The Sovereign Mind

A few years ago, when my wife and I were looking to buy our first home, we had a conversation with a seller’s realtor that went something like this:

Realtor: “Well you know, when your considering how much you can afford for your home, you should take into account that your mortgage interest will be tax deductible.”

Me: “Yeah, that’s true. But this home still seems like it might be out of our price range.”

Realtor: “Really? Well, that tax deduction will save you a couple hundred dollars on a house like this.”

Me: “Actually, I’ve looked at the numbers, and that assumes that we are currently itemizing. Since we’re not, a lot of that tax deduction will just go to getting us over the line where taking the itemized deduction is better than taking the standard deduction on our tax returns. In our case, I think it will only save us about a hundred dollars.”

Realtor: “Oh… well, you should really talk to a financial advisor about that… so, let’s take a look at the basement…”

During our home buying experience we were bombarded by anecdotes about how much money people make from their home. People would tell me that they sold their home for $50,000 more after 5 years, but completely ignored the fact that they paid almost that much in mortgage interest and property tax over that same amount of time.

We did end up buying a house (not from that realtor), but I didn’t think of it as an investment primarily. What we wanted was difficult to find in a rental, and we wanted our own space. We bought in a location that was not part of the bubble for the most part, we got a fixed rate loan, and made sure we could afford the payments. I can’t say we were completely responsible: we did get a zero down payment loan.

My personal story aside, let’s re-think the rent vs. buy assumptions:

Most of the angst regarding the current housing crisis is related to this common theme:

Why should the little guy suffer because banks and real-estate investors made bad decisions?

That seems like a reasonable question. If the real estate market tanks, it makes sense that the investors and banks should lose money. They are the ones that had the money to invest and were making the decisions. But I have bad news: If you own a home, you are a real-estate investor, and a pretty badly diversified and leveraged one at that. And you’re not only invested in the real estate market, but also in all of the financial system that decides how it is managed. So that’s why the little guy (or at least the little real-estate investor) suffers because of the housing crisis.

So how did that happen? You wouldn’t take out a loan at 7% to borrow $200,000 to invest in the stock market, would you? That would be very risky because even if the stock market drops 1%, you are now short $2,000, or more considering your interest is still added in good times and bad. Of course you wouldn’t do that unless you have money to burn, but that’s what you are doing when you buy a home. Some thought the real-estate market was a safe investment (it’s not as volatile as a stock), but that was foolish thinking. If it can go up fast (which it did in many markets), it can come down fast. That is a basic principle of investment: The more reward, the more risk.

Not only that, but home ownership also makes you less mobile, making it more difficult to find new jobs in new places during economic trouble.

This lesson comes too late for the 10% of home owners that find themselves upside down in their loans, and there’s no doubt that mortgage brokers who sold them on false hopes have their (big) share of blame as well. But what about the future? What should be done to prevent this from happening again?

I think the answer is simple:

The concept of home ownership should no longer be part of the American dream.

Apparently I’m not alone. Even Barney Frank, who has been one of the biggest proponent of the home ownership for all (otherwise known as the “everyone should be a highly-leveraged and badly diversified real-estate investor” policy), is now saying that perhaps home ownership for all was not the right policy to pursue:

One of the problems that we got into was we did way too much home ownership and way too little rental housing. And [we need to start] getting the federal government back in the business of rental housing. And passing legislation to restrict bad subprime loans will be high on our priority list.

I’m not sure I agree with his knee-jerk reaction that the government needs to provide said rental housing, but I agree that “we did way too much home ownership” as both a government and a society.

For years people have been saying that renting is “throwing your money away” and promoting home ownership as the basic status symbol of economic prosperity. Who has been saying this? Well, the same Barney Frank for one. His own website touts the benefits of the “Expanding American Homeownership Act of 2007″, some of which include lower down payments and more mortgages to higher risk borrowers.

But politics aside, I hope we will learn this lesson from this crisis: The American Dream cannot be purchased with a credit card. The American Dream is not about what you own; it is not about short-cuts or get rich quick schemes; it’s about what you do; it is about freedom: freedom to work, be smart, innovate, struggle, and succeed.

Wow, could I think of a more boring title for a blog post?

Economics is probably considered one of the most boring of topics, but it also happens to be at the root of many policy debates. As I browse some blogs in my free time, I’ve noticed that it seems a lot of people are clueless when it comes to economics. Am I especially troubled by the characterization (which is gaining supporters recently) that the free market as a failed experiment. Certainly there are aspects of our economic system that have problems and have let to our current recession, but to characterize the free market as the cause of everything that is bad is to desecrate the system that has allowed us to become the most productive society in the world.

Many policy debates between liberals and conservatives hinge on a fundamental question: What economic factors should be controlled by government, and what factors should be left to the control of the free market? Of course that’s a simplification, but that’s the root of it. In debating this question, I’ve heard statements from both sides (but not necessarily representative of everyone on their respective sides) that I believe indicate a flawed understanding of basic economics. Here are two paraphrased examples from both sides:

From the left: Businesses should be taxed more because they are lucky to be running in such a prosperous nation (the U.S.) that we live in. Business should have the pay a high premium to be allowed to do business here.

From the right: Since consumers would usually buy a cheaper car that is worse for the environment than a more expensive car that is better for the environment (all other factors being equal), that means that consumers don’t value environmental conservation. Environmentalist shouldn’t be pushing for more environmentally friendly cars if the free market won’t produce those cars by itself.

Today I stumbled across a useful website: http://www.basiceconomics.info/. I think I will use it to link to in response to such statements. Specifically, the first comment (from the left) exhibits a lack of understand of the negative effects of business taxes, and the second comment exhibits a lack of understanding of externalities.

Why is this important? Is it just a game for political junkies? I don’t think so. These issues are important to the future of our world–the one our kids and grandkids will live in. So I hope more people (particularly those who seek to promote government policy) will educate themselves in basic economics. And I will hold myself to the same standard. The website I linked to seems to be an unbiased economics introduction. But if you feel it leaves out important information or is biased, please feel free to offer a link of your own.