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Mortgage Income Tax Deduction is JUST a Subsidy to Banks

Posted in Financial Literacy, Just the Facts, Uncategorized with tags , , , , on August 22, 2011 by marcitz

For years there has been a religious like devotion to the Mortgage Income Tax Deduction (MITD) and its benefit for the home buyer.  In stark economic truth it is actually bad for home buyers (twice) and great for banks.  This is further proof of how stacked the economy is in favor of the banks.  So the banks exploitation of society hasn’t been going on for 10 years, its been going on for over 60.  Here is the mathematical and social proof.

  • The MITD applies to interest only.
  • It allows a home buyer to pay more in monthly interest payments because they will get some of that back as part of MITD.
  • So consumers are willing to pay more interest which means they are willing to pay more for a house (because they can support a larger loan principle).
  • The interest goes to the bank who profits by the uptick in interest payments.
  • The buyer pays more for a house.
  • The taxpayer (who is also the home buyer) pays for that payment to the bank out of their own taxes (cause tax dollars are diverted to the MITD)

Its that simple and we’ve been falling for it since the end of World War II.

Here are some numbers:

  • Let’s say (without the MITD) the you have $2000 to spend on a mortgage per month you’ll buy a certain amount of house.
  • If you add the MITD you can now buy about $2500 of house (assuming you have 20% tax rate, not realisitic but makes the math simple for this exercise).
  • Your spend $2500 and you get $500 back with the MITD.  So what happens is a person is now willing to spend 25% more on the same house because they can afford 25% more in monthly INTEREST payments.  Since houses are basically bidding processes enough people compete such that the price goes up to absorb the entire deduction.
  • At the end of the day the person is no better off and actually is worse off because they scrape to find the extra $500 per month and then get relief at tax time with a big check the makes them whole (losing any interest they could have earned on that $500 in the interim and possibly incurring financing charges because they needed to get that $500 cash flow somehow in the interim, lets say through credit card debt.)
  • In the meantime the bank collected that $500 extra a month and they didn’t need to give it back. That came from the government (AKA the taxpayer).
  • Hence the buyer gets to pay more for a house and more for his taxes overall.

So next time you brag about your mortgage income tax deduction remember you just helped make a bank wealthier at your own personal expense (both as a buyer of house who paid more than you needed to and as a taxpayer who financed it).

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Rising Interest Rates Mean Falling Home Prices

Posted in Just the Facts with tags , , , , , , , , , on February 13, 2011 by marcitz

A recent broadcast on NPR called Buyers Face Gamble with Rising Mortgage Rates made it clear that buying a house now may be a very bad idea.  While they gave some very good points they missed some very key (and much more concerning) points.

While they pointed out that its dangerous to buy now because prices are due to fall another 10% but that threat existed  before interest rates rose.  With interest rates rising that will be a new and different reason to drive housing prices down leading to enhanced price decreases.  Afterall the logic is housing prices go up when interest rates fall because its cheaper to buy that house (you pay less on your mortgage purely because of interest rate) so you have more to bid in getting that house.  Well the same logic applies in the negative.  Prices go down when interest rates go up because people have to put more of their budget into servicing the mortgage debt and less into the principle so they get a smaller loan.

Oh and one other thing.  With rising interest rates those that have to refinance will be less able to do so for two reasons.  The comps will fall with enhanced falling prices (so they’ll get lower appraisals and won’t be able to refinance as much) and they will be less able to afford the refinance as well as the whole point of the refinance was to lower your monthly payments.  Bonus issue is with falling prices they’ll just be more foreclosures anyway.  The net of these two-plus issues is that foreclosure rates will increase again creating more supply providing the third impetus for housing price declines.

Don’t anyone let you believe the market turns around this year or in 2012.  We’ve got until 2013/2014 before anything long term happens (not these little short-term govt incentive inspired blips) and that won’t be spectacular.  Get into a mental place where a good housing market means flat growth.

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What the Economy Needs Now is More/Faster Foreclosures

Posted in Just the Facts, Stories with tags , , , , , , , , , , , on April 15, 2010 by marcitz

Recently I read the following quote about how to “save” the housing market and the overall economy:

Indeed, Casey Mulligan, an economics professor at the University of Chicago, argued that both the Bush and Obama administrations had focused too much on making house payments affordable, based on income levels, and not enough on reducing debt.

Here’s a great way to reduce debt, GET OUT OF IT. 

For some reason all those people who are walking away for their houses (or are threatening to do so) seem to understand that much better than the government who keeps trying to keep people in debt.  Further proof that people understand this is shown by the high rate (>50%) of re-defaults by people who were already helped once. (high recidivism rate). 

Given that the public is embracing this approach to solving their own problems maybe the solution should be making it EASIER for people to actually walk away.

Here is why this is a potentially great (and new-fangled) solution.  At the heart of the current logjam is that different people are upset about approaches to saving the economy for different reasons.  Here are the most prevalent of those arguments:

  • Bailouts help the evil banks by having the government make their bad (or worse yet fraudulent) investments almost whole.
  • Bailouts reward individuals who were irresponsible.
  • Not propping up housing prices will keep unemployment high because any economic recovery will be hampered.
  • Taxpayer money shouldn’t be used to help those (individuals OR banks) who took egregious risk with no downside.

So if we look at making it easier for people to walk away everyone gets a sense of satisfaction (but also has to contribute to the pain). Specifically:

  • Banks will have more foreclosures on their hands (pain) but they won’t have the overhead of formal foreclosure proceedings because the owner willing ceded the property (benefit).  Also they won’t face increasing pressure from the government to abrogate contracts (and deal with the lawsuits that will inevitably follow) with their investors.
  • Homeowners who walk away give up the asset they treasured (pain) but get to move on to a life where they don’t have day-to-day financial worries of this magnitude (benefit).  Also they can quickly make amends for that one-time lapse in judgement like a hangover cure or the morning-after pill.
  • Unemployed homeowners get the added benefit of being able to go where the jobs are and NOT be stuck in a house they can’t afford in an area where they can’t work.   Their pain and their benefit is having to relocate.
  • Taxpayers – In the short-term home prices will drop (pain) but will quickly recover as a new wave of buyers can finally jump in and this won’t cost them a single nickel (benefit).

How can this be accomplished?  The government needs to create a “credit amnesty” program where people have a fixed time  (6 – 12 Month period) to walk away from their houses without any penalty on their credit reports and no taxes on forgiven debt.  Just write it off and start over.  They also need to find a way to faciliate faster foreclosures.  Finally (and there would be some additional taxpayer pain in this) the government could offer tax credits for moving expenses.  This has two benefits.  One it facilitates the move for both sellers (underwater homeowners) and buyers (to pick up those homes that are now available but in a different area), not to mention it funds jobs for movers.

The added bonus to this plan, like King Solomon dividing the baby,  is that the truly committed long-term homeowner will surface.  They are the ones that will, of their own accord, make whatever sacrifice is needed to keep their home.  Those that aren’t committed will simply take the opportunity to walk away and start anew, also a laudable goal.

Granted I’m not the biggest fan of this idea but in the spirit of shared sacrifice its the best I’ve seen so far and much better than any artificially cramming down of interest rates and principle balances.  So I vote for this.

(Follow Me on Twitter at watchingmarcitz) 

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Your House “Value” Has NOT Changed

Posted in Just the Facts, Stories with tags , , , , , , , , , , on April 8, 2010 by marcitz

There is a mad rush to protect the American Dream of home ownership.   But its not under any threat because the “American Dream” value of that home hasn’t changed.  People buy homes because they want that American Dream.  The most commonly reasons people VALUE having a home are:

  • A place to call my own
  • A place to raise my children (schools, friends, etc…)
  • A place to plant a garden
  • Build up a nest egg for when I retire

Well last time I checked none of that has changed so why the panic and the rush to save people?   Granted your nest egg may be a little smaller but at least you won’t waste your money all those years on rent and over the long term this will recover, you just have to be in it for the long term.

Why do I bring this up?  Well its because I think we, in our rush to help the so-called “vicitms” of the housing crash, are confusing the issues in a detrimental way.  If you bought a house for the above (long-term) reasons then nothing has changed so you don’t NEED a bailout. If you bought it solely as a short-term investment then you are a SPECULATOR and DON’T DESERVE a bailout.  Often the former is used to justify the latter and that needs to stop.

From a recent New York Times article came this quote,  ”There is also the risk that more people will decide that they are so far underwater — that is, they owe so much more than their homes are worth — that it makes more sense to just walk away.”

True but is that right?  Look when you bought your house you clearly said “this asset gives me value for the price I paid for it” otherwise you wouldn’t have made the single most expensive purchase in your life.  For most home owners that value is that “sense of place” (see the list above) and regardless of underlying “pricing comps” that place (and related value)  is still very much the same (garden, kid’s school, etc…) .  If you can still afford the payments isn’t it providing the same value/sense of place regardless of the underlying price?  Also if you plan on being there for a long time (isn’t the main reason for homeownership “stability”) then short term price drops don’t really matter.   When you invest in a stock you don’t drop it the minute it dips.  

If you feel you should walk away then you are treating your house MOSTLY as a short-term investment and not as your long-term commitment to the “American Dream” so you can’t use those arguments in justifying help for those investors.  Oh and if you can’t afford the payments then you can’t afford the house so its better to get you into a living situation you can afford so you can start your discretionary consumer spending again (which is what the economy really needs). 

One additional argument is “well they lost their job”.  Unfortunately we all are at risk of that so when chosing your living situation you need to assume that is part of the model when calculating the purchase price of a house.   Renters also lose their jobs and none of them are clamoring for rental reductions.

Given that here’s another crazy solution.  Why not put less money into housing subsidies and more into supporting all unemployed people regardless of their chosen model for putting a roof over their head.  This current HAMP plan (especially the unemployment provisions) show that the government doesn’t want everyone to have a roof over their heads.  Just the homeowner.  IMHO housing (regardless of financial structure) should be a right in general, the financial form it takes (renting versus mortgaging) to obtain it should not matter.

(Follow Me on Twitter at watchingmarcitz) 

(Having problems with your Toyota.  Learn how to get more for your troubles)

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Countdown to Renter’s New Year

Posted in Uncategorized with tags , , , , , , , , , , , on March 30, 2010 by marcitz

Well it’s almost the New Year for the Renter.

Today is Christmas in that the government will officially stop buying Mortgage Backed Securities allowing housing prices to resume their downward spiral towards reality and affordability. 

When this countdown timer reaches zero the government’s Home Buyers Tax Credit will expire at which point all renters should unite and scream “Happy Renter New Year!” that is unless we wake up hungover the next morning only to find out that the government has again taken away the punchbowl of renter justice.

Or are we going to be able to “Party Like Housing was Priced in 1999″?

Click to see the countdown timer

(Follow Me on Twitter at watchingmarcitz) 

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Why Higher Prices are a Bad Sign

Posted in Just the Facts with tags , , , , , on October 11, 2009 by marcitz

In the San Francisco Chronicle this week there was an article that tried to find a positive sign of a housing recovery from the fact that house listing prices had started to rise.  The article did point out that this was strange given that all other stats (selling price, # of sales, and price per square foot) had been falling at the same time.  Still the general consensus was that a good thing was happening and I quote “this optimism is a trend for the area…”  Try again…

What is really going on here is quite a bad sign and represents the last ditch efforts of sellers to deal with increasing buyer negotiating power (and proof that they finally accept the switch to a “buyers market”).   Specifically sellers now know they will be forced to negotiate A LOT more than they thought up until now.  In fact they all have in their heads a percentage (much larger than before they adopted this strategy) of how much they will have to lower the price of their house to get the deal done and they believe that is an absolute.  As a result the only way to combat that is to raise the price so when the required and large discount happens you still can capture some upside.

Here is an example from the recession of 1980.  My father sold window coverings to bring in some money above his teaching salary.  Typically they are priced with 50% margin (so window blinds he lists for $100 cost him $50).  He carried sheets that had these list prices on them and his customers all knew what the margin was (most people assume 50% for most products regardless of the truth).  Then one day his distributor, during the economic downturn of the early 80s,  offered him some “60% markup sheets”.  Simply put these were the same list price sheets but they had a 60% margin built in.  So now the same blinds had a list price of $125.

The result?  Well without saying anything (because of the common market belief in a 50% margin) he could offer his customers 50% off (in theory offering the blinds “at cost”) making them extremely happy and more willing to buy even during that recession.  In reality he still got to pocket 10% ($12.50) margin and no one argued.  Afterall you can’t get something below cost can you?  This was also very believable to the customer because it was a recession so my father should just be happy to sell at cost just to keep his business around, if not profitable.

So that is what is going on here.  Sellers are increasing the implicit markup knowing they have to sell “at cost”.  In this case the “cost” is the minimum price at which the seller is willing to offload the house.  The “markup” is actually the percentage that they know they will have to reduce the price to move the sale given current market conditions.  Like the story above they just pad the “markup” so when that percentage comes off they get to preserve some margin.  Assuming this works.

Don’t get me wrong, when the market does truly recover of course listing prices will rise, justifiably.  The difference  here, however, is that none of the “true” stats (those that represent actual buyer behavior as opposed to seller aspirations and packaging) show this upward momentum.   Remember listing prices don’t actually mean anything.  In the world of economics (as opposed to the world of real estate fantasy) the true “market clearing price” of an object is what the buyer is willing to pay (and actually close the transaction) NOT at what price the seller is initially willing to sell.

So in the end this strategy is a form of seller capitulation and not market improvement.  Sellers now know they must discount heavily (not just a token amount) and are trying to preserve some minimal upside.  Strap in because this ride is a lot longer than most wish to believe.  To the 5 year old real estate optimists in the back seat “no honey, we’re not there yet, why don’t you nap some more.”

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Why Case-Shiller Is A Bit Fucked

Posted in Just the Facts with tags , , , , , , , on October 4, 2009 by marcitz

As the old Real Estate aphorism goes “Only 3 things matter – location, location, location”.  So the issue with relying on Case-Shiller (which has been “growing” for three months – yippity f-ing doodah!)  is that the “city” used for valuation is usually a multi-county location with each location being at a different stage in the price cycle.  The “San Francisco” area ranges from Pacific Heights to the Brentwood suburbs over 55 miles away.  Brentwood may have bottomed but it will take some time for the Silicon Valley and the “City by the Bay” to follow it into the abyss.  Oh and by-the-way Silicon Valley, typically considered Santa Clara county, is not actually in the index.

The recovery that Case-Shiller has been talking about is allowing the far out suburbs to mask further falls in the inner-core. The net result is, as Case-Shiller recovers, people closer to the namesake city buy too soon under the false pretense that their little pocket of the world has improved with the broader index.  Ironically those in the exurbs will now do better than those closer to the city named in the index.

How will prices in the inner core eventually fall into the abyss?  Simple migration.  The cheapest areas will draw from their neighbors (Brentwood from Dublin) lowering the prices for the neighbors as well (as Brentwood represents a “substitute” in classic economic parlance).  Those now lower price neighbors will then draw from their neighbors one step closer to the inner core (Dublin from Castro Valley) drawing down the prices there.  This will then continue  as such – Castro Valley from Fremont, Fremont from Mountain View and finally Mountain View from Palo Alto.  In the end nature abhors a pricing vacuum and one currently exits in the exurbs.  It will take some time before it really sucks here in Palo Alto.  But it will suck!

The net-net is the worst place to buy right now is anywhere near the city named in the index.   Oh and if your not actually in the index then purchase at your own risk.  You say you live in the “San Francisco” area but remember that it is a spiritual and not a statistical distinction according to Messrs. Case and Shiller.

To add to the scary (and highly varied picture) take a look at this chart which shows how wildly different the valuation story is WITHIN  the “San Francisco” area:

http://www.housingbubblebust.com/OFHEO/Major/NorCal.html

Also look at this analysis as why Palo Alto is in for a fall (albeit 2 years later) like Brentwood: http://invisiblerenters.com/2009/06/23/why-palo-alto-housing-will-fall-30-or-more/

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A New Measurement for House Price Declines

Posted in Just the Facts with tags , , , , on August 3, 2009 by marcitz

Given the severity of house price declines it only seems like it merits its own measurement as neither the English system (inches, feet, pounds, etc…) nor the Metric system (meters, kilometers, grams, etc…) can properly convey the magnitude of the fall.  For this I propose a new measurement called the Greenspan which measures the distance between the value of your house at the peak of the market and what it will measure at the bottom of the market (whenever that occurs).

Why call it the Greenspan?  Here are three very sound reasons:

  • “Green” is, of course, the symbol (in the US) of money and wealth.  For example “after the latest economic collapse I have a lot LESS green.”
  • “Span” measures distances and often LARGE ones (like bridges and the distance from one side of the Grand Canyon to the other).
  • “Greenspan” as in Alan Greenspan the person who is significantly responsible for this mess.  It it is time he is honored for his role in this.

As a baseline, a single Greenspan is a 25% fall in value from peak.  Given that the average US market will probably fall by as much as 2 Greenspans in total.  Certain markets (like Vallejo, California) could see a drop of 3 Greenspans.

Remember real estate is local so your Greenspans may vary. 

See how Palo Alto, California is due for AT LEAST a 1.2 Greenspan drop.

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Why Palo Alto Housing Will Fall 30% or More

Posted in Just the Facts with tags , , , , , , , , , , , , , on June 23, 2009 by marcitz

Green shoots, the recovery is here, houses are bottoming!

Not so fast!  Yes many areas may be reaching a bottom but that does not mean that all places have hit bottom.

For example it is believed that housing bubble ground zero locations like Vallejo, California have come close to a bottom.  Therefore, hot areas like Palo Alto, must also be similarly close to that bottom eventhough prices there have not fallen (on a percentage basis) nearly as much.

The typical explanation for the differential treatment is that Palo Alto is desireable and therefore immune to a large price decline. I would like to suggest that its not about “absolute” price but “relative” value.

Yes, a house in Palo Alto will ALWAYS be worth more than a house in Vallejo but I argue that the RATIO of house prices should remain close to constant. If Vallejo rises in value then Palo Alto will rise in value but if you divide the value of a house in Palo Alto by the value of a house in Vallejo the resulting number should, over the long term, be relatively the same. So that is what I did.

Using data from Zillow I took the sales price per square foot of houses in Palo Alto over the past 10 years (2000-present) and divided it by the same metric from Vallejo to plot the ratio. For extra credit I also calculated the ratio of Palo Alto to both Hayward and Mountain View.

Why Hayward and Mountain View? Simply put Hayward is a little closer in and a more rational commute (not many people would think you were NUTS to commute to the Silicon Valley/San Francisco job centers from there). I chose Mountain View because that is the, only slighly less desireable, southern neighbor to Palo Alto.

So here is a picture of what I found:

Price Per Sq Ft Ratios

What does this all mean?  Well let me state one other assumption and that is let’s assume the year 2000 was a ratonal year and that that ratio represents a normal premium of Palo Alto over the other cities.  (older data was not available from Zillow)

Lets divide the chart into 3 segments:

  • 2000-2001 – The “normal” period in which the ratios represent the typical balance.
  • 2002-2006 – The “bubble” in which all hell broke loose.
  • 2007-2009 – The “deflation” of the bubble. (NOTE most people agree that the bubble started deflating in 2006-2007 across the US.)

So in the “normal” period we see the ratios between Palo Alto and its neighbors staying relatively confined (maybe a 5-10% swing at most).  This is what you would expect.

Now if we look at the “bubble” period we see a relatively dramatic drop in the ratio which means that Vallejo and Hayward were gaining on Palo Alto.  Did they actually become more desirable?  Well traffic would go up (more people were moving there driving up those prices) so I would say “no”.  What it really means is that the bubble valuations hit Vallejo first.

Now if we look at the “deflation” period we see the ratio turning DRAMATICALLY in the other direction and well above the historical norm.  This means that either (or both) that deflation hit Vallejo first and the bubble hit Palo Alto second.

One might argue that this means Palo Alto is safe EXCEPT for the fact that the ratio has so dramatically outpaced where it was in the “normal” period in 2000-2001.   If it had returned to the levels of the normal period in 2000 then there would be nothing noteworthy here.  In fact Vallejo returned to almost the exact same price per square foot in 2009 that it was in 2000 where as Palo Alto was still almost double where it was in 2000 as shown here.

price comparison

So what would it take for this ratio to fall back into line (and deflation to hit Palo Alto second)?  Simply put, compared to Vallejo, Palo Alto prices would have to fall 39%.  Compared to Hayward they would have to fall 26%.  This of course assumes that Vallejo and Hayward have truly bottomed out which is probably not the case.  Assuming they have even the most conservative estimate pegs Palo Alto at a 26% fall.

Heck even compared to it’s neighbor Mountain View it would have to fall 11% to come into line with the historical ratio.

In short Palo Alto has some falling to do.  It just was late to both parties.

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Killing MORE Myths of Homeownership

Posted in Just the Facts with tags , , , , , , , , , , , , , , , , , , on May 4, 2009 by marcitz

So my last article on the myths of homeownership was so popular I decided to produce a sequel.  This is not so hard because there are so many.  Enjoy!

Myth #6 – Once you pay off your home you get to live in it for free

The theory goes you have 30 years of payments (lets assume you haven’t, like friends of mine, refinanced it over-and-over again pushing out the end of the loan).  After that you have no more payments.  With rent you will have payments every month forever.   The latter is true, the former notsomuch.  In fact there are many substantial ongoing payments you will encounter with your house including:

  • Property tax is forever so you pay that every year even after the mortgage is done. It may also be variable depending on the property tax laws where you live. So it behaves like rent both in its ongoing behavior and the fact that it can change and grow over time.  Here’s another thought to consider.  Property tax is a major source of school financing.  Given the “great recession” we are in (and will continue to be in for the next 2-5 years) other sources of funding are being cut making schools even more dependent on property taxes.  As school quality is a major contributor to housing values expect home owners to be extorted into paying increased property taxes to preserve their home values.
  • Maintenance also goes on forever and that is variable and unpredictable. So it also behaves like rent but much more violent in its swings.  I never got a bill from my landlord for $15,000.  As a homeowner its only a matter of time before you get that bill for a new roof ($15,000) or new pipes ($thousands).  Sure renters implicitly pay maintenance but it is more smoothed out through the rent and periodic rent increases.  Oh and if you live in New York City you are familiar with “maintenance payments” which are often substantial (in the thousands) and are paid monthly (like rent).

Myth #7 – At least your monthly payments are predictable and won’t go up like rent

Well this really depends on how you financed it. A very large percentage (and possibly the majority) of mortgages done in the past 8 years were adjustable-rate.   That could swing way above rent or way below depending on the interest rate environment.  Given the dramatically low interest rates that drove the housing bubble and there is really no where for your mortgage payment to go but up.  Combine this with the large amount of cash being pumped into the economy (which will lead to inflation) and you are looking at MASSIVE interest rate adjustment 2-5 years out meaning your “rent” is going to go up possibly 20-100% (my rent has never gone up more than 10% and that was during a boom and during a bust it actually went down).

So remember, homeowners and renters are not so different except for the massive loss in equity that ownership is currently providing. 

Please feel free to bust more housing myths in the comments section.

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