Chuck Ponzi November 9th, 2005

Although this is old news, in a bizarre, surprising twist (even for bubble sitters like myself), the president’ s council for tax reform has supported a dramatic reduction of the mortgage interest deduction.

Our favorite pundit, Mr. Lereah has weighed in that home prices could fall 15%.

I fail to see a problem with this post. If the government’s intention is to make home prices within reach, this will most assuredly allow MORE people, not less to afford a home. Reasoning, you might ask?
1. Lower downpayments
Need we say more? This goes without saying if housing prices are lower. However, some might argue that the upset in the credit markets would cause a reversion to the mean with respect to down payment requirements. However, this is already in process with the guidlines set forth by the fed recently, and lenders would stop acting so irrationally seeing that asset prices were artificially inflated. Long-term, however, downpayments will be lower considering the lower prices.
2. lower prices mean higher interest rates for lower-income, less-qualified buyers have less “bite”.
Ever seen what a 1% increase in rates does to a $200K loan, what about a $400K loan? What about as a percentage of after-tax income? Use of after-tax money represents a non-linear basis of income. However, one argument is that this would increase RE speculation, since interest for business purposes is deductible and therefore lowers the cost of borrowing for investors vs. homeowners. The danger is the same the other way. Why not make all interest deductible then? Why not make most every expense deductible for that matter like businesses and small business? This is just how our tax system is currently setup; any radical changes is just as likely to reward other undesirable activities. The graduated income tax system we have now is intended to better favor lower-income families, this would just be aligning some provisions in the overall system. Consumption taxes have their own problems.
3. Greater capital availability for “productive” assets increases american’s job base by supporting high-tech investment
This is a no-brainer. Instead of willy-nilly investing our capital into a nonproductive asset, we might actually invest in assets that add value in international competitiveness and create domestic jobs. A stronger trade balance would offer strength to the beleagured dollar and keep other products cheap for Americans. While we would all agree that real-estate in general adds productive value, what value does a 4000 sq ft house offer over a 2400 sq ft house? What value do sky-high realtor commissions have in the international competitive arena?

Who would lose with this legislation?
1. Homebuilders - don’t believe the hype, they are alredy on their way to being entrenched; this is a cyclical business and we’re on the downside. The stock market already knows what the average American doesn’t since the stock market is forward-looking, while real-estate measures are backwards looking. You can’t drive an economy looking out the rear-view mirror.
2. Retailers - the cash-out refi is already over, but this would drive a stake in the heart of the asset-backed debt monster. Is this a bad thing?
3. Overextended homebuyers - This is a tragedy, and to make the transition easier, the country should grandfather the breaks and transition them in for the next 5 years for current homeowners to gradually ease into the change and to get their finances in order.

Who wins?
1. The capital markets/American economy
2. Average americans
3. The middle class (gasp!, is there one left?)
4. Prudent home-buyers who never borrowed more than they could comfortably pay

In the end, 10% year-over-year appreciation in homes is not an American god-given right. It has been worse, and it could be much, much worse. This is just a single step in the right direction.

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