Observations on the current housing deflation, analysis of contributing factors, ideas on the importance of housing in the overall economy. by Gene DeNardo
(libertarian)
Friday, November 21, 2008
We all share the need for some form of shelter. A dwelling protects us from the weather. It serves as a barrier to intruders, people who for one are not welcome in close proximity to ourselves. It is an enclosure for those welcome, our family and friends, etc. Second only to food, it is fundamental to our comfort.
Recent financial circumstances have made home ownership both tragic and suddenly affordable. If you find yourself "underwater" or have even experienced foreclosure, the drop in home values has been catastrophic. On the other hand, if you have never been able to afford a home because of ridiculous inflationary prices, the current conditions could now make ownership possible.
The cause of this drastic pricing correction is obvious. The Federal Reserve has once again introduced into the economy too much currency at an overly depressed interest rate. Housing prices swelled, fueled by the extra cash and widespread speculation that the boom couldn’t possibly end, until it became obvious that housing prices had far exceeded the actual value of their utility. Since the house is a "real good" and the money was no longer representative of the "actual value" of the good, the price began its downward spiral seeking a more realistic value.
The Federal Reserve believes the same thing that got us into the situation, too much money, will also remedy the problem. But there are two obstacles to this remedy: the money is not be being directed to the places where it is most needed and no one is "looking" at the money in the same way.
The "faith" that drove prices to extreme highs is no longer there. While there was and is plenty of money around, people come to the realization that values didn’t reflect the production of "real goods", but rather the creation of debt. When the values declined, the debt levels remained. The numbers just didn’t work out in the long run.
The role of the mortgage backed security in the crisis can’t be overlooked. The packaging of these securities, in combination with a never ending supply of currency, allowed the mortgage vendors to concentrate on the deal rather than the substance of the deal. Profits were made on the transactions rather than the feasibility and return of the loans.
There was more money to be made packaging and selling the mortgages than securing an interest amount that would rationalize making the loan in the first place. This increased the amount and velocity of loans, which made more money available to the housing market which pushed prices artificially higher and higher.
Mortgages probably would have little value on the secondary market in an economy based on sound money. An investor might pay a broker to originate the mortgage, but why would the investor and broker originate loans at below market rates? If the original loan is at market rate that leave no headroom to "resell" the loan at a profit unless at some future point rates changed. And, they certainly could change in either direction, which would drive free market loans to their highest possible level in the present. Loans would most likely be originated to be held, not resold.
Government intrusion into the housing market can only raise the cost of housing. This is true because government can only "intrude" by injecting capital in one form or the other. Any extra capital, no matter where it is added to the housing sector, will raise prices. That is the basic law of supply and demand.
It might be argued that government could lower prices by withdrawing money from the housing market. But, the only possible way this might be accomplished is to "produce" less new currency. This would lower the "price" of existing housing by lowering the aggregate amount of dollars in relation to existing housing stock, but would at the same time raise the value of money. If you already had the money, housing would be more affordable, if you needed other’s money, it would be the same or possibly less affordable.
Land taxes, in contrast to improvement or the portion of property taxes devoted to the house, can lower the cost of housing. When the land is taxed, holding and speculating bare land incurs a cost rather than a subsidy. Land owners are encouraged to either develop the land or sell it to someone who can utilize it. Land values fall to utilization values rather than future speculative values. House prices better reflect their use value.
Tax the house itself and you get the opposite effect. Even if the tax lowers the value of the house in proportion to the tax, which is unlikely, the house still has consistent costs and the tax must be paid for by someone, whether builder or buyer. A tax on land improvements always lowers the supply of the improvements.
Most American homebuyers view our mortgage interest tax deduction as something that makes our homes more affordable. The deduction does lower the tax liability of those who exercise that option, but it actually raises the price of housing.
Housing prices are dependent on the availability of capital. Banks factor in the interest deduction when they calculate the ability of the potential homebuyer to afford a mortgage. If you can use the deduction, the bank believes the amount of the deduction can be added to what you can afford as a mortgage payment, raising the amount you can afford to spend on a house and the amount the bank will loan out to you.
Not everyone takes advantage of every dollar the bank agrees to loan to them, but most people get pretty close. This addition to the mortgage calculation allows more capital to be dedicated to the housing market. House prices increase as a result. What you gain on your tax return, everyone loses on higher prices on the housing stock.
Free marketers often decry all zoning as evil, but the truth is any presence of government is a form of zoning. Any road, sewer, water, electrical wire, etc, that is installed and paid for by public funding is a form of public zoning and determines where and how much development will occur.
Zoning that classifies areas for specific types of development is only an extension of the intrusion government has already made into the economic sphere. To propose that infrastructure is "okay", yet any form of zoning beyond that is a no-no, is naïve at best. Once, government intrudes, zoning is a given. The argument should be based on whether intrusion should occur at all and if so, to what extent.
Much zoning is based on the fact that we have allowed harm and injury to occur with no compensation awarded to those injured. We require zoning for oil refineries because our court system has failed to classify the pollution they emit as harmful or injurious. Zoning is then needed to protect neighborhoods and individuals from harm that the courts have failed to recognize. We create the problem by accepting harm without consequence then add a regulation to protect those with political clout from the harm.
Zoning can be accomplished by the workings of a free marketplace. For it to be successful, any harm or injury incurred, such as the oil refinery example above, must be accounted and compensated for. The right of each individual to be free of aggressive harm or injury must be upheld. Restrictive zoning can protect some, but can never replace just compensation or removal of the source of harm.
When housing reflects the overall economic condition is it said to be a "determined" factor. That is, the cost, supply and condition of the housing stock reflect the state of the overall economy.
The recent ongoing housing crisis is due in no small part to the fact that in our economy housing is a "determining" factor. It has become an overriding force in the economy due to state intervention and the resulting monopoly conditions of the financial sector related to housing. Housing availability and pricing is not the result of consumer demand, but of control of the marketplace by the government and its parasitical beneficiaries. The housing market can never be stable until it is allowed to reach its own equilibrium free of restriction and encumbrance.
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