Governments use taxes to advance diverse goals. Manipulating taxes can stimulate portions of the economy Congress wants to advance, or effectively shut down portions of the economy Congress wants to discourage. In an earlier post, I gave the example of Congress ending the long standing policy of allowing individuals to use real estate depreciation (a non-cash accounting technique) as a deduction against personal income, to reduce taxes. Congress (rightly) concluded that too much money was being directed into real estate and wanted to re-direct those funds.
Congress ineptly handled the change, and as a result, caused the collapse of the Savings and Loan industry, which cost billions of dollars to rectify. Thousands of individuals were also injured by being thrown out of work, or losing the value of the investments they made.
Now, pressed to reduce the deficit, Congress is considering ending the ability of homeowners to deduct mortgage insurance from their income before their tax liability is calculated. The deduction was long allowed to encourage home ownership. Clearly, such a change would discourage home ownership, but it would raise additional revenues.
Apparently, Congress has never considered tax policy as an aid to environmental protection, or to avoid the Government's having to step in when industry fails, as happened earlier this year with when BP's well in the Gulf of Mexico spewed millions of gallons of crude oil into what had, up to then, been a pristine ocean.
I propose that Congress should impose a tax of say, 15% of any revenue produced by such wells every year and hold that tax in a special fund. When the well is depleted, or effectively shut down and a decent interval has passed to stand as proof that the well does not leak, then the well owner should be allowed to withdraw the majority of that fund, and the remainder should revert to the government as a tax.
The oil company could show the fund on its books as an asset, and even borrow against it. If however, the well discharges oil into the environment, the fund could be tapped to pay for the costs of clean-up. A similar system could be imposed on any industry with long-term pollution potential, such as refineries, strip mines, and manufacturers which use toxic substances as an unavoidable part of their process. One example: I understand the metal for dry wall screws and certain other fasteners are hardened with arsenic.
By providing companies with an incentive to monitor their own long term environmental risk, they would be far more diligent than is now the case.
Just a suggestion. GYL
Sunday, December 12, 2010
Sunday, February 7, 2010
The Mortgage Debacle, Part 2
In my first post, I discussed the current real estate collapse and its predecessor in the late 1980s. This post will add some background and venture into commentary. Just to review, the real estate market collapse in the mid 80s was directly attributable to Washington’s implementing two policy goals: first, to redirect investors away from real estate, and second, to end persistent inflation. The tool Congress used was a radical change in tax laws which upset two generations of precedent.
Congress’ goals were rational and well-intentioned, but their methodology was flawed. Had Congress applied changes in the tax laws to new real estate projects only, the market would have gradually adjusted. Instead, Congress’ wholesale revision of fundamental tax structure quickly destroyed the wealth of thousands of taxpayers who, following long established rules, had been investing in real estate "tax shelters." They could do so because S&Ls made the loans that made that possible.
When prices began to fall, the collateral supporting the S&Ls' loans disappeared, and when loans went bad, the properties couldn’t be sold for enough to pay off the debts. At the same time, the Federal Reserve Bank set interest as high as 16% and private money was available only at rates exceeding 18% at the peak. Bank and S&L portfolios couldn’t earn enough money to pay depositors, and the banks bled money until credit became unavailable. Everyone went broke, which does indeed discourage taxpayers from investing in real estate.
Congress successfully blamed the S& L debacle on "greedy" and "incompetent" S&L operators. There were indeed some badly run S&Ls owned by greedy operators, but the underling cause of the disaster was Congress’ good idea.
So, we can chalk up that debacle to the inability of Congress think through a complex problem, or to anticipate what the effect of the changes they put in place would be.
The disaster we are living through now was only partly created by Congress: the rest was caused by greedy, opportunistic individuals. Congress decided, in accordance with fundamental precepts of the Republican party, that federal regulations were holding back the true profit potential of the individuals who made generous political donations to the senators and congressmen. And if de-regulating airlines was good, de-regulating banks and financial institutions such as investment banks was even better, because the people who ran that fun-house were the best and the brightest. Free-market dogma holds that such institutions will be "self -regulating".
People were offered, and took, loans they knew they could never hope to repay without selling the property, but since property prices were shooting up like fireworks, they figured that if they didn’t get on the band wagon, they’d be left behind.
The comedian Lewis Black describes Democrats as the party of no ideas and Republicans as the party of bad ideas, and warns us that when Democrats and Republicans agree on something, that's when we're in real trouble. He’s absolutely right.
Before "deregulation," banks kept the loans they made and worked with their borrowers if they ran into trouble. But the new methodology was for banks to make loans and sell them in bundles as investments, so they can get more money to make more loans. Banks began looking to the origination fees as their principal source of profit, not the long term collection of well made loans. When they focused on the short term profits they set an inevitable train wreck in motion and no one in Congress noticed.
What Congress failed to consider was that "the people" would get the wind of real estate profits in their sails, and would conclude that prices would always go up. Only suckers didn’t risk buying houses they couldn’t really afford, because before the loans came due, or before the interest rates went up, everyone could sell at a profit and pay off those goofy loans.
And, when the excrement hit the fan, we were told that the banks were "too big to fail" and we the people had to save them with money we didn’t yet have (government deficits). So the bankers got to keep their bonuses and everyone else got to pay to make that possible.
What happened is we privatized profits and socialized risks, and nobody will ever be held to account for the debacle. The public voted the Republicans out and now criticize the Democrats for not being able to quickly fix the problem. If the American public had any real self interest we would have voted every sitting representative and senator out of office and started fresh. Just who’s crazy?
Congress’ goals were rational and well-intentioned, but their methodology was flawed. Had Congress applied changes in the tax laws to new real estate projects only, the market would have gradually adjusted. Instead, Congress’ wholesale revision of fundamental tax structure quickly destroyed the wealth of thousands of taxpayers who, following long established rules, had been investing in real estate "tax shelters." They could do so because S&Ls made the loans that made that possible.
When prices began to fall, the collateral supporting the S&Ls' loans disappeared, and when loans went bad, the properties couldn’t be sold for enough to pay off the debts. At the same time, the Federal Reserve Bank set interest as high as 16% and private money was available only at rates exceeding 18% at the peak. Bank and S&L portfolios couldn’t earn enough money to pay depositors, and the banks bled money until credit became unavailable. Everyone went broke, which does indeed discourage taxpayers from investing in real estate.
Congress successfully blamed the S& L debacle on "greedy" and "incompetent" S&L operators. There were indeed some badly run S&Ls owned by greedy operators, but the underling cause of the disaster was Congress’ good idea.
So, we can chalk up that debacle to the inability of Congress think through a complex problem, or to anticipate what the effect of the changes they put in place would be.
The disaster we are living through now was only partly created by Congress: the rest was caused by greedy, opportunistic individuals. Congress decided, in accordance with fundamental precepts of the Republican party, that federal regulations were holding back the true profit potential of the individuals who made generous political donations to the senators and congressmen. And if de-regulating airlines was good, de-regulating banks and financial institutions such as investment banks was even better, because the people who ran that fun-house were the best and the brightest. Free-market dogma holds that such institutions will be "self -regulating".
People were offered, and took, loans they knew they could never hope to repay without selling the property, but since property prices were shooting up like fireworks, they figured that if they didn’t get on the band wagon, they’d be left behind.
The comedian Lewis Black describes Democrats as the party of no ideas and Republicans as the party of bad ideas, and warns us that when Democrats and Republicans agree on something, that's when we're in real trouble. He’s absolutely right.
Before "deregulation," banks kept the loans they made and worked with their borrowers if they ran into trouble. But the new methodology was for banks to make loans and sell them in bundles as investments, so they can get more money to make more loans. Banks began looking to the origination fees as their principal source of profit, not the long term collection of well made loans. When they focused on the short term profits they set an inevitable train wreck in motion and no one in Congress noticed.
What Congress failed to consider was that "the people" would get the wind of real estate profits in their sails, and would conclude that prices would always go up. Only suckers didn’t risk buying houses they couldn’t really afford, because before the loans came due, or before the interest rates went up, everyone could sell at a profit and pay off those goofy loans.
And, when the excrement hit the fan, we were told that the banks were "too big to fail" and we the people had to save them with money we didn’t yet have (government deficits). So the bankers got to keep their bonuses and everyone else got to pay to make that possible.
What happened is we privatized profits and socialized risks, and nobody will ever be held to account for the debacle. The public voted the Republicans out and now criticize the Democrats for not being able to quickly fix the problem. If the American public had any real self interest we would have voted every sitting representative and senator out of office and started fresh. Just who’s crazy?
Thursday, January 14, 2010
Some Thoughts About the Current Mortgage Foreclosure Glut
Home foreclosures are being filed at a record pace here in Chicago and around the Country. A wave of commercial foreclosures will be arriving soon. An underlying problem is that the overall real estate values have fallen to the point that properties are worth less, in many cases, than the loans against them -- in everyday terms, the loans are "under water".
The last time this happened was in the late 1980's. You may remember the "S&L Debacle". Then, Savings and Loans (specialized banks set up to make home mortgages), failed at an alarming rate. Congress and the press attributed the catastrophy to greedy, inept S&L owners. There were some greedy, inept S&L operators, to be sure, but actually, two miscalculations by the federal government were the real cause of the disaster. First, in 1986, the IRS ended the practice of allowing tax payers to deduct real estate depreciation from their personal income tax returns. For years, the real estate business grew like wildfire as promoters designed "tax shelters" -- real estate projects structured to maximize investor's tax benefits. There were other tax shelters, too, like investing in movies, but the economic impact of those was microscopic compared to real estate.
When congress ended real estate depreciation deductions, they didn't do so only for new projects, they applied the change retroactively, so that taxpayers who invested in shelter deals in prior years lost the benefits immediately.
At the same time, Congress decided to "Whip Inflation Now" (the "WIN" incentive). To do that, they pushed interest rates up so that people would not be tempted to invest in new business ventures, including real estate projects, with borrowed money. The unintended effect was to place banks and S&L's in a situation where they had to pay 16 - 20% and more to attract deposits -- which they needed to support loans already outstanding, while carrying loans they made when interest rates were much lower. Banks and S&L's hemoraged money until they had none left.
With no money to lend to those who might want to buy real estate and with the value of the real estate falling each day, so many banks and S&L's failed that the government set up the Resolution Trust Company, a government agency to take over failed financial institutions. It took years for the real estate market to recover.
Then, in the late 1990's Congress struck again, along with a weird social movement. First, Congress decided that it was every American's inalienable right to own a home. Then, Congress de-regulated the Banks.
People began buying homes, not just to have a place to live, but so they could "flip" them and make a profit. In fairly short order, individuals who a few years earlier couldn't qualify to finance a used car were signing "no documentation" loans and buying homes they couldn't possibly afford. Loans with low initial interest rates flooded the market, encouraging individuals to buy bigger and bigger homes and sell them before interest rates adjusted upward.
Stories began to circulate about the fabulous money otherwise marginal individuals could make, and "flipping" became a social movement. Churches assured parishioners that Jesus wanted everyone to be wealthy. Real estate investing became a mania. It was like musical chairs with money.
When the music stopped, lots of people couldn't find seats. When the value of real estate stopped climbing, the whole house of cards collapsed. Now, as the economy continues to contract, real estate values shrink further and further and those who can't service their loans through income, face the loss of everything they once had.
Next: What to do now?
The last time this happened was in the late 1980's. You may remember the "S&L Debacle". Then, Savings and Loans (specialized banks set up to make home mortgages), failed at an alarming rate. Congress and the press attributed the catastrophy to greedy, inept S&L owners. There were some greedy, inept S&L operators, to be sure, but actually, two miscalculations by the federal government were the real cause of the disaster. First, in 1986, the IRS ended the practice of allowing tax payers to deduct real estate depreciation from their personal income tax returns. For years, the real estate business grew like wildfire as promoters designed "tax shelters" -- real estate projects structured to maximize investor's tax benefits. There were other tax shelters, too, like investing in movies, but the economic impact of those was microscopic compared to real estate.
When congress ended real estate depreciation deductions, they didn't do so only for new projects, they applied the change retroactively, so that taxpayers who invested in shelter deals in prior years lost the benefits immediately.
At the same time, Congress decided to "Whip Inflation Now" (the "WIN" incentive). To do that, they pushed interest rates up so that people would not be tempted to invest in new business ventures, including real estate projects, with borrowed money. The unintended effect was to place banks and S&L's in a situation where they had to pay 16 - 20% and more to attract deposits -- which they needed to support loans already outstanding, while carrying loans they made when interest rates were much lower. Banks and S&L's hemoraged money until they had none left.
With no money to lend to those who might want to buy real estate and with the value of the real estate falling each day, so many banks and S&L's failed that the government set up the Resolution Trust Company, a government agency to take over failed financial institutions. It took years for the real estate market to recover.
Then, in the late 1990's Congress struck again, along with a weird social movement. First, Congress decided that it was every American's inalienable right to own a home. Then, Congress de-regulated the Banks.
People began buying homes, not just to have a place to live, but so they could "flip" them and make a profit. In fairly short order, individuals who a few years earlier couldn't qualify to finance a used car were signing "no documentation" loans and buying homes they couldn't possibly afford. Loans with low initial interest rates flooded the market, encouraging individuals to buy bigger and bigger homes and sell them before interest rates adjusted upward.
Stories began to circulate about the fabulous money otherwise marginal individuals could make, and "flipping" became a social movement. Churches assured parishioners that Jesus wanted everyone to be wealthy. Real estate investing became a mania. It was like musical chairs with money.
When the music stopped, lots of people couldn't find seats. When the value of real estate stopped climbing, the whole house of cards collapsed. Now, as the economy continues to contract, real estate values shrink further and further and those who can't service their loans through income, face the loss of everything they once had.
Next: What to do now?
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