Wednesday, February 27, 2008

Housing: Why We're All Doomed

I don't think there's any even remotely good way out of the housing crisis - here's why:

For any market where the supply of housing can be increased, high prices are not sustainable. If a 3 bedroom house in Nevada is selling for half a million dollars, someone is going to go build another house in Nevada for less than half a million dollars, sell it, make a profit, and repeat until the price of housing comes down.

So for any market that isn't limited by available land, there's no sane way to prop up the price of housing. Anyone who took a mortgage based on bubble-level housing prices is simply screwed; when we (homeowners) buy a house, we are assuming market pricing risk ourselves. The only way out is to give up on equity (if there is any), stop payments, let the bank foreclose, and forget about your credit rating for the next decade. This transfers the market risk unceremoniously onto the investors who bought the mortgage.

(Requiring a real down-payment was the safety mechanism that kept these kinds of things from happening - of the people I know who bought a house, I don't think any of them actually put 20% down.)

Most of the "rescue" packages I've heard discussed on the media come down to some mix of either strong-arming lenders into accepting new financing terms or providing new financing. I have no qualms with strong-arming lenders even if it makes libertarians cringe. The libertarian in me says: buyer beware...investors should know that if their investment requires elected officials to stand by while citizens get the short end of the stick in an investment, someone is going to step in and do something populist. That's part of the risk of the investment. When you buy asset-backed whatevers, you should care about what the underlying asset is because that's the only thing protecting you. (Sure the house behind the mortgage has value, but having to foreclose to make good on the loan is an ugly solution.)

However I simply don't think adding additional financing is going to do a lot - we could hope to stem the wave of foreclosures but not the price change for anyone who bought a house at peak prices. If you're underwater, why would you want to accept fixed rate financing so you can protect your negative equity? I think it's a question of "how much is a credit rating" worth. Is a credit rating worth $50,000?

I'm not saying we shouldn't have additional loan help. In particular, I think that there needs to be disintermediation in the mortgage business (letting the people writing the mortages not own them has proven to be a bad idea). Securitization of mortgages has lowered their cost; if we are going to go back to traditional lending and we want to maintain credit costs similar to what we've had for the last twenty years, new investment has to come from somewhere.

Subsidizing housing prices seems like a non-option and unfeasible; not only would additional housing subsidies further increase the overall supply of housing (via new construction), but the scale of the problem is too large. Consider: by spending $150 billion we don't have, the government is putting a mere $600 in our pockets per person. How many home-owners are only underwater by $600 or only behind by $600? The rebate is a drop in the bucket, which is why it won't address housing problems at all. You can see how the market correction is beyond the scale of government intervention.

Stepping back, I come to a question more fundamental than "what went wrong" and "what should we do"...I want to know: should we even own our own homes at all?

When I plan my retirement savings each year, I try to diversify my investments - within stocks, I have an index fund to protect me from one company's downfall. Not all my money is in stocks, etc. etc. If I said "I'm going to put all of my life savings into Raytheon stock" you'd say I was an idiot.

But wait - look at my total set of investments. I have more money plugged into domestic property (in fact, into a single unit in a single neighborhood) than I have in all of my other investments combined!! That's not diversification at all? I am subject to an immense amount of market risk!

Home ownership is heavily subsidized in the US, and that's one of the reasons Lori and I bought - it's generally a better deal than renting. But this exposed us to huge market risk. I think one of the reasons that the housing crisis has hit so hard is that the nature of houses as a commodity has changed over the last thirty years. With the invention of securitization, REITs, etc. it's possible for speculative money to enter the real-estate market in a much bigger way and this means that the volatility of housing prices is going to resemble the rest of the instruments wall-street pedals. I think that, as a country, we didn't see our houses as dot-com stocks until it was too late.

(Here's my alternate approach: owner-occupied REIT coops. Basically the ownership rights (when you move, what you can do to the property) remain with the owner-occupier of the house. But the capital gains are owned collectively by all participants in the co-op.

(The owner-occupier would be forced to hold a larger stake in his or her own property, perhaps a minimum of 20%, so that the owner has a strong interest in maintaining property value.)

This would allow home owners to spread market risk across geographically diverse areas and/or different market profiles, or even sell off market risk to outside investors who want to buy it.

Saturday, February 16, 2008

Bob Vila Probably Picks His Own 401k

Why can't we all? With tax time approaching and the recent news about 401k abuses, a simple remedy occurs to me.

The fundamental problem with 401ks is that they provide the only outlet for someone to save 25% of their income for retirement with tax deferral. So your choice is: use the company's 401k (no matter how expensive, how lame the investment choices, and how much the kickbacks) or lose that tax-deferred savings vehicle entirely. (A traditional IRA pales in comparison, with its $4000 limit, plus if you're married the maximum income ceiling is relatively low.)

This isn't a problem for me - as a self-employed contractor, I get a SEP-IRA. I get all the savings of a 401k (up to 25%) but I can put it anywhere I please, shopping the market place for an IRA that has investment choices I like and isn't gummed up with fees.

So my proposal is greedy - it solves our problems but doesn't help savers who aren't
paying attention. Simply put:
  • The IRS should allow savers to treat all employment income as eligible for a SEP-IRA as long as the tax payer opts out of his or her company 401k.
  • Matching benefits would be paid to the employee for direct deposit into the SEP-IRA.
The tax treatments and infrastructure already exist! Consumers could vote against their company with their feet.