The American shopping list: Part 3, the tourist traps
[Continued from yesterday’s Part 1 and Part 2.]
In the first part of this post , I offered the globe-trotting policy maker —
I’ve got your policy palmed in my hand
— four authentic American wares sure to suit any housing ministry’s mantelpiece:
Mickey always wanted a piece
Three levels of government
Credit enhancement at the affordability margin
Public-private housing finance agencies
Inclusionary zoning
Yesterday, in Part 2, we delved into five additional knick-knacks that could well go with your legislature’s color scheme:
A Community Reinvestment Act
Workforce housing initiatives
Soft debt.
Soft equity via investment tax credit
Tax Increment Financing
Beyond these safe and sane choices, there are things in the American idea-pots that are – well – distinctive to us, and whose importation is questionable, if not positively dangerous.
Once lit, hard to extinguish
Remember, what gets enacted in Vegas, doesn’t necessarily get repealed in Vegas.
“Vegas, baby!”
What not to buy
1. Premature securitization. For the last half-decade, many was the international or global conference whose focus was securitization. Its purpose is to create liquidity in primary originators who have built up a loan book and who seek to recycle their capital into cash so as to restart their loan pipelines.
New loans on their way
Securitization is seductive because it can be done at large scale, it involves high finance (and therefore sounds intellectually bracing), and it sounds as though efficiency can be squeezed out of the system with no risk. As Mycroft Holmes explained it:
By now Mycroft Holmes’s enormous waistcoat was dusty with rainbow hued chalk dabs as this securitization primer roused his enthusiasm.
“[The risk is] too significant by far,” he repeated, glowering at those unseen readers who had not read yesterday’s post. “We have all of the risk and one-third of the capital. We would rather have all of the risk laid against one eighth of the capital. To do that, we slice off another tranche.”
“The 8.0% yield from the aggregate loan pool, when securitized with 6.5% A piece and an 8.25% B piece, yields our bank 16.6% on the C piece. We have doubled our effective yield on capital by squeezing out the seven-eighths that is risk-free or low risk, and selling those safer slices in the capital markets. That, sir, is one of the several things an investment banker does. There can be further complications. I have drawn this diagram assuming all the loans are the same maturity, and the security coterminous as well. If we add a time dimension, in effect taking this image out into a third spatial dimension — you may wish to recall our discussion of the financing quilt — the potential for arbitrage rises, as does the risk profile.” He slapped chalk from his fat palms.
Watson realized that when evaluating securitizations, one had to study the fine print
“Indeed, now I come to think of it, perhaps we are better served as our bank by lying in wait for those who understand risk less well, and who are about to put themselves into dutch, overusing these brave new financing techniques, for a New Century.”
Mycroft was wiser than he knew [in April, 2007 — Ed.]. The recent subprime mess has been, if not caused by securitization, at least enabled and magnified by it. Securitization enabled the capital markets to blind themselves to the risk, and now creates blockages to loan modification which, although greeted with skepticism in some quarters, are nevertheless an essential tool in stabilizing both the property and credit markets.
I’m skeptical that the markets will evolve the way you think
The point is not that securitization is intrinsically bad, but rather that (a) it is no substitute for a proper primary mortgage market, and (b) it is an all-too-tempting quick fix that enables elected officials and policy makers to dodge their responsibility to create a functioning ecosystem.
Just one bite, Adam
Before one thinks about securitization, therefore, one needs to have a well diversified and healthy origination system.
“Not that I loved securitization less, but that I loved origination more.”
2. Government-sponsored enterprises (GSEs). After we created the FHA, Congress came up with the fundamentally sound idea of migrating credit enhancement to a public-private partnership (not dissimilar from a housing finance agency), and chartered the government-sponsored enterprises, of which the two largest are Fannie Mae (whose story is told here) and Freddie Mac. They started out as small departments within HUD —
“Privatize me! Privatize me!”
— but once privatized, have grown rapidly, and today have enormous market capitalization, and wield considerable political influence. They’re so big, in fact, that they may be too big to fail, and the effort to reform them appears to have stalled in Congress.
The evidence suggests, at least by negative inference, that they offer negligible affordability benefits, and that the capital markets rely on them at the expense of sound independent underwriting.
Further, we know GSEs are still systemically risky. They can turbocharge the balance sheet, manage earnings, and squelch critics.
Once planted, they become hard to control.
“Charter me! Charter me!”
3. The alternative minimum tax (AMT). An economist’s fantasy and a taxpayer’s nightmare, the AMT is in effect a parallel-universe tax system. Taxpayers pay the higher of two tax calculations, and while the AMT uses a lower marginal rate, it disallows most deductions.
I dreamed I was a ravished captive of a malignant tax provision
Originally created to assure that all taxpayers pay some tax, the AMT has never been calibrated for inflation, with the result that as each year goes by, its rising tide drowns ever more tax returns. What was supposed to apply only to ‘fat cats’ (i.e., people who make more than legislators) is now affecting ordinary Americans (i.e., people who make less than legislators).
What, thinks the gentle reader, does an obscure tax provision have to do with housing?
Simply this: in
· It’s irresistible because, as the AMT engulfs and devours more taxpayers, it is becoming a political liability for all parties, especially whoever controls Congress.
· It’s immovable because it raises enormous revenue for the government, so that to eliminate requires finding revenue somewhere else.
Tut, tut, my good man, chuckles the foreigner. We would never adopt so regressive, complicated, cumbersome, and economy-restricting a tax as that.
We never use such things
To which the patriotic Yank replies, in a spat, “VAT!“
No fat in this VAT
4. The mortgage interest deduction. What? shrinks the
You think they’ll repeal the mortgage interest deduction, Barney?
It’s normally the biggest deduction any individual household takes, and is a source of considerable psychic comfort to homeowners all across the country.
The criticism against this is simple:
Biggest. Tax. Expenditure. Ever.
The mortgage interest deduction costs $70 billion annually. That’s more than twice the entire HUD budget.
Now, it would be one thing if the mortgage interest deduction made homes more affordable, but since markets always clear, home prices reach an equilibrium based on people’s ability to make monthly payments, a mortgage interest deduction simply pushes home prices up:
What does this mean for home ownership generally? Because markets move fast, changes in interest rates are reflected in market prices almost immediately.
Need proof?
Ask
Today, to suggest eliminating the mortgage interest deduction will get you consigned to the outer darkness. So for those of you who lack a mortgage interest deduction, don’t introduce it unless you’re willing to have it a part of your tax code more permanent than a permanent law.
Why are these better-nots?
None of these last items are categorical No’s — after all, they seemed like a good idea at the time here in the
However, they do have one thing in common:
They’re largely irreversible.
The problem in housing policy is that markets change much faster than do programs, and any program gains proponents as it gains beneficiaries.
Once you’ve discovered it’s a bad idea, you can’t get rid of it.
Wish I didn’t have now what I didn’t have then
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