Saturday, October 31, 2009

Our Ownership Society:

There is something very Orwellian about how over the last 20 years the government has created policy toward an "ownership society". People are being strong armed by the government to buy houses so they can become "owners". Today, a more accurate definition would be the "inverse ownership society" where about a quarter of home owners are underwater in their mortgages. Home equity for our country's housing stock is at 40%, by far and away an all time low. Before the 1980's it was always the goal to pay off one's mortgage. This changed during the Reagan years when a house became "a payment". It's all part of the "trickle down" economic theory: give wealth to the rich elite and maybe some will trickle down to the masses. Presently, the goal of the government appears to be to get people to buy houses and become debt slaves to Wall Street even when they can rent and save a substantial amount of money.

The government's ownership policy propaganda worked well until our country's housing values were driven up in price beyond what people could afford to pay. This house of cards ended in 2007 but the government is still pushing ownership. I can think of no reason why a citizen owning an overvalued home does anything to help our economy. It just enriches Wall Street, impoverishes the financially uneducated and brings more speculation and volatility into the market. In a normal world I would hope that a benign government would reward saving and prudent living. Our present government's "ministry of saving"(Orwellian Reference) is creating a mountain of debt to reward people for getting into more debt. I agree with Bill Gross of Pimco. He says that asset values in our country are $15 trillion overvalued. I believe that a big part of this problem is bad government policy.

Presently our government is poring trillions of dollars into subsidies for housing:

  1. Reduced mortgage rates: The Federal Funds Rate is at zero and the GSE's are guaranteeing most of the mortgage market. The Fed is buying mortgage backed securities and also buying treasuries thus pumping trillion of dollars into the banking system. The mortgage market is on life support from the government. It has ceased to function normally. It is a two step program back to normal. First, the government must stop injecting liquidity into the banking system. Second, the government must back out of the financial markets. I believe that someday it might be possible for the government to complete step one and to stop pouring trillions of dollars into Wall Street and the banking system. Maybe in 5 or 10 years. But it will never be possible for the government to complete step two. The housing market is addicted to government money through the GSEs. For taxpayers to extricate themselves from this largess would take a revolution. This will always be a hidden tax on taxpayers to prop up home values.
  2. Embedded tax breaks: This is mainly the deductions for home ownership at tax time. Our country must gift homeowners a portion of the interest and real estate tax that is paid for a primary residence. The second gift that is given is the untaxed profit that a homeowner gains with the $500,000 tax exemption. Another gift is one given to investors in the fantasy depreciation of the property. An example would be the $36,000 expense for depreciation that the owner of a $1,000,000 property gets to claim every year. In the real world there is no loss on the $1,000,000 property. That is why I call it fantasy depreciation. In theory it is required to be paid back when the rental property is sold. But if you have a good tax person this fantasy depreciation will never be paid back to our country.
  3. Fun new tax breaks: This would be the homeowner tax credit. The government is giving $8,000 to new home buyers. It has immediately increased the value of all lower end homes sold and therefore it will probably become embedded into the tax code. I will be very surprised if it is eliminated in April, 2010.

Tax breaks are a big driver of overpriced housing. There are also many other factors that created this inverse ownership society. The Interest Rate Mega Bubble, The peak of the baby boomers, women joining the workforce, The Greenspan Put and the weak dollar are just a few other examples. All of these events raised the price of housing to where it is today. None of these events will occur again and some will reverse to create a drag on housing prices. There is nothing in the future that can artificially drive housing values higher except the speculative nature of The Herd. I sold my home in 2007 with the intent of buying again in 2010 but I am starting to rethink my thesis. I am happily renting and saving a substantial amount of money(against the government's wishes) and see a lot of market volatility in the future due to massive temporary government intervention. I am tempted to use my "house down payment" money to hedge the markets instead of becoming a part of the "ownership society". This may seem crazy but in this totally dysfunctional market betting against The Herd could be more prudent than betting that the government can create prosperity with more debt. My major concern is that The Herd is totally clueless to the "New Normal" that the government has imposed on our future. Our generation has forgotten how to save. We are propping up asset values above fair value with temporary strong armed government intervention. In my opinion it is impossible for these asset values to hold up in the long run. We have been through a period of prosperity unequaled in history and all we have to show for it is debt. We are trying to hang on to this prosperity by using more debt. This will only create volatility and dysfunctional markets in the short run. It will not change the final result in the long run. This will be the "New Normal".

During the stock bubble of the late 90's I remember many people telling me that they were going to retire early and live off the gains from their stocks. During the housing bubble not only were people going to retire early from selling their home for "millions" but also people were using their homes as ATM's to supplement their household income. It was mass hysteria. The new hysteria is the present thinking that if our country creates enough debt we will spur ourselves out of the doldrums that has been created by the record leverage and debt that we already incurred. Today we have much more debt than anytime in our nation's history. The government is trying to keep this Ponzi finance scheme going but it will just create more bubbles and dysfunction.

The present bubble is in long term US treasuries. When this bubble pops it could drive interest rates up and home prices down. Unfortunately long term savers could be directly brutalized by the spike in interest rates and indirectly by inflation. Therefore a prudent saver must hedge against bad government policy. The direct hedge would be shorting long term treasuries. Indirect hedges could be short plays on the dollar, interest rate ladders or just trying to time the markets. Market timing has been my strategy for the most recent stock and housing bubbles. This is not a perfect strategy but it has worked up till now. I think this zero sum game pitting winners against losers will become more complicated in the future. At this point I have no idea what the "New Normal" will look like. It depends on the government, The Financial Elite and The Herd. I will definitely purchase a home in the future but I believe there is no hurry to do so. The Japanese "lost decade" has been continuing for a generation with asset values still trending downward. The Great Depression lasted over a decade and had pretty high interest rates in a contracting economy. Our government seems dead set on implementing the same policy as these two monetary and fiscal fiascos. Yes we can have interest rate inflation but asset inflation seems very far off on the horizon. Maybe I will opt out of the "ownership society" for a little while longer.

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