right now, you are probably outraged at somebody.  Perhaps you’re outraged that Denise Richards was voted off “Dancing with the Stars” last night.  Perhaps you are outraged that American Idol was preempted for the Presidential primetime press conference last night.  Perhaps you are also outraged about “bailed out” companies paying their employees bonuses.  If that’s the case, perhaps you need to think through this issue a bit more.

We in the US have what is, mostly anyway, a capitalist economy.  Control of business rests with the private sector.  Businesses are supposed to make decisions that are in the best interests of shareholders or investors.  When a company decides to pay a bonus to its employees based on some sort of performance metric, that’s their decision to make.  It is also in the best interest of employee retention to keep the promises made.

So AIG got a large bailout from the government (whether it should get one in the first place is another topic).  It then proceeded to make good on its promises to employees.  In large part due to media attention, the public became outraged that government bailout money was being used to pay bonuses to “employees who ran the company into the ground.”  While I’m sure at least a few employees contributed to AIG’s poor decisions, I’m sure there were many others that were not involved at all.  These employees hit their performance targets for the bonus and were paid accordingly.  What is wrong with that?  The New York Times has published a resignation letter from an AIG employee who received such a bonus.

I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage.

If this guy were an auto worker, plumber, or some other union job and had his company promised bonus stolen from him by politicians, he’d be turned into a hero.  Unfortunately for him he is a highly productive and highly compensated executive.  Because his bonus number is in the 6 to 7 figure range, the average American expresses what is actually jealousy, as outrage.  So while those responsible for the mess at AIG have (wisely) disappeared, those that are left and are actually trying salvage something for the American taxpayer are thrown under the bus.  For the average American, knowing the whole story is not necessary, making a stink about it is.

This unwillingness of Americans to actually seek out the whole story before passing judgement outrages me.  Even if you don’t like it, you still have to play by the rules.  These employees were promised bonuses for hitting performance targets.  If they hit their targets, they get paid.  There really isn’t much to understand.  Be jealous if you want, but outraged?  If you really want to be outraged let’s think of some real abuses of the American taxpayer.  At McDonald’s, the person who takes your money and puts it in the register gets paid ~$6.15 an hour.  At the highway tollbooth, the person who takes your money and puts it in the register gets paid ~$30 an hour.  Why is there such a large discrepancy?  In private business, pensions have largely been replaced with 401k’s.  Fulfilling pension obligations is something that’s seen as far too expensive.  Yet for government employees, pensions still reign supreme.  Shouldn’t there be some concern for the American taxpayer that the pension obligations are too expensive?  Yet we never hear about these outrages.

Next time you’re feeling outraged I encourage you to get the whole story first.  You might be surprised what you learn.

Jon Economy

Wow.  Who would have thought it would come to this?  The House has passed a bill to recapture the bonuses paid to AIG employees through taxes.  One small step for taxpayers, one giant leap for socialism.  I’m pretty sure this kind of law is unconstitutional but I don’t sit on the Supreme Court so what do I know?

Don’t get me wrong.  I think it sucks that the people that ran these companies into the ground get paid a bonus.  Unfortunately, though, the bonuses written into the employees’ contract.  I might not like that contract but there are lots of contracts I don’t like.  Remember the Detroit “jobs bank?”  The “jobs bank” was where laid off autoworkers could go to get paid for doing nothing.  So as part of restructuring GM to get get it’s government bailout the “jobs bank” was eliminated.  Did we try to collect back pay for those laid off workers who had utilized the “jobs bank?”  Of course not.  I’m sure it would be equally popular and equally easy to pass a tax on “jobs bank” pay.  But it didn’t happen because it’s unconstitutional.

The tax bill sets a dangerous precedent for “taxing groups we don’t like.”   This idea is nothing new.  We’ve been doing it for years with extra taxes on smokers, drinkers, trans-fat eaters, and other “dirty” classes.  But this time however we are targeting individuals with our taxes.  Can you imagine a “people who got away with murder tax” or “baseball players with fat heads tax” targetting OJ Simpson and Barry Bonds?  Both of these people cost taxpayers alot of money in legal fees, should we not try to recapture that with some taxes?  Perhaps that really loud guy who has those TV commercials: “Billy Mays.”  I and others view him through our government bailout funded DTV converter boxes.  So he made tons of money and annoyed millions of viewers at a huge cost to the American taxpayer.  How about a tax on him too?

It’s a slippery slope.  At the bottom is socialism, I hope we don’t go that far…

Jon Economy

According to an article in the New York Times, many banks have decided they don’t want a bailout any more.

As public outrage swells over the rapidly growing cost of bailing out financial institutions, the Obama administration and lawmakers are attaching more and more strings to rescue funds.

The conditions are necessary to prevent Wall Street executives from paying lavish bonuses and buying corporate jets, some experts say, but others say the conditions go beyondprotecting taxpayers and border on social engineering.

Some bankers say the conditions have become so onerous that they want to return the bailout money.

Surprised?  Not me.  I think alot of banks accepted the bailout “just because everybody else was doing it” and they felt they needed a bailout as well to remain competitive.  Then they found out about all the crap they would have to put up with as a condition of accepting the bailout.  Suddenly it didn’t seem like such a good idea any more…

The banks are still private businesses.  They have to answer to shareholders.  If the right business decision to make is to send bailout money back, that’s what they need to do.  Now if only we could make the bailout uncomfortable enough to get bailed out homeowners to send money back…

Jon Economy

I think that in our current system, the penalties for skipping out on your obligations are not severe enough.  The system should be set up such that it’s a no-brainer that someone with the means to keep paying should do so.  Faced with the prospect of 10 years in debtors prison, I’m sure all but those in the worst financial condition would choose to keep paying.

That said, anybody who is in this situation needs to evaluate the value of their credit rating.  Is your credit rating worth $100,000 or whatever amount you stand to save?  Probably not.  Since that is the only penalty in non-recourse states, why not break your contract?  If you sign a 2 year contract for a cell phone and 2 months later decide you don’t want it, you cancel your contract paying the early termination penalty.  The cell phone companies were wise enough to create this penalty for breaking your contract, such that getting out of the contract hurts.

The banks were foolish.  They loaned money to people they shouldn’t have.  They eliminated downpayment requirements.  They failed to create a system of penalties for non-payment.  Just because the banks were stupid, doesn’t mean you have to be.  If it makes financial sense: walk away.

Now if I were running the banks, this is what my fix would be for this moral hazard.  Create a bank blacklist.  If you have a foreclosure in your past, you won’t get credit for 30 years, period.  No credit cards, car loans, mortgages, margin trading, nothing.  Faced with 30 years of having no access to credit, I think I’d keep paying and I’m sure others would as well.

Jon Economy

So while I’ve disputed it for a long time, it appears the US may finally be in a recession.  No I don’t know this for sure but it seems likely that we are in a recession that began in July 2008 (the start of the first quarter to show negative GDP).

While it appears likely the we have finally entered a recession, I’d say it’s far from a sure thing.  You may have noticed prices at the gas pump are half of what they were 4 months ago.  While I imagine for most people fueling their vehicle is actually a very small part of their overall budget, that $20-$30 extra bucks every two weeks for some reason makes people richer/poorer depending upon which direction fuel prices are going.  What’s really funny is the government could raise taxes an equivalent amount and nobody would blink an eye.  But display that price at the pump and people complain.  Along with the cheaper fuel, lower prices for everyday goods are likely to follow.  The American consumer is far from dead.

So then we have the media effect.  Right now it’s “cool” to be frugal.  Clip some coupons and shop at the discount grocer and you’ll get an article written about you.  Suddenly saving money is big news.  Fortunately, for the most part America’s sense of economics is not too keen.  While people will try to be frugal, they’ll be largely unsuccessful.  They’ll read that flat panel TV’s use less power than CRTs and run out and buy one to save on their electric bill.  They’ll drive out of their way to save $0.67 at the discount store.  They’ll sign up for their cable providers “bundle” offer to save them money and end up with a higher bill in the end.  They’ll be lured to the mall by offers of 50% off but neglect to notice that the original price has been market up.

Time will tell, but we’ll see where the economy goes from here.  My opinion is that reports of the death of the American consumer are greatly exaggerated.

Jon Economy

While people seem to be quick to blame the Bush administration for the current mortgage crisis, history does not support this claim.  I found a interesting, though 2 months old now, article that has some choice tidbits of information that are widely unreported.

“Spurred by worries that Fannie and Freddie were cooking their books and taking too many risks, Treasury Secretary John Snow proposed placing the companies under Treasury oversight with strict controls over risk and capital reserves.”

This proposal was back in 2003!  So what became of Snow’s plan for strict oversight?  It was blocked, of course, by none other than Democrat Barney Frank.

“These two entities—Fannie Mae and Freddie Mac—are not facing any kind of financial crisis,” said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. “The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.”

But it’s so much easier to blame the Bush administration, isn’t it?

Jon Economy

Here’s a great YouTube video montage of C-SPAN clips. Certainly seems to be at odds with what you hear on the news. Republicans actually were calling for more regulation of Fannie and Freddie but their attempts were blocked by key Democrats, including of course Barney Frank…

Be sure to watch all the way to end for a clip where Bill Clinton agrees with the Republican attempts to regulate Fannie and Freddie and criticizes congressional Democrats for blocking the new regulation.

Jon Economy