The Moral Hazard of Promoting Homeownership

One of the high -- or low, depending on which candidate one supports -- points of the final debate before the Iowa caucuses came when Michele Bachmann let loose with both barrels on Newt Gingrich for his consulting/lobbying/whatever-the-heck-he-did-to-earn-$1.6-million-from-Freddie-Mac-and-Fannie-Mae.  To which Gingrich responded in part (emphasis mine):

I want to state unequivocally for everyone watching tonight:  I have never once changed my positions because of any kind of payment.... and the fact is I only chose to work with people whose values I shared and having people be able to buy a house is still a value that is important in America.

Sorry, Mr. Gingrich, but I disagree.

Now understand that, like virtually every American, I very much want a society where everyone who wants to buy a house can afford one.  But only if the buyer buys his house the old-fashioned way -- i.e., he (a) makes a substantial down payment (say, 20% of the purchase price) -- and (b) can make the mortgage payments without undue hardship.  And above all, he views the house as a home and not as an investment.

Clearly, Gingrich is saying something different, and the difference is between enabling homeownership and promoting it.  The former is fine, but the latter -- the idea that the government must actively encourage people to buy houses and enable them to do so by circumventing prudent private-sector lending criteria -- is wrong.  More than that, it's dangerous.

Those seeking the Great Recession's cause need look no farther than the federal government's ham-handed attempts to manipulate the residential real estate market through Fannie Mae, Freddie Mac, Fed-mandated artificially low interest rates, the Community Reinvestment Act, and various and sundry other congressional carrots and sticks -- all built on the fantasy that the basic laws of economics, which apply to every other aspect of life, do not, or can be made not to, apply to the federal government.

How many of you own a computer?  Let me hazard a guess: all of you, or else how are you reading this article?  Now, how many of you own a computer that is worth more today than it was when you bought it?  Unless you're one of the few prescient owners of, say, a pristine, perfectly preserved model of the first Apple computer, can we agree that the answer is none of you?  Ditto for most car owners, washing machine owners, and so on, down the line.  Most of us, most of the time, just naturally expect the items we buy to lose value over time.

And, being a licensed real estate broker, I can personally testify that it's the same in real estate, or at least it is in commercial real estate.  When an investor considers the purchase of a building, he examines that building with the same critical eye as someone who invests in stocks, vintage wines, baseball cards, or anything else.  He does his due diligence and does it carefully, fully aware that the value of a building, like the value of anything else, can go up -- or it can go down.

But sadly, the average Joe buying a house seems not to understand, let alone accept this obvious fact.  Instead, he operates on the -- let's be brutally frank here -- absurd belief that residential housing prices can, indeed, must move in only one direction:  up.  It doesn't matter how much Average Joe paid for his house, what shape it's in, where it's located, how many other houses (supply and demand) are on the market at whatever time that he decides to sell his.  No, in the residential market, economic laws, even the basic law of supply and demand, do not apply.

And so, when the market value of Average Joe's house goes down instead of up, something has gone wrong -- not in the reasoning that motivated him to buy the house, but morally -- at least to hear liberal Democrats -- and, sadly, all too many conservative Republicans.

Worse, too many people, of both parties, of both political philosophies, believe that when housing prices fall, the federal government has a duty to skoosh 'em up again.  And since the federal government cannot, however fervently it wishes it could, suspend the law of supply and demand by edict, the only way to sop up excess supply is to increase demand.  And the only way to increase demand in a shortage of qualified buyers is to bring in a lot of unqualified buyers.

And that's precisely what we've been doing by, for example, lowering creditworthiness standards, forcing down interest rates, and reducing the percentage of purchase price required for a down payment.  And with Franklin Delano Obama and John Maynard Bernanke in charge, don't be surprised if we get a lot more of these shenanigans.  Because what Frankie and Johnnie don't seem to understand is that when one artificially increases demand, one ultimately inflates supply -- its size, its price, or both.  Which in turn requires further lowering of interest rates and further loosening of creditworthiness criteria, which then further inflate supply and...well, you get the idea.  Continue the process long enough, and it's just a matter of time until we bid farewell to economics and enter the realm of mathematics.  After all, how much lower than zero can interest rates go?

So what should the government do?  May I suggest that it do nothing?  Let interest rates rise, thereby both increasing the value of people's savings and encouraging them to save more.  Government is not the only one with a borrowing and spending problem.  Average Joe is up to his eyeballs in debt, and, just like the government, he needs to retrench, rebuild his balance sheet.  And most importantly, he needs to cut up his credit cards and learn to buy only what he can afford, with money he actually has, after he's socked away a portion for savings.  Let housing prices fall to their true market value, thereby making them affordable.  Let mortgage lenders lend based on the traditional criterion -- i.e., their estimation of the borrower's ability to repay the loan.  And for God's sake, privatize Freddie and Fannie.

And those of you thinking about buying a house need to think twice.  Do you love the house and want it to live in, or is it an investment, too?  If the former, then by all means, buy if you can afford it.  And by "afford," I don't mean barely -- I mean comfortably, or at least without undue hardship.  If you and your spouse currently work outside the home and one of you cannot, or decides not to, work, will you still be able to pay your mortgage?  And utilities?  And property taxes?

And those who want their house to be an investment need to think three times.  Why do you expect the value of the house you're contemplating to increase?  And no, "because it went up for the previous owner" is not an answer.  Nothing goes up to infinity; someone will be the last person in line, holding the bag.  Don't let it be you.

Consider also the experiences of the "investors" who invested their entire savings in Enron stock and Bernie Madoff's Ponzi scheme and lost everything.  At the risk of stating the obvious, had these folks diversified and invested only 1% of their savings in these vehicles, they would be a lot better off today.  So maybe sinking the bulk of one's assets into a single investment idea -- including one's home -- is not such a great idea?  Maybe it's better to rent one's dwelling and invest the cash that would have gone for repairs, property taxes, and the myriad other costs associated with owning and maintaining a home, in a diversified portfolio of bonds, CDs, mutual funds, and individual stocks instead.  Maybe that would happen more often if the government treated all investments, including investment in a house, equally.

But the biggest factor in my disagreement with Gingrich and his homeownership-promoting ilk is the moral hazard.  How do we bail out the current cohort of people who paid too much for houses they can't afford, without creating an expectation of future bailouts and creating the conditions for another bubble?  And how do we maintain the purchasing power of people's savings -- and avoid discouraging people from saving in the first place -- if we essentially print money to finance the purchases of these overpriced homes?

I leave you with this final thought, based again on my experience as a commercial real estate broker.  In the commercial real estate market, the federal government has no program to promote "business property ownership" or to "make commercial buildings more affordable."  And in this environment, only the biggest, richest enterprises -- your Microsofts, your Ford Motor Companies -- buy the buildings that house their businesses.  Overwhelmingly, businesses choose to rent, including giants such as Google, which rents its Manhattan space.  (Oh, to have been the broker on that deal!)  That most businesses choose to lease, rather than buy, their places of business ought to tell you something.  These guys are not stupid.

But apparently, many homebuyers are.  And the government, with its policy of encouraging people to buy instead of rent, is not helping.

Gene Schwimmer is the author of The Christian State.

One of the high -- or low, depending on which candidate one supports -- points of the final debate before the Iowa caucuses came when Michele Bachmann let loose with both barrels on Newt Gingrich for his consulting/lobbying/whatever-the-heck-he-did-to-earn-$1.6-million-from-Freddie-Mac-and-Fannie-Mae.  To which Gingrich responded in part (emphasis mine):

I want to state unequivocally for everyone watching tonight:  I have never once changed my positions because of any kind of payment.... and the fact is I only chose to work with people whose values I shared and having people be able to buy a house is still a value that is important in America.

Sorry, Mr. Gingrich, but I disagree.

Now understand that, like virtually every American, I very much want a society where everyone who wants to buy a house can afford one.  But only if the buyer buys his house the old-fashioned way -- i.e., he (a) makes a substantial down payment (say, 20% of the purchase price) -- and (b) can make the mortgage payments without undue hardship.  And above all, he views the house as a home and not as an investment.

Clearly, Gingrich is saying something different, and the difference is between enabling homeownership and promoting it.  The former is fine, but the latter -- the idea that the government must actively encourage people to buy houses and enable them to do so by circumventing prudent private-sector lending criteria -- is wrong.  More than that, it's dangerous.

Those seeking the Great Recession's cause need look no farther than the federal government's ham-handed attempts to manipulate the residential real estate market through Fannie Mae, Freddie Mac, Fed-mandated artificially low interest rates, the Community Reinvestment Act, and various and sundry other congressional carrots and sticks -- all built on the fantasy that the basic laws of economics, which apply to every other aspect of life, do not, or can be made not to, apply to the federal government.

How many of you own a computer?  Let me hazard a guess: all of you, or else how are you reading this article?  Now, how many of you own a computer that is worth more today than it was when you bought it?  Unless you're one of the few prescient owners of, say, a pristine, perfectly preserved model of the first Apple computer, can we agree that the answer is none of you?  Ditto for most car owners, washing machine owners, and so on, down the line.  Most of us, most of the time, just naturally expect the items we buy to lose value over time.

And, being a licensed real estate broker, I can personally testify that it's the same in real estate, or at least it is in commercial real estate.  When an investor considers the purchase of a building, he examines that building with the same critical eye as someone who invests in stocks, vintage wines, baseball cards, or anything else.  He does his due diligence and does it carefully, fully aware that the value of a building, like the value of anything else, can go up -- or it can go down.

But sadly, the average Joe buying a house seems not to understand, let alone accept this obvious fact.  Instead, he operates on the -- let's be brutally frank here -- absurd belief that residential housing prices can, indeed, must move in only one direction:  up.  It doesn't matter how much Average Joe paid for his house, what shape it's in, where it's located, how many other houses (supply and demand) are on the market at whatever time that he decides to sell his.  No, in the residential market, economic laws, even the basic law of supply and demand, do not apply.

And so, when the market value of Average Joe's house goes down instead of up, something has gone wrong -- not in the reasoning that motivated him to buy the house, but morally -- at least to hear liberal Democrats -- and, sadly, all too many conservative Republicans.

Worse, too many people, of both parties, of both political philosophies, believe that when housing prices fall, the federal government has a duty to skoosh 'em up again.  And since the federal government cannot, however fervently it wishes it could, suspend the law of supply and demand by edict, the only way to sop up excess supply is to increase demand.  And the only way to increase demand in a shortage of qualified buyers is to bring in a lot of unqualified buyers.

And that's precisely what we've been doing by, for example, lowering creditworthiness standards, forcing down interest rates, and reducing the percentage of purchase price required for a down payment.  And with Franklin Delano Obama and John Maynard Bernanke in charge, don't be surprised if we get a lot more of these shenanigans.  Because what Frankie and Johnnie don't seem to understand is that when one artificially increases demand, one ultimately inflates supply -- its size, its price, or both.  Which in turn requires further lowering of interest rates and further loosening of creditworthiness criteria, which then further inflate supply and...well, you get the idea.  Continue the process long enough, and it's just a matter of time until we bid farewell to economics and enter the realm of mathematics.  After all, how much lower than zero can interest rates go?

So what should the government do?  May I suggest that it do nothing?  Let interest rates rise, thereby both increasing the value of people's savings and encouraging them to save more.  Government is not the only one with a borrowing and spending problem.  Average Joe is up to his eyeballs in debt, and, just like the government, he needs to retrench, rebuild his balance sheet.  And most importantly, he needs to cut up his credit cards and learn to buy only what he can afford, with money he actually has, after he's socked away a portion for savings.  Let housing prices fall to their true market value, thereby making them affordable.  Let mortgage lenders lend based on the traditional criterion -- i.e., their estimation of the borrower's ability to repay the loan.  And for God's sake, privatize Freddie and Fannie.

And those of you thinking about buying a house need to think twice.  Do you love the house and want it to live in, or is it an investment, too?  If the former, then by all means, buy if you can afford it.  And by "afford," I don't mean barely -- I mean comfortably, or at least without undue hardship.  If you and your spouse currently work outside the home and one of you cannot, or decides not to, work, will you still be able to pay your mortgage?  And utilities?  And property taxes?

And those who want their house to be an investment need to think three times.  Why do you expect the value of the house you're contemplating to increase?  And no, "because it went up for the previous owner" is not an answer.  Nothing goes up to infinity; someone will be the last person in line, holding the bag.  Don't let it be you.

Consider also the experiences of the "investors" who invested their entire savings in Enron stock and Bernie Madoff's Ponzi scheme and lost everything.  At the risk of stating the obvious, had these folks diversified and invested only 1% of their savings in these vehicles, they would be a lot better off today.  So maybe sinking the bulk of one's assets into a single investment idea -- including one's home -- is not such a great idea?  Maybe it's better to rent one's dwelling and invest the cash that would have gone for repairs, property taxes, and the myriad other costs associated with owning and maintaining a home, in a diversified portfolio of bonds, CDs, mutual funds, and individual stocks instead.  Maybe that would happen more often if the government treated all investments, including investment in a house, equally.

But the biggest factor in my disagreement with Gingrich and his homeownership-promoting ilk is the moral hazard.  How do we bail out the current cohort of people who paid too much for houses they can't afford, without creating an expectation of future bailouts and creating the conditions for another bubble?  And how do we maintain the purchasing power of people's savings -- and avoid discouraging people from saving in the first place -- if we essentially print money to finance the purchases of these overpriced homes?

I leave you with this final thought, based again on my experience as a commercial real estate broker.  In the commercial real estate market, the federal government has no program to promote "business property ownership" or to "make commercial buildings more affordable."  And in this environment, only the biggest, richest enterprises -- your Microsofts, your Ford Motor Companies -- buy the buildings that house their businesses.  Overwhelmingly, businesses choose to rent, including giants such as Google, which rents its Manhattan space.  (Oh, to have been the broker on that deal!)  That most businesses choose to lease, rather than buy, their places of business ought to tell you something.  These guys are not stupid.

But apparently, many homebuyers are.  And the government, with its policy of encouraging people to buy instead of rent, is not helping.

Gene Schwimmer is the author of The Christian State.