Greedy businessmen and bankers price themselves out of the market. Greed is not enough to make you rich, you need a product that everyone thrives for.
The true culprit of this crisis was not greed, leverage or bad lending practices, but a little known fact. America has a tax code that allows Americans to deduct from taxable income, the interest on home mortgages, extendable to summer homes and sail boats. Up to 1 million dollars worth of mortgage.
The extent of this tax benefit is not always recognized. For example, at a 6% interest rate a US$ 1 million mortgage will allow you to deduct US$ 60.000.00 from your taxable income of, say, U.S. 200.000.00, reducing your taxable income to US$ 140.000.00.
Now multiply that by a 30 year mortgage, and you will have a taxable income deduction of US $ 1.800.000.00 on a US $1,000,000.00 mortgage. The number is not exactly correct, (interest diminishes with time) but that is how many homeowners calculate it. Depending on your tax bracket that can be a 50% saving.
Obviously it’s not a brilliant government economic policy, because it creates the following predictable consequences:
1. It stimulates indebtedness and over-indebtedness of practicably every American citizen. The higher the real estate debt, the higher your deductible allowances.
"There are no cows more sacred in the tax code than the deductions for mortgage interest and property taxes. Together, they add up to at least the $ 75 billion annual subsidy for housing and Homeowners. " The New York Times.
Houses paid in cash get no deduction. Rather than subsidizing the cost of home building, government is stimulating excessive loan taking.
2. It stimulates mortgages with minimal down payments, and maximum debt. Banks that demanded 30% down payments were outsmarted by competition.
3. The US tax code allows for a 100% deduction of the nominal interest rate, which means a 200% to 300% deduction of the real interest! So you pay 2% real interest, but get 6% tax deduction. The 4% inflation is actually income, it’s the amount your principal repayment is being eroded by inflation. No one is speculating with home appreciation, just waiting for inflation to do its job.
You need to live in countries with high inflation to understand all this, but believe me, the U.S. Tax code is allowing a much greater deduction by using nominal interest rates.
So no matter what your tax bracket that’s equivalent to zero real interest rate after tax!
Would you live in a house without paying interest? Who is being greedy here? Banks or taxpayers?
Only in America does someone secure a second mortgage after struggling for 20 years with mortgage payments. All over the world families want fully paid homes not fully leveraged homes. But the tax incentive here is too great to forego.
4. It stimulates over-production of home building and house price inflation. Especially when the FED established negative real interest rates, as they did in 1999, 2000,2001 and 2002. That was governments doing not banks.
Now for the good news. Because no one is mentioning all this as the real underlying driver of this disaster, this diabolical engine will remain in force, Obama is even considering more tax incentives.
In six months or less, Americans will be back buying up houses for the tax advantage.
Don’t forget that 1.5 million Americans will marry in 2009, and will be using their Mortgage Interest Deduction. Then there are those 200,000 who plan to buy Mortgage Interest Deductible summer homes and the 300,000 Americans that will be getting a divorce.
A total of 2 million homes, compared to 737,000 homes currently under construction. The inventory of truly salable empty houses is 300,000 to 400,000.
And more. The real interest rate today is now negative, homes are 12 to 25% cheaper, if not more.
Once Americans realize that the prices of housing have stopped falling, houses will be bought for their tax benefits once again if nothing else.
There is even a hidden cost in delaying home purchases, which is this nearly 50% tax incentive, depending on how you calculate the numbers and the inflation rate you expect.
The real culprit of this crisis was not the free market, banks, profit motive, or greed. It was an economic policy to encourage housing, distorting the free market, giving absurdly high incentives (nominal interest), in a ludicrous way via debt.
Disclosure: I do no not own any American bank stock. Only emerging market namely Brazilian shares, which includes one bank.
