Housing, Dating, Marriage and the Tax Code

 |  Includes: FMCC, FNMA
by: Matthew Rafat

Housing investors and fans of Robert Shiller's MacroShares Major Metro Housing Up ETF (UMM) should pay attention to the dating scene. The WSJ recently had an article on Japanese dating trends. The following sentence from the article made me think about modern marriage and housing prices:

Experts say that in tough times, single women feel an urgency to get married for financial stability, while men tend to put off marriage until they feel they can afford it.

I agree with the sentiment expressed above. If my thinking is typical, then pro-marriage advocates should promote low inflation. If a person has steady wages, s/he will probably want to buy a house. Once s/he buys a house and has money coming in, then marriage and children become the next natural step. Of course, people may marry and have children without owning a home, but most women want a stable place to have and raise their children. This is sometimes called the "nesting instinct." This nesting instinct is one reason housing prices and marriage are inter-related, especially because first-time homebuyers heavily impact housing demand and sales. If you still don't see the connection between marriage, children, and housing prices, listen to Barry Ritholtz:

A newlywed couple buys a starter home from a family (with another child on the way), who are moving to a bigger home, and whose seller is moving to an even nicer part of town, and so on. It is a long chain, not of mere lateral moves, but increases in size, cost (and property taxes). If any of those sales fall through, the entire chain collapses...Can they [the newlywed couple] afford that starter house? If not, then the entire real estate chain is frozen.

In his example, Mr. Ritholtz uses a married couple expecting children. But if houses are too expensive, then the typical younger person will delay marriage because s/he will not overpay for a house and/or will be concerned about taking on too much debt. Also, if a typical younger person's net worth is low, then s/he will not have a financial safety net and will be disinclined to purchase a house due to the fear of missing monthly mortgage payments. It takes time to build a financial safety net, so we may assume it will take several years before a typical younger person will be able to purchase a home. Thus, in an area with expensive homes, the typical person in his or her 20's and 30's is likely to delay getting married and having children. These seem like reasonable assumptions. The question is whether these assumptions rationally lead to the following conclusions:

1. If the government removes the home capital gains exemption and the mortgage interest deduction, then homes will become more affordable;

2. People are more likely to marry and have children if they can afford a home;

3. Therefore, to promote marriage, the government should not subsidize home purchases and sales.

The more I think about it, the more I believe our taxation system is anti-marriage because it encourages housing inflation. So many people complain about Greenspan and derivatives when discussing the housing bubble, but what about the tax code itself? Our tax code almost guarantees steadily increasing housing prices because of the mortgage tax deduction and the $250K exemption on capital gains when selling a primary residence. No other investment receives such generous tax treatment. But who decided it was a good idea to heavily subsidize housing transactions, and did that person think of the consequences?

The higher the price of a house, the longer a person has to save up to buy one. If single family houses become really expensive--like 500K+, which is still typical in the Bay Area--then the idea of saving a 10% to 20% down payment before the age of 35 becomes almost impossible. This is common sense, but if you're not convinced, just look at the Federal Reserve's numbers. According to the Fed (PDF file: February 2009 report, page A11), in 2007, the median net worth of an under-35 years old person in America was only $11,800--down from an astounding $80,700 in 2004. The median net worth of someone 35-45 was a much more respectable $86,600. Based on these numbers, and assuming banks will require at least a 10% down payment for a mortgage, it is safe to say that the typical metropolitan resident has to wait until around 35 years old to buy a single-family home (not a condo or townhouse). Again, assuming a link between homeownership, marriage and children, the longer it takes for couples to afford a home, the more difficulty couples will have getting married and having children.

However, many people get married before they turn 35 years old, and they want to buy a house, prices be damned. How does a bank accommodate a young newlywed's desire to own a home? Well, we've already seen what happens--the banks would issue the loan and then pass on the risks to Fannie Mae (FNM) and Freddie Mac (FRE). They did this because the tax code encouraged and continues to encourage homeownership. Thus, the predictable result of subsidizing/inflating housing prices is funny accounting (e.g., Alt-A mortgages, NINJA mortgages, "liars' loans," etc.), a steadily increasing marriage age (for those who decide to wait), or both.

If we are truly concerned about marriage and birthrates, isn't it time to re-examine the mortgage tax deduction and the government's plan to re-inflate housing prices? After all, the current tax system benefits banks and mortgage lenders more than the typical American family. By subsidizing houses so heavily, the American government is inflating the value of an essential asset and giving money lenders tremendous power over our lives. Our parents didn't have such high levels of mortgage debt, and they managed just fine. Heck, our grandparents would probably start a revolution if they were under our current system. If you think I'm overstating my case, research American history, especially the Great Depression. One of my favorite sepia pictures shows about fifteen Americans protecting a house from foreclosure. Anticipating the local sheriff, the resident and his neighbors had placed a very visible noose on the front door's awning and stood in the front yard, armed with rifles. I'm willing to bet the sheriff skipped that particular house and the bank wrote off the mortgage.

You don't have go too far back to see how tax incentives have inflated housing prices. For example, there's no question that tax incentives have created housing size inflation. Just look at the size of houses built in the 1950's--they were small, decent houses. American parents did a good job raising kids in those smaller, more affordable houses. Why do we need such large houses today? Who benefits from these larger homes? The developer and bank, which charge prices based on square footage, or the typical homebuyer? Is it really worth delaying marriage and having fewer children so we can pay the bank an extra ten years' worth of mortgage interest and principal?

I'm really getting off-topic now, but there is also an interesting sociological issue with allowing the tax code to inflate housing values. More specifically, couples on the coasts and in metro areas need two incomes to own a decent single-family home. This two-income requirement skews the dating game in favor of both high-earning men and high-earning women; as such, it devalues hopeful stay-at-home parents. If a man or woman is an excellent homemaker but does not earn much money, s/he may be at a disadvantage when "competing" for a long-term relationship. As a result, a woman might be an excellent secretary, waitress, and/or mother, but her "value" will be less in an area where two incomes are necessary for homeownership. By using the tax code to inflate housing values, one could argue our government has placed women who are interested in having and raising children at a competitive disadvantage.

My conclusion: if you want to fix the marriage problem and avoid another housing bubble, re-examine our tax incentives. Encouraging inflated housing prices isn't the best way to keep a nation growing, and it doesn't encourage upward mobility. (It sure does help the banks, though.)