By Overlooking Housing, the Debt Ceiling Debate Falls Short

By Jesse Keenan, Managing Editor,

The current high stakes game of default crippling Washington is being framed by a highly polarized non-debate between two ideological points of contention: entitlement cuts vs. net tax increases. With upwards of one trillion dollars in housing losses attributable to the GSEs in the near future, somehow the unsustainable housing finance system is being overlooked in the broader debate to minimize taxpayer’s long term debt exposure. What makes the system unsustainable? According to Federal Housing Finance Agency, the GSEs account for 97% of all mortgage backed securities’ issuances. This is compared to just 44% of the total market share at the height of the market in 2006. With virtually all of the housing financing pricing power caught up in the requisite liquidity of the Treasury, together with increasingly conservative underwriting standards arising from the ashes of short-term emergency measures, the average housing consumer is facing near term interest rate risks. These interest rate risks may not be as detrimental to those who are otherwise required to put a significant chunk of equity into a transaction; but, the overall impact on purchasing power parity by and between markets is significant.

Just a single basis point increase could reduce real purchase power by as much as twenty thousand dollars. A single basis point in the prime market could easily result in a two to three point increase in real rates. Under this scenario, values might respond with another 30% decrease in value relative to demand based on median income values. While extreme, the fear alone of rocking the boat, and the resulting inevitable rise of prime rates, is perhaps why Washington is not poised to seriously take on any one of the thirty-two bills pending before Congress. This doomsday valuation model runs parallel to the fact that while foreclosures appear to be on the decline as a year-to-year percentage, the reality is that drawn out overburdened court systems, together with a strategic lack of REO capacity, are now the cog in the wheel that is just skidding across the sandy trail of the wagon train. Eventually, the horses (i.e., GSE’s) dragging the wagon instead of rolling it are going to simply give out from exhaustion. If the U.S. defaults on its debt, the scenario above is a realistic outcome wherein the horses just drop dead and the wagon sits idly by because it is more cost effective to walk to the next town than it is to buy another horse and wagon.

However, homeownership rates as a percentage of the whole are only down roughly 3% from their all time high of 69% at the height of the last cycle. So, there is really very little correlation between valuation decline and homeownership rates, which is somewhat counter intuitive when you think about the millions of households who are or have been subject to foreclosures. So, the NAR’s real rhetorical appeal is buying for the sake of buying, which is exactly the same type of emotive rhetoric that drove the speculation which broke the back of the market. This phenomenon of a continued push for homeownership is negatively biased by the necessity of an increasingly mobile workforce which bears a much higher transaction cost to relocate. Conversely, those employers who are hiring find it difficult to aggregate a skilled workforce who is not otherwise cost burdened by the firm’s current location. This in turn adds an additional cost to the firm who often has to relocate to where the cheapest high-skilled laborers are. This might work well for Georgia, but not so well for New Jersey. This cycle of spatial dislocation in the workforce certainly does not help the promotion of job growth, which is ultimately the key to the entire problem.

Job growth certainly equals more revenue, but revenue is a two sided sword which in the world of housing is most certainly driven not by outlays but by tax policy. So, perhaps the push should be to promote rental housing, or at least reduce the production and demand incentives in favor of for-sale housing. This way you save the taxpayers in the long run and you don’t create artificial value in housing which skews market dynamics. The first step is to eliminate the mortgage interest tax deduction, which has empirically been shown to progressively benefit the most wealthy tax payers. Second, amortization periods should be aligned so that rental housing depreciates by component part instead of the entire building. Therefore, the useful life of the roof, MEP, elevators, structure, cap ex improvements and the like are amortized independent of each other to more accurately reflect the necessity for maintaining necessary cash reserves for anticipated replacement costs. This extends the life of the building and improves performance. Likewise, it makes it easier and more cost effective to make environmental retrofits, a whole other policy goal all together. The list of tax policy implications for housing and real estate is a long one; but, if comprehensive tax reform is on the agenda, why not hit two birds with one stone?

Whether it is tax reform or GSE reform, the debt ceiling debate will never be comprehensively addressed without systematic alignment of politically neutralizing policy goals which are inclusive of social outcomes, economic realities and non-biased tax principles. Unfortunately, it does not appear to be feasible for all of this to be accomplished prior to August 2nd. But, that is OK. This isn’t the first time the U.S. has defaulted on its debt and we are still alive and kicking today—if only barely. In fact, the U.S. has defaulted on its debt in some form or fashion in1782, 1862, 1934 and in 1979. Oddly enough, each one of these years represented extremely tough times for real estate markets. Is there a historical connection between debt and real estate? There is absolutely a connection—whether it is a matter of correlation or causation is one for the history book. For now, let us hope that a failure of government to act does not trigger a slide in real estate and housing which will take decades to overcome. For now, there is still a chance to repair the wagon and feed the horses.

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