Deficit Reduction

Yesterday the news was that the President's deficit-reduction panel came back with a list of unpopular suggestions to reduce the national debt by $4 billion over the next decade. Here's an example of an article on the subject.

Housing Prices will Drop

When I bought my house last year, I knew the housing prices were inflated. They always will be as long as the government subsidizes mortgages by giving a tax break for the interest. I told my family and friends that I was betting on the government not changing their policies anytime soon. Sounds like a pretty good bet. Well, the housing prices have continued to drop, but for other reasons entirely (no one is really good at determining the real worth of real estate). But it looks like I might lose my bet about the government as well. Part of the proposed effort to reduce the national debt is to end the tax break on mortgage interest.

Can I tell you---I’m thrilled. Sure, I would suffer from this decision, as I don’t plan to sell my house soon (for one thing, there is a huge loss incurred during a sale due to realtor and closing costs). If I were to venture a guess, I would say that this will cause an eventual 25% drop in home prices, but it won’t happen all at once. In fact, it might not be finished by the time I do sell my house (I hope).

The bottom line is that the government should stop sticking its business in things. Lower house prices are a good things for the world. Since when do we want things to be expensive? Hopefully some day we can all afford to live in great big houses (I’m being silly here---this is unrelated to the current discussion). Inflated prices inflate the risk that home owners take on. Some people make it big when they sell their house, and others lose and “need” a government bailout to reduce foreclosures. Ironically, this inflated market was encouraged by well-intended but unsophisticated law-makers who wanted to tamper with the system and help ease the burden of home owners. Didn’t work. Please, let free people be free and take care of ourselves.

What does a tax break have to do with home prices. Well, people tend to buy a home based on their monthly payments. If you give them a tax break, which reduces their monthly payments, there’s a good chance they’ll purchase a more expensive home. So now it’s as if there is a larger pool of money that people are using to buy homes. This translates to increased demand, which sends the home prices up. Who is gaining through all this? After all, the federal government is giving money to someone, or this change wouldn’t be part of a deficit reducing proposal. Well, it depends on a couple of things. If the house prices don’t change enough, then the home owners are the ones pocketing the subsidy. Those with more expensive houses pocket a larger subsidy (don’t read into this too much---I’m against progressive taxes anyway, so this isn’t really a problem in my view, when you work it all out). On the other hand, if the prices increase to the point where a person is still paying just as much for their mortgage with the tax break as they would have been paying without it, then the beneficiary is a little bit surprising. I want to say it’s the banks. They are now able to earn more money from interest because house prices are more expensive. But let’s be careful there. Under a competitive system, banks are only charging enough interest to cover their expected losses from default. Sure, they are earning some profit, but we can’t just say that they are pocketing all of the government subsidy. Consider this. Those who owned houses when the policy was first put into place experienced a welcome increase in house value. They sold their houses and pocketed the profit. Okay, well that only happened during the transition, so where is all the money going now. No, the real answer is that it’s paying the price of greater uncertainty. With higher house prices there is greater uncertainty. A bank charges interest because there is a possibility that a person will not pay off the loan. At the same time the house might have lost money. So there is no guarantee that the bank will recover it’s loan. Interest is the only way for the bank to recover this loss (since they don’t make any money from the home price increasing). With higher home prices, some people are making lots of money off of their home sales. Others are foreclosing. The government subsidy is paying for the interest, which is the expected loss, to allow you to have such high prices and potentially make it big when you sell your house.

In reality, the subsidy is being split between these two expenses. Paying for greater uncertainty, so that individuals can hold larger lottery tickets, and actually paying a part of the mortgage. The degree at which the money is split between the two depends on how much the home prices are affected by the subsidy. Demand is only one factor that affects the price of a resource. Supply is the other. Homes are supplied by construction, so that should anchor the price a bit. However, it’s quite clear that home prices swing around, pretty much superfluous to any kind of anchor. I don’t know why this is. Perhaps it is because of construction laws restricting cheap construction in desirable places. I know that Stanford University can’t build on their enormous lots of land. It’s probably part of the effort to maintain a “healthy” (read: inflated) housing market.

There’s one more thing to consider about interest rates. Interest rates are actually heavily influenced by the Federal Reserve. They are not dictated by a free market. Don’t ask me what that does to my analysis.

Raise the retirement age

Yes, it is difficult for anyone to lose money they were expecting. That’s what happens when a system breaks, such as the entire federal spending system. The good news is that the elderly are not the only ones who asked to wean themselves from government spending. Read my previous statement about my house. If you’re lucky, you downsize your house during the bubble and enjoyed a small inheritance.

The bottom line is that the government needs to get out of almost all aspects of our lives. Let us be free. It’s too bad that someone has to suffer during the transition. Just like anyone else, the elderly should look to family and friends for support.