Category: housing subsidies

A Debate on Subsidies

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January 12, 2025

by Stephen Stofka

This is ninth in a series of debates on various issues. The debates are voiced by Abel, a Wilsonian with a faith that government can ameliorate social and economic injustices to improve society’s welfare, and Cain, who believes that individual autonomy, the free market and the price system promote the greatest good.

After a few pleasantries, Abel began, “Last week, we finished talking about the government’s role in the social contract. The scope of that role is the key difference between your group and mine.”

Cain nodded. “Your group thinks of the federal government as an insurance company. Our group tries to keep your group in check. It’s not easy.”

Abel replied, “Your group may believe in a more limited role for government as a general principle, but you advocate policies that contradict that principle. Take housing as an example. It is a private good that is heavily subsidized by the federal government.”

Cain tilted his head in an equivocating manner. “Let me stop you there. Are you asking whether our group supports federal underwriting of thirty-year mortgages? In principle, we shouldn’t. The federal government should have a minimal role in the exchange of private goods. As a practical matter, the entire housing market would collapse if the federal government did not underwrite most mortgages in the U.S.”

Abel interrupted, “But your group doesn’t support the federal government’s student loan program.”

Cain nodded, “That’s right. An education is a different type of good than a house. An education can’t be separated or alienated from a person. A house can. I would prefer that the federal government not be involved in the mortgage market, but few states have the resources to underwrite mortgages. Private banks prefer not to underwrite 30-year mortgages at low interest rates. Only the U.S. and tiny Denmark have 30-year mortgages at fixed interest rates (source).”

Abel said, “But the higher education market would collapse without federal student loans, grants and subsidies. That same practical reasoning supports the federal involvement in underwriting higher education loans.”

Cain shook his head. “Housing has a concrete public aspect to it. Education doesn’t. The Constitution specifies a role for the federal government. It is to provide for the ‘general welfare,’ not private welfare. An education is inseparable from a person’s private welfare.”

Abel objected, “But private welfare contributes to the general welfare. This is a sticking point between our two groups. Your group regards the general welfare as only those goods or services that are available to all. The sum of individual welfare is the general welfare.”

Cain replied, “Look, everyone who wants a subsidy claims that their private welfare will contribute to the public good. Car manufacturers want protective tariffs and subsidized loans, claiming that it will help preserve jobs. Ranchers want below market rates on grazing land for their catttle, claiming that they will be motivated to act as good stewards of that land and help preserve it. College students want subsidized loans and grants on the premise that their improved skills will contribute to a better society, a more productive work force.”

Abel argued, “But your group is more likely to support subsidies for ranchers and farmers.”

Cain shrugged. “The subsidy for grazing fees is about $100 million, according to one estimate. Americans have $7.5 trillion in federally backed mortgages at an interest rate that is at least 5% below market. That’s an indirect annual subsidy to homeowners of $350 billion, with a ‘b.’ Subsidies to farmers and ranchers are like drops in the bucket compared to the subsidies to homeowners. Divide that $350 billion by approximately 50 million federally backed mortgages and each mortgage holder gets an average annual subsidy of $7000. The federal government looks like it has deep pockets. Everyone wants to stick their hand in those pockets. It’s the road to ruin.”

Abel argued, “But the federal government has a long history of handing out subsidies. In the 19th century, they gave out vast tracts of western lands to the railroads for pennies an acre. After the tracks were built the railroads sold the land to developers for many times what the railroads paid. Then the developers sold the land for many times that to homesteaders. Subsidies are a tool of government.”

Cain interrupted, “Tools to achieve what? Policy goals. Who sets those policy goals? The politicians in Washington. What is their policy goal? To get re-elected. How do they get re-elected? By gettting subsidies of some sort for their constituents. What is the sum of those individual efforts by elected officials? A government whose main purpose is giving out subsidies. There has to be some principle in place to limit that kind of largesse.”

Abel asked, “So what? End all subsidies? That is not going to happen. America binds all these regional interests together by handing out subsidies to homeowners, students, farmers, ranchers, people of every business type. In an earlier era, Senate leaders inserted earmarks for those senators who held crucial votes. Former OMB director George Shultz quipped, ‘the budget process was a fight of the parts against the whole and the parts always won.’ (Behn 1977, 109).”

Cain interrupted, “That practice promoted increased spending and deficits. When the government borrows money, that increases the money supply and inflation. Then the Federal Reserve has to fight inflation by adjusting interest rates. Higher interest rates causes a drop in investment which can raise unemployment. There’s just a whole cascade of economic effects.”

Abel argued, “In 2006, John Boehner, the former Speaker of the House, ended all earmarks in the House. Have deficits decreased? No, they have gotten worse. So has the polarization in the Congress and in the country. The public is like a pack of hungry dogs. Give each of them a little bit of meat and they won’t tear each other apart.”

Cain shook his head. “Tell the voters on the campaign trail that they are a bunch of dogs. The problem with your group is a lack of respect for the public and way too much respect for politicians and experts.”

Abel conceded, “Ok, maybe the hungry dogs imagery wasn’t the best, but look at the defense industry. It wields a lot of influence on Capitol Hill and your group is a big supporter of defense contractors. Defense is one of the few legitimate constitutional duties of the federal government, you say. Each individual representative in Congress votes for more defense spending if it will mean more federal tax dollars coming into their state. Each representative competes for defense dollars even if it is wasteful. It’s pork barrel politics.”

Cain said, “The saying goes, ‘something that can’t last forever won’t.’ The country can’t keep running deficits and borrowing money from the private sector. The interest on that debt keeps getting larger every year. It’s unsustainable. Deficit spending is a security issue. If and when a large war breaks out, the country will not be able to muster a strong response.”

Abel nodded. “Our group agrees that deficit spending is a problem. Your group thinks that earmarks are a big part of the problem. We don’t. Pork barrel politics joins people together. All the different constituencies in the country gather together to pull one of two ends of the rope. What we need is higher taxes on upper income households to afford those earmarks.”

Cain shook his head. “Higher taxes reduces investment.”

Abel interrupted, “So your group says. During the 1990s, both taxes and investment increased. In fact, investment increased at the highest pace since World War 2, and we had budget surpluses by the time Clinton left office at the end of the decade. Higher taxes do not reduce investment.”

Cain argued, “Look, the birth of the internet and the computer age was a special case. That exception does not support your case.”

Abel smiled. “Taxes and the effect of taxes is a whole other discussion. See you next time.”

Cain nodded and turned to leave. “Until then.”

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Photo by Anna Samoylova on Unsplash

A 2010 analysis by the Congressional Research Service found that few developed countries offer 30-year mortgages at fixed interest rates. https://crsreports.congress.gov/product/pdf/R/R41432/3

An analysis by the Center on Biological Diversity estimated an annual subsidy of $100 million to ranchers in below market rates for grazing fees. https://www.biologicaldiversity.org/programs/public_lands/grazing/pdfs/CostsAndConsequences_01-2015.pdf

Federally backed mortgages rose from $707 billion in 2009 to $5 trillion in 2010 and have risen steadily since then. https://fred.stlouisfed.org/series/BOGZ1FL403065005Q

Behn, Richard. 1977. “The False Dawn of the Sunset Laws.” The Public Interest (Fall): 103-118. doi: https://www.nationalaffairs.com/public_interest/detail/the-false-dawn-of-the-sunset-laws.

The Federal deficit as a percent of GDP https://fred.stlouisfed.org/series/FYFSDFYGDP

Tevlin, S., & Whelan, K. (2000). Explaining the investment boom of the 1990s. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.221415 In the seven-year period 1992-1998, investment growth averaged a record-breaking 11.2%. A copy of the paper can be found at https://www.federalreserve.gov/pubs/feds/2000/200011/200011pap.pdf

A Debate On Rent Control

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November 24, 2024

by Stephen Stofka

This is part of a continuing series of debates on economic and political issues. Substack users can find last week’s debate on climate change here. WordPress and other  users can visit my web site innocentinvestor.com here. Wishing everyone a good Thanksgiving this next week.

This week’s letter is about the price system, continuing an imagined conversation that began with last week’s letter. What is a price? Is it a measure? If so, it is not a good one because prices keep changing from year to year. Let’s imagine a haircut from the same stylist that costs 5% more in 2024 than in 2023. Did the quality of the haircut change? No. the service delivered is the same but not the price. So, what is price? It must be a good in and of itself – a commodity like wheat. A good that “evaporates” like water in the sun. The CPI calculator at the Bureau of Labor Statistics indicates that a $1 in 2024 buys what $0.50 did in 1995. Any interest earned on savings has barely compensated for the loss of buying power (see notes).

And now the conversation between Abel and Cain continues:

After the usual pleasantries, Abel said, “Last week I pointed out market failures where the price system in a free market does not control a negative externality like pollution. Another flaw in the pricing system is its inability to cope with social justice issues. Your group favors policies that emphasize growth. You claim that more growth will benefit everyone, including minorities. What about rent control? Land can’t grow. In densely populated cities like New York, the only way to grow the housing market is to build up. Zoning policies restrict the height of many residential areas, and the current residents prefer it that way.”

Cain replied, “Rent control is a price control and our group does not favor price controls in any form. They distort the supply and demand dynamics of a market. Rent control encourages landlords to make only those repairs which will avoid regulatory fines from housing authorities. The quality of the housing stock declines and that only contributes to the problem. Housing authorities must devote more resources to inspect properties, handle tenant complaints and regulate landlords.”

Abel interrupted, “So what’s your suggestion? In crowded markets like New York, the housing supply is too rigid, so it doesn’t shift to meet demand like in a supply demand model. If prices were allowed to find an equilibrium on their own, many working people would be priced out of the market. They would have to move further away from the city and drive long distances to get to work. This would choke an already overtaxed traffic and transit system. What’s your group’s answer? Let people move to another state? The tri-state area has already become a giant metropolis because families have tried that solution. The problem persists.”

Cain nodded. “Yes, there are choke points where circumstances or political interests constrict supply. The first question politicians should ask is ‘How can we adapt the price system to help manage this particular market?’ If we look at improperly maintained housing as a pollutant, perhaps policymakers could use a permit system or tradeable credits, the same system that has been successful with some pollutants.”

Abel asked, “How would that work? Make available a number of permits to not maintain housing units to safe health and safety standards? Housing can’t be turned into a lab experiment.”

Cain responded, “Each city may devise different pricing solutions. Some may work better than others, allowing competing policy frameworks to be tested in different circumstances. The point is that regulations and rent control should not be the first tool that policymakers reach for.”

Abel asked, “Has anyone used an incentive-based strategy using the price system to tackle the problem of affordable housing in a dense urban area?”

Cain replied, “Not that I am aware of.”

Abel argued, “Proves my point. Some issues cannot be resolved through the price system. People tolerate many inconveniences in a big city because there are many factors that induce them to stay.” Abel ticked them off on each finger, “Jobs, family, public transportation and infrastructure, civic associations with people having similar interests, schools for the kids, sports teams, the availability of internet, public institutions like libraries, internet, parks, museums.”

When Abel paused to take a breath, Cain interjected, “I get your point. A home of some sort in a city gives people access to amenities that are not available in a rural district with 2,000 residents. People want availability to all that stuff and pay as little as possible.”

Abel interrupted, “Are you saying that working people who spend half of their income on a place to live in New York City are freeloaders? It’s the upper income people that employ them who are freeloading. The rich are getting labor at an affordable rate. If working people could charge enough to cover their living expenses, they would get paid a lot more than they do.”

Cain argued, “It’s the rich people who are paying most of the state and local taxes that pays for all those amenities. The rich are subsidizing these institutions that the working class take advantage of.”

Abel said, “The median rent in the Bronx is 60% higher than the national average, according to an analysis by Zumper. The average monthly rent for a 2-BR apartment is almost $3500 and the  Bronx is one of the more affordable of the five counties in New York City. The national median annual wage for warehouse workers is $38,000, according to the BLS. That’s almost $3200 a month. A couple working two blue collar jobs would be spending more than half their gross income on rent. A prudent percentage is 30%, or less than a third of gross income. If New York City policymakers were to require employers to pay 60% above the national average, those warehouse workers would make almost $61,000 a year, or $5100 a month. Two incomes at that wage would total over $10,000 and that $3500 median rent in the Bronx would be about 34% of income.”

Cain dismissed Abel’s argument. “Those New York City employers wouldn’t be able to compete with other companies in surrounding regions with lower costs. They would leave or go out of business. There would be fewer warehouse jobs. That couple would have to compete with others for blue collar jobs. The increased supply of labor competing for jobs would further lower the market wage and make the couple dependent on social welfare programs. The city would have less tax revenue because those warehouse employers have left the city. Less property tax, less income tax, less tax on business income. The city could not afford to pay more benefits and might declare bankruptcy like it did in the mid 1970’s. A complex negative feedback loop. Policymakers who tinker with natural market forces only make the problem worse.”

Abel objected, “If that couple followed the signal of those market forces, they would move to a lower cost area in a nearby state. There would be fewer workers in New York City, driving up wages. As the couple tried to find work, they would drive wages down further in that nearby state. Those lower costs would enable employers to reduce their prices and put the New York City companies out of business.”

Cain responded, “In order to survive, those New York companies would also leave the city. Anyway, capital relocates faster than people. As soon as policymakers announced a law mandating that employers pay premium wages, a lot of blue-collar companies would relocate out of the city. Our blue-collar couple would be out of a job. Just as with a previous scenario, the couple would be dependent on the government for aid. The price system promotes independence.”

Abel protested, “Paying higher rents than the national average does not promote worker independence. A dense housing market is a seller’s market, a landlord’s market. Without some laws in place to protect renters, they would be entirely at the mercy of landlords. Market prices in a dense housing market like New York only promote independence for those with capital and access to capital like landlords.”

Cain shook his head. “Once again, your group and mine can’t agree. Your group blames capitalists for everything.”

Abel replied, “That’s overstating our objections. Capitalists promote a dynamic economy that responds to changing circumstances. But capitalists can’t operate only in the framework of the pricing system. In some markets, price dynamics often make the problem worse. As Keynes and other economists have shown, an unguided free market system can settle at equilibrium points that are below the productive capacity of a nation’s people and businesses. There is no automatic mechanism to move an economy to an optimal equilibrium of productivity.”

Cain turned to go. “Well, our group disagrees. The free-market system promotes growth, and it is growth that generates a productive equilibrium.”

Abel replied, “I know your group believes that, but belief doesn’t make it so. The housing market in New York City is just one example of market failure, the inability of prices to allocate resources. It is one of many.”

Cain replied, “Maybe we should talk about market failures next time we meet. Behind every market failure is a policy failure, believe me.”

Abel responded, “See you next time.”

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Photo by Shehan Rodrigo on Unsplash

Buying power note: Inflation has averaged 2.76% annually since 1995. The interest on a 1-year Treasury note (FRED Series DGS1) is similar to a 36-month CD rate and has averaged 2.6%.

Subsidies and Deficits

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November 12, 2023

by Stephen Stofka

Note: at the end is a correction to last week’s letter.

This week’s letter continues to investigate the subsidies, both direct and indirect, that secure re-election for politicians but make deficits inevitable. This week there was weak market demand for $24 billion of newly issued 30-year Treasury bonds, forcing primary dealers like J.P. Morgan to absorb 24% of the debt, more than twice their usual participation rate. Treasury bonds carry little if any credit risk because the U.S. can always pay its debts by issuing more debt. However, long term debt exposes traders to market risk that they must offset by demanding a higher rate of interest for purchasing the debt. Higher interest payments narrow the budget space for subsidies and benefit programs that politicians dole out to gain constituent support. The long term outlook is that our arguments over fairness will cause greater fractures in our society.

As social animals we begin at an early age to form a sense of fairness that can test parents’ patience. An older sibling gets to stay up later at night and that is unfair. The level of chocolate milk is lower in one glass than in a sibling’s glass and that is unfair. We sympathize with animals who suffer the loss of their parents, their herd, or their environment. While we may have an instinctive ability to recognize unfairness, we must be taught how to construct rules that are based on fairness. These involve conflicts over sharing toys, a playroom, or a TV game console. Through experience and temperament, we build a framework of fairness that is unique. As we grow older we glue these values together with justifications and associate with others who share similar values. We form interest groups that compete for federal, state and local benefits, reasoning that our welfare is the general welfare.

We have been taught since childhood that public laws and public monies should be spent on the public good. We may not recognize property arrangements that advantage one group by disadvantaging another group, or at the expense of the general public. The exchange of goods and services take place in a web of property rights whose density obscures the dependencies between parties. Those rights are instituted and enforced by a network of government institutions – a legislature or council, an executive agency, the courts and a police force. Those rights favor a majority according to some characteristic, or an effective interest group that directs public money and property to their cause.

At the heart of most contentious Supreme Court decisions is the reality that one group of people in this country are going to indirectly subsidize others. One group of people will have to give up something – call it rights, power or a sense of safety – for other people to enjoy rights, power or greater security. More than 200 years ago, Adam Smith wrote that a well governed society with a respect for private property could produce a greater prosperity for everyone in the society. His was a long term vision. In the short term empowerment is a zero sum game and that is why so many issues in our society are contentious.

When a subsidy benefits a relatively small group of people, they fight hard to protect that subsidy. When the costs for the subsidy are spread over a large group, there is little opposition to the subsidy. An interest group becomes part of an Iron Triangle to protect the subsidy. This triangle consists of the interest group, a legislative subcommittee and an executive agency. An example is the ethanol subsidy. Department of Energy data shows that, in 2022, 35% of the corn crop in America was devoted to the manufacture of ethanol. Over its life cycle, ethanol added to gasoline reduces greenhouse gas emissions (GHG) by 40%, according to several studies. Farmers receive a maximum subsidy of $20 per dry ton of corn or other feedstock that they sell to biofuel plants. Biofuel producers receive a tax credit of 46 cents per gallon of ethanol. The consumer’s cost for the 10% addition of ethanol is small. The benefits to the ethanol blenders and farmers is large. A senator or representative in a farm state like Iowa is expected to protect that subsidy.

As I noted last week, just six tax expenditures reduced tax revenue to Treasury by almost $700 billion last year, more than half the total deficit. The largest expenditures were the exclusion of employer paid pension contributions and health insurance premiums. How many of us will agree to give up their tax exclusion in the interest of making tax rules uniform? Homeowners can enjoy 30-year mortgages at low rates because the federal government effectively underwrites those mortgages. In Britain, homeowners do not enjoy the protection of decades-long mortgages. According to a recent article in Forbes, 800,000 fixed rate mortgages in Britain were due in 2023, and 1.6 million will be due in 2024. Homeowners will have to remortgage at higher rates.

The slim Republican majority in the House cannot agree within their own caucus to bring a bill before the House for a vote. Lawmakers prefer to complain about spending because that is a popular stance with their constituents. A lawmaker’s abiding concern is getting re-elected by their constituents. Few will complain about raising tax revenues if the revenues are to come from a broad group of taxpayers. Democratic politicians argue for higher taxes on a small group of the rich for fear of antagonizing the majority of their voters. Reducing revenue by subsidies and tax exclusions is as much a policy choice as spending appropriations. Without a continuing resolution in the next week, the federal government will begin to shut down non-essential facilities. The House has not been able to produce a budget on time in thirty years because lawmakers have limited choices. Taxpayers, favored industries and social welfare interest groups will oppose a lawmaker who advocates the elimination of a tax exclusion, a subsidy reduction for producers or households.

We are a nation competing for space at the public trough. For at least a generation, our federal government will be unwilling to collect enough revenue to meet spending commitments. Buyers of U.S. debt will realize the inevitability of deficits rising faster than economic growth and reduce their holdings of long term bonds.

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[Photo by Anna Samoylova on Unsplash

Keywords: ethanol, subsidy, tax expenditures, deficit

Correction: In last week’s letter I wrote “ twice last year’s deficit of $118 billion.” The link was to the average monthly deficit. That should have read “twice last year’s average monthly deficit of $118 billion,” not the deficit for the entire year. The total deficit for last year was $1.375 trillion.

A Graduated System of Benefits

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October 29, 2017

My kids will learn that they are the sons and daughters of charity parents.

Two weeks ago, I wrote about the measurement of the poverty rate in America. Why is our standard different than the one adopted by all other developed countries? What efforts have we made to alleviate poverty, and have those programs helped or hurt the poor?

Qualifications for benefits under various programs rely primarily on paid income. As a person exceeds certain thresholds of income, benefits are reduced or stopped entirely. Regardless of how we define a reduction in benefits, it feels like a tax to the recipients. Under these programs, the poor pay the highest tax – 100%. $1 earned above a certain threshold results in a $1 reduction in benefits. There is a very real incentive to hide reported income.

As I showed earlier, the poverty standard adopted by the U.S. undercounts the number of poor. On the other hand, income earned in the underground economy is not counted and results in an overcount of the poor.

We may associate “underground” with “illegal” but it includes both legal and illegal activities. A better synonym would be “unreported.” Workers in the unreported economy may include the kid down the block who mows our lawn, the guy who repaired our fence, the woman who walks our dog when we work late.

Almost all of us are part of the unreported economy whether we realize it or not. Recent estimates of the size of this shadow economy in the U.S. are from 7% to 11%. In dollar amounts, that’s $1.4 trillion to over $2 trillion. In less developed economies, it can be as much as 25%.

The tragedy of current programs is that they often discourage recipients from getting more work, or better paid work. The loss of Medicaid benefits dissuades a single mom with children from taking on employment unless she can find an employer who provides health insurance for her and her children. Many don’t.

Income above a certain threshold may disqualify someone from housing benefits. Under a Section 8 housing program, a low-income person pays 30% of their monthly income for housing (Section 8 FAQs). HUD, a Federal agency, and state agencies pay the rest of the rent. Section 8 housing is in short supply. The amount of paperwork and inspections required by HUD dissuades many real estate owners from enrolling their properties in the program.

These programs would improve by paying benefits on a graduated scale rather than using a qualifying threshold. Under the current system, a person making less than half the area’s median income, let’s say $24,000, gets housing assistance and other benefits. If they make above that, they may receive nothing under some Federal and state programs. That is the equivalent of a 100% – or higher – tax.

This graduated scale should apply to everyone. That includes the richest people on the planet like Bill Gates and Warren Buffett, who would also be eligible for housing vouchers, food stamps, for supplemental income and Medical benefits. As income increased, benefits would be gradually decreased. Bill Gates would be eligible for housing assistance, but his monthly benefit would be $0. For many of us, there would be no incentive to apply.

A graduated scale would help eliminate the quiet shame that some people experience when they receive public assistance. Like it or not, there is a stigma attached to being poor and receiving benefits.

A person with a disability can receive Social Security and Medicare. They can be quick to point out the fact. They are not on SSI, a program for low-income people. They are on Social Security. They paid into the insurance system. They got hurt. They are collecting on the insurance payments they made during a lifetime of work. Because they are disabled, they are on Medicare, not Medicaid. Medicaid is for poor people. If they are poor, it is only because they became disabled.

If I am a worker with a family to support and I make $11 per hour, or about $450 a week, my family is qualified to receive housing, food, medical and other assistance programs. I may be experienced in a few construction trades, but my tools were stolen last year. Perhaps I don’t have reliable transportation. I could make more money if I could get some tools or a more reliable car, but I can barely take care of my family. How can I get ahead?

A concrete contractor offers me a job paying $20 an hour for a project that will last the summer months for sure. However, the winter months may be a bit lean. The additional income will put me over the income threshold and my family will lose most of the benefits.

If I calculate the benefit my family currently receives in addition to my current $11 per hour wage as a janitor, I am receiving the equivalent of about $20 an hour. Even though I prefer to take the new job, I should continue to work at my current job for the sake of my family. Perhaps I can find a few jobs on the side, or “under the table,” but these are sporadic.

If I continue to stay out of the construction trades, my skills will atrophy. My self-confidence will erode. My kids will learn that they are the sons and daughters of charity parents.

The example above is all too common. If we had a gradual system of benefit awards, such a worker would be more inclined to take that better paying job. With a higher income, they might be able to get a loan for more reliable transportation. Their family might be able to afford more housing choices.

Who benefits under the current system? Whenever a poorly performing system stays in place, there is usually a small group of people who benefit under that system. They don’t want it to change.

Am I being a bit too cynical? No. It is Realpolitik. The practical benefits for one group of people outweigh any moral considerations by that group. In a later blog, I’ll look at who benefits from the current system.

Mortgage Mosh Pit

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In my series of Federal teat suckers, I’ll now look at the housing market.  If you are a homeowner with a 30 year mortgage, it might surprise you to find that you are on the home stamp program, a program that may pay you each month about the same as the average food stamp recipient.

President Obama has recently spoken about a 5 – 7 year transition of the mortgage market from federal quasi-governmental agencies like Fannie Mae and Freddie Mac to the private market.  The problem is:  private market lenders do not want to loan money to homeowners for thirty years.  A 30 year mortgage has no prepayment penalty so that the homeowner can pay off the loan at any time and refinance when rates are lower.  In the private market, lenders – and bondholders – like to be paid more interest when they tie up their money for longer periods of time and 30 years is a very long time. A history of the 30 year mortgage.

Let’s compare Joe homeowner to one of the largest and most dependable companies in the world – Johnson and Johnson (J&J).  For more than a 100 years, this company has regularly paid dividends to their stockholders and paid off their bonds.  In August 2010, the company sold 30 year bonds at 4.5% (Source).  Joe homeowner could get a 30 year mortgage for about 4.4% at that time.  What would you choose if you had the money?  Loan it to J&J or loan it to Joe homeowner for his mortgage?  In a realistic private mortgage market, Joe homeowner, with a good credit rating, would need to pay 2 – 3% above what Johnson and Johnson is paying simply because Joe is a riskier bet than J&J.  But that higher interest rate would price a lot of potential homeowners out of the market. 

The monthly mortage payment (PI) on a $250,000 30 year loan at 5% interest is $1342.  At 7%, the monthly payment is $1663, more than $300 higher.  At 8%, the monthly payment is $1834, a $500 free monthly premium to the homeowner.  So why do banks and mortgage companies loan money on mortgages?  Because the Federal government backs 90% of the mortgages in this country.  The government and its quasi-government mortgage agencies effectively loan the credit rating of the richest country on the planet, the United States, to little Joe homeowner, enabling him to save hundreds of dollars each month on his house. 

In Colorado in 2007, a low income family of 3 received a little over $400 a month in food stamps (Source).   Food does not build equity –  homes do.  The government’s home stamp program pays Joe about as much as the food stamp family and lets him keep any home appreciation – or lately, depreciation.  In addition to the home stamp program, the federal government has a stamp tax program that enables Joe to write off most of his mortgage payment for the first ten years since it mostly interest.  Not only does Joe get $300+ a month in savings on his mortgage but gets an additional $150+ a month in reduced income taxes. 

Until the meltdown in the housing market, the thinking was that real estate values always went up so the government was happy to loan its credit rating to homeowners at little or no cost.  Happy teat-sucking homeowners voted for the politicians who continued these home welfare programs. Then, in 2007, the unthinkable happened.  First home prices stopped rising, then started to decline in some markets.  Then the banking crisis of 2008 hit and price declines accelerated, leaving many recent homeowners “underwater”, owing more money on their house than it was worth.  Job losses and continuing price declines led many homeowners to walk away from their homes.  As of mid 2010, Fannie Mae and Freddie Mac had “borrowed” $148 billion from the Treasury (Source) to make up for the losses.  Mega-banks have written down billons and some estimate that the default total will approach $1 trillion.

In a recent Bloomberg article, “About $600 billion of the [Option ARM – Adjustable Rate Mortgage] loans were made from 2005 through 2007, according to industry newsletter Inside Mortgage Finance. Of those packaged into bonds, some 20 percent have been liquidated at losses to investors, and almost half of the remaining ones are at least 30 days delinquent, in foreclosure or have been seized by lenders, according to data from JPMorgan.” “A model developed by JPMorgan Chase & Co. analysts predicts that 70 percent of remaining option-ARM loans that were bundled into bonds will eventually default.” 

The federal government will continue to be pumping in money to the home stamp program for years.  The $148 billion already pumped in is just a down-payment on this program.  In his 2012 Budget, Obama wants to spend $85 billion on the Food Stamp program called SNAP, an annualized increase of 7.5% over 2010 spending.  If only we could hold the increases in the cost of the home stamp program to those levels.

Poverty

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This past week the Census Bureau released their annual estimate of median income and poverty.  For 2009, the poverty level increased from 13.2% to 14.3%.  Economists and policy makers have been debating the definition and calculation of poverty since the introduction of the social welfare programs of the Great Society  in the 1960s.  Since the mid-nineties, many have called for a revision of the calculations that gives weight to cost of living variances in the country.  To most people, that makes sense.  Because it makes sense, it is a political hot potato.  The thresholds of poverty are used to determine eligibility for a number of federal programs.  Adjusting  those thresholds would qualify many more people for assistance in some areas, particularly larger metropolitan areas, while disqualifying some in rural areas where the cost of living is less.

How does the Census Bureau measure poverty?  They include all cash income but non-cash items like Medicaid, food stamps and housing subsidies, like Section 8, don’t count as income. (Source)  To qualify for housing assistance, the family’s income may not exceed 50% of the median income for the county or metropolitan area in which the family chooses to live.  The rent subsidy is generally the lesser of the payment standard minus 30% of the family’s monthly adjusted income or the gross rent for the unit minus 30% of monthly adjusted income.

Let’s look at two “traditional” families of four in Denver, Colorado, where wages and cost of living are only slightly above the national average. (Source)

In Family A, Dad works a regular job as a laborer for $12 an hour for 35 hours a week, slightly more than the median hours worked per week, earning about $22000 per year.  Family A’s income is at the poverty level, qualifying them for housing assistance, Medicaid, food stamps and other assistance programs for meeting their monthly bills.  Family A’s adjusted income per HUD standards is gross income less about $500 per dependent, or $20K.  They would pay 30% of that for rent, $6000, for an apt renting for about $9600 annually, receiving about $3600 in tax free income.  In addition, they would get about $325 in food stamps  per month, or another $4000 in untaxed income.  In addition, Dad would get $34 per week in Earned Income Credits, paid by his employer, for an annual total of about $1800.  Since they qualify for Medicaid, this family would have no or minimal health insurance premiums. This family would pay no federal or state income taxes but they would be subject to the FICA payroll tax of about $1650 per year. This family’s net effective income is about $30K.

In Family B, Dad works for $22 per hour for 35 hours a week, earning an annual gross of $40,000, about 16% – 18% less than the median household income for Denver but about equal to the median wage.  This family’s income is in the 40th percentile of Denver area income, slightly above that percentile for the country as a whole.  This family does not qualify for either  housing assistance, Medicaid, food stamps, the energy assistance program LIHEAP or the Earned Income Credit. Dad pays 50% of a $1200 HMO family medical plan which his employer offers, an annual cost of $7200.   This family pays about $120 per year in federal and state income taxes and $2500 in FICA taxes.  This family’s net effective income is also $30K.

Two families – one at the poverty level of income, one slightly below the median income level – have approximately the same level of disposable income.  Either there are a number of families classified as poor who really aren’t poor or about 40% of the households in this country are effectively at or below the poverty level.