Tuesday, September 15, 2009

Real Estate: Elements of the Storm

I was thinking about the whole continuing real estate problem...

One thing I think has changed over, say, 30 years ago is that we are practically a society of transient workers now. Fewer people work in stable jobs that linger for 20 years. Far more people work in jobs that last, say, 2-8 years before requiring them to move on. Maybe the old job went to India. Maybe it got bought by a bigger company. Maybe the facilities simply moved to another state. Maybe they found a better offer somewhere else. Whatever the reason, they're moving and moving and moving again.

This alone creates a strong feeding ground for a real estate disaster. Short term purchases are far more likely to run into some type of recession that causes house prices to drop, and now you're screwed. Your job went away. You need or strongly want to move. You can't because you owe more than the house is worth.

I also think ARMs are going to play a big factor, especially as interest rates start going back up. You lose your job, you need to sell but you can't because your loan is underwater. So you stay on, maybe take a lower paying job, squeak by with your mortgage, but then interest rates go up and your ARM starts costing more. Now your job didn't change, but you can't afford your house anymore and you can't sell it because the loan is underwater.

And I was thinking about "specialization". America produces a lot of specialized stuff. The problem with specialized stuff is it takes specialized skills, which is why people have to move so much. When your job manufacturing printing presses goes away, you can't just find another printing press manufacturing job in your area. There aren't any. Everything in your area is another specialized job for which you do not have the skill. To find another job for your skillset, you need to move. If you can't move because your mortgage is underwater, you're screwed.

I'm wondering if these are the elements of the "perfect storm".

1) Americans stopped producing mundane, non-specialized goods. We only produce specialized goods.
2) When your specialized job goes away (which it will eventually, because this is the nature of specialized work), you have to move.
3) If the housing market takes any sort of tumble, your mortgage may be underwater and you can't move.
4) You are boned and the economy starts to buckle when enough people land in this situation. Too many people find themselves applying to Home Depot for work because their skill sets are too specialized and they can't reach the work for their specialization.

For the coup de grĂ¢ce, let's think about tax write-offs for mortgage interest.

Let's say you want to buy a $200,000 home and you have $40,000 in the bank.
Do you:
a) Put $10,000 down (5%) and spend the other $30,000 elsewhere
b) Put $40,000 down (20%)

With no tax incentive for mortgage interest, you would do "b". This would lower your interest payments and save you a lot of money. In fact, you may be encouraged to pay off your premium as fast and as early as possible just to get out from under your interest payments.

A tax incentive allowing you to write off mortgage interest wipes out that advantage, though. Doing "b" saves you nothing. You will instead do "a", use the government tax incentive to write off what would have been the savings of "b" and then spend the rest of your money somewhere else.

So we have created the perfect storm:
  • Specialized workforces move a lot and therefore tend to have newer home loans.
  • Tax incentives encourage new home loans to be as close to the cost of the house as possible.
  • Any drop in housing prices, therefore, will very quickly put our loans underwater, potentially inflicting personal financial ruin.
  • Enough people in personal financial ruin becomes national financial ruin.

If my theory is true, then this entire economic disaster can be attributed to government interference:
  • Tax incentives for home loans are a government intrusion into personal finances which has encouraged reckless behavior by individual home buyers.
  • High government taxes impacting basic manufacturing jobs have encouraged those jobs to move out of the country, necessitating that our work force become more specialized and therefore more transitory.
Transitory workers + incentives for dangerous financial situations = the perfect storm.

If my theory is correct, we haven't heard the last of this current recession because we haven't done anything to improve the two factors that fed it: government meddling in personal finance and government taxes making basic American manufacturing uncompetitive in the global market.