Is the mortgage interest deduction, in the tax act of 1986, the root cause of the current recession?
No.
This recession is like every recession in that the economy is based on everything grows all of the time. In this case, the housing bubble burst when people started losing jobs - people who could not (or did not) save enough for an emergency. Once the foreclosures started everything went downhill. Couple this with a reduction in spending from people not wanting to pay $4 per gallon for gas, $25 to check bags when flying, not eating out as much, etc and you have the opposite of inflation which companies were (are?) too slow to adjust their prices for causing higher unemployment.
In short, a perfect storm of two huge economic downturns feeding on each other.
I do not understand the question. What does the mortgage do with the recession. Mortgage interest has been deductable for years before 1986.
Another No, this time because the deduction has existed since 1913, when it included interest on all consumer loans. The 1986 act simply eliminated all but mortgage interest deductions
NTY (subscription) link here.
If you believe that “too many mortgages” caused this depression, then I think the better explanation for that is the easy availability of mortgages, which was caused by the demand for commercial mortgage-backed securities. I don’t think the deduction for interest on mortgages really figures into this at all.
There is a certain amount of truth to this. The mortgage interest deduction has created a strong incentive to buy instead of rent, and also makes the cost of renting artificially high. My wife and I recently bought because after house prices came down, we ended up saving about $300 a month by paying a mortgage instead of rent (even after taxes and insurance).
As a result, the US has a much higher rate of home ownership vs renters. One reason for the the massive increase in foreclosures was this insistence that people buy instead of rent. The web is full of calculators that will show you how much house can buy for the amount you are renting, and that amount is artificially shifted because of the tax deduction. Take it away and suddenly you are better off renting.
But why is this a problem? Because home ownership is a long term commitment, and renting is not. There are a variety of studies linking high rates of home ownership with high rates of unemployment. The tax deduction helped create a buy mentality that pushed people to own who shouldn’t have.
At the time, a lot of purchases made sense in the short term. We save a ton now that we own, but we are also locked in, and we know that we have to keep the house a minimum of 3 years to make it worth while. If either of us lose our jobs, it will be significantly harder for us to move. And if we had to move soon we would take a HUGE loss.
What I found really strange about the recent recession was that friends of mine began using foreclosure in their normal vocabulary. When they needed to move, they crunched the number and found it was better for them to foreclose or shortsell.
4 years ago they were driven to buy a 3 bedroom townhouse in the burbs, and partly because of that mortgage deduction. 3 years later they found out they were dramatically less flexible, and the few hundred they were saving a month was meaningless compared to the massive loss they took on the sale.
As a compare and contrast, Canada provides a deduction for renting to people below a certain income. As a result, that group (the sub primers if you will) were encourage to rent instead of buy. When the recession hit they didn’t have to walk away from an underwater mortgage, they just had to move to a cheaper apartment.
My personal thesis would be that the culprit of the housing crisis was the Fed’s adjustment of interest rates.
Basically, the idea is that if you could predict the economy, you would use those rules to compete unfairly–i.e. you’re acting outside of the rules. This will, in way or the other, lead to the downfall of the predictive capabilities of the original theory.
The Fed has found a “sure winner” in playing with the interest rate to rein in or spur on the economy. You know, when interest is low, that within the next 6 months there will be start greater growth to the economy. And you also know that as soon as it does, the Fed will raise the rates again.
Being able to predict when growth will occur–i.e. when people will start buying houses–and that the income rate will raise soon after, a greedy man will realize that if you peg the price of a house to the income rate, you can lure suckers in, and starting soon after be able to bleed them dry. If only one or two people were doing this, they might truly rake it in. If large segments of the housing sector all catch on to the scam and try to do it, you end up breaking the system and raising the income rate ends up trashing the economy instead of fixing it.
From this, I’d expect that even if you patch up the rules for mortgages, it’s just a matter of time until someone figures out another way to take advantage of the Fed and we end up in the same spot.
Having said all that, though, the current recession was caused by panic. The housing market was not a multi-trillion dollar deal. If people had kept on like they were, investing, speculating, etc. they’d have hardly felt any loss from the fallout.
I disagree. Dozens of other countries have a Federal Reserve Bank that adjusts the interest rate in the exactly the same way the US Fed does. Why would that cause a different result in the US?
I have to also disagree with this. Not the panic part, but the part about people continuing to invest. House prices shot up and an insanely high rate and eventually hit a ceiling. They became a commodity that were bought and sold like barrels of oil. When they reached their peak, the smart investers sold, the dumb investers continued to buy for a full year after it was brutally obvious prices were going to crash. Dido for the price of oil, it shot up, peaked, and then crashed. People didn’t need to panic, they also didn’t need to keep investing. They needed to realize the housing market peaked and wait two years before they bought.
As an example, HGTV was still airing “Flip this house” long after the market peaked. And didn’t start airing “Real Estate Intervention” until after the bottom.
People were told the value of their house would continue to go up, and that was absolutely wrong. It peaked, and need to correct. People continuing to buy was a huge chunk of the problem.
http://www.truthdig.com/report/item/20080531_the_corporate_state_and_the_subversion_of_democracy/?ln Here is a nice long article describing what went wrong. It was a systematic take over of our government by corporations who are looting America for all the can. The deregulation, the “one sided free trade” which justifies moving American jobs for lower wages and lack of environmental rules. Corporations headquarter themselves in some tax haven while gobbling up American tax money and exploiting defenseless countries. It is much bigger than a tax reform act.
Why am I not surprised one person rushed to blame the incompetent government, and another person rushed to blame evil corporations.
Going forward, wouldn’t it make more sense (and save a lot of time) to eliminate both of those options and put thought in to actual reasons?
Someone needs to come up with a method for doing it first, which relies on what all avenues are available. Possibly there aren’t ways for one to do it in other countries. Possibly cutting off this one avenue in the US is removing the only chink that there ever was or will be.
Personally, I would generally trust human ingenuity to find a way eventually, but who knows how long that will take.
Let me amend myself to saying that they should have kept on like they were, outside of the housing market. Within that market itself, they shouldn’t have pulled out as much as they did.
One aggravating feature lies in the realms of handed down expectations, and realities.
There has always been an expectation that prices will rise, so get as big a mortgage as you can, sure it will hurt, but you won’t be able to afford the house mopre easily in the future.
The pain should go away quickly as in a relatively high inflaflation economy, then rises in your income will erode the value of the loan.
Of course, along with this, your paper value of the house goes up due to inflation too, so you make a paper profit.
Now the reality, low inflation, rising prices, less secure employment.
Low inflation means you feel the pain for much longer as your wages don’t go up as quickly - and if you were on a special low start deal, then when it runs out, you may not be able to manage your mortgage.
You now have a choice, go bankrupt, or hand over the keys and walk away. If lots of others do the same, it snowballs because then you have a declining house price market, people are getting mortgage pain on an asset whose value is reducing - so more people walk away, and housing value declines further.
Meantime, the effect of wakling away is that the mortgage insurance kicks in, well these insurances were parcelled up and resold again and again, in a way that completely obscured the true risk, so the returns were much lower than needed to cover those risks.
With a seeming high return on these insurance deals, and everyone getting commission out of it, no-one was interested, and it was not possible anyway, to properly verify the risks, so the corporates just kept taking the easy money, and the mortgage brokers just kept selling those lies to people who were bad risks.
Once it gets rolling, its hard to stop, people cut their spending, which reduces sales, which in turn costs jobs, and the resultant unemployment causes more to walk away.
Once the money folk realised things were seriously amiss, they tried to hang on to assets, and stopped the money go round, but since they are all linked through bonds, insurance, etc, the whole lot is in danger of sinking, share values go down and once secure loans made upon the backs of shares suddenly are not secure any more, so rates on those loans go up.
No, that happened in 1986. This depression began in 200x, 200x is many years later.
far too simple a reaction. the article I cited gives regulation, oversight, a corporate culture and political shenanigans as being part of the mixture. You obviously did not read it.
There are a couple reasons for the recent housing mess.
A big part of it is Barney Frank. He pushed to have banks loan to low income individuals, especially Fannie and Freddie. The other lenders followed suit, but to deal with the risk they started selling CDO’s, a bunch of mortgages bundled into a package otherwise known as Collateralized Debt Obligations. The low interest rates, the pressure from the gov to get low income people into housing and the CDO’s created an environment where banks could dump off the risk (CDO’s) and had to compete with the government (Fannie and Freddie). The people buying the CDO’s were using a flawed formula to figure out the risk of the CDO’s so they thought the CDO’s were a lot safer than they actually were. All this gave the mortgage folks every reason to sell a mortgage to anyone they could*. They were selling off the risk after all. The people buying the CDO’s thought that they were safe investments. So the lenders started lowering minimums to buy a house. The low interest rate also helped. This put more (unqualified) buyers into the market and caused the prices to rise insanely.
Then the shit hit the fan. The buyers of the CDO’s found out that they were becoming worthless at a rapid pace once the foreclosures started. The lenders tightened lending across the board. Suddenly, a lot of paper that used to be worth lots of money wasn’t anymore. The people in the houses couldn’t make payments because they bought too much house to begin with. No one could get a loan to buy the houses on the market (new or used) so the housing market tanked. Oh, and there were a bunch of people who pulled equity form their houses when the prices were hign. Suddenly the house wasn’t worth what they owed on it including the amount they borrowed against the equity.
The scary thing is that the next big problem (beside half of Europe defaulting on their loans) is commercial. Basically the same type thing. The commercial real estate market is tanking. It could get really ugly.
Slee
*Side note, I bought a house on the downside. The market was higher than it is now but it was in the reasonable range (~90 to 100 a sq foot, which is about what it was before this whole mess got out of control). When I got my loan through Schwab they offered twice what I could afford. Schwab is a stable and well run company. Other lenders offered me up to three times what I could afford. It was crazy. Luckily I can do math.
sleestak is not connecting the dots. The goal of making mortgages more obtainable for lower income people goes back quite a while, and Bush was for it also. There are many good reasons for this policy, not the least that neighborhoods are better when full of homeowners.
Here are the dots. CDOs, which were new and unregulated, disconnected the risk of a mortgage from the company writing the mortgage. CDOs with a flavoring of subprime mortgages got higher interest rates, so mortgage writers had an incentive to write subprimes for people who would have qualified for a better mortgage and for people who wouldn’t have qualified at all except for fraud encouraged by the mortgage companies. The banks, making a fortune on these, had no incentive to stop. I don’t know if any were really so stupid as to not believe the bubble would stop, but we know that one did, and bet against the bubble with AIG. All of this was in the short term interest of all parties. The only way to stop the looming disaster would have been regulation - but Greenspan refused to do anything, and even prevented the states attorney generals from doing anything. That was part ideology, and part the realization that forcing the mass of workers with stagnant salaries to buy only what they could afford would have pushed the nation into a recession. Fannie and Freddie’s portfolios were far better than the other mortgage companies, but got worse since in their semi-privatized state they felt obligated to get the returns the private banks did.
And in any case, as has been mentioned, the mortgage interest deduction was not introduced in the tax reform of 1986, but many years earlier.
Will you stop crying about Frank and Fannie and Freddie. Fannie and Freddie did not originate mortgages. They did not write, them, sell them, or create the financial packages that were packaged and sold. Nor did they have anything to do with Swaps, which was the financial bankers selling insurance on mortgages and the creative certificates they pushed. Of course they were called “swaps” which got them free from the insurance regulators, who probably would not have done anything about it. They sold insurance that they knew damn well they could not pay off. Their sorry asses should be in jail.
There wer many factors. the mortage deduction has nothing to do with it.
In 1976 when we purchased our present house to qualify for first home our mortage payment could not be more than 1/4 of our net income. That is after taxes, and any other outstanding loans.
2 years ago at some banks it could not be larger than 1/2 of the gross income. These loans were set up to fail.
In some places, San Jose, Ca., houses were over priced. As an investor if I put 20% down I expect to neutral or slightly positive cash flow. If not the house is over priced or rents are too low. In Santa Clara county it took normally 50 to 60% down. To me that means people were paying more than what the houses were worth.
In those condition something is going to give. As people could not pay for their overpriced mortages they had to sell. As too many home owners and investors had to sell the prices dropped.
I have put a lot of time and thought into this issue and others like it, and I have come to the conclusion that both of them share some blame, as well as every single US citizen.
We the people are responsible fore being uneducated on government processes for decades, allowing our federal government free reign to keep consolidating power to the point where they are holding all the keys and guarding all the doors of the economic world. We are responsible for being able to name every Superbowl Champ for the last 50+ years but not being able to name the three branches of government. We let them steal and rape our country.
The government is to blame for it’s lust for power, ignorance to the Constitution, and viewing the “bottom line” for them as the be all and end all. They are selfish pimps and whores, and that’s all there is to it (with a handful of exceptions).
The corporations are now in cahoots, via lobbyists. Money makes the whole dirty machine go, and who has the most money? Huge global corporations.
Many of the biggest contributers to campaigns contribute to BOTH SIDES of the ballot, which stinks to high heaven in my opinion. The only person who bets on all the horses is the one who is determined to win no matter what.
I’d just like to point out our Economy was quite stable up until the inception of the Federal Reserve (not even 20 years before the Great Depression). The Federal Reserve allows the oligarchy to have a bottomless well of money (essentially loaned to us at interest via Treasury stocks and bonds). Through the Federal Reserve and a barrage of federal programs over the last century, more and more economic clout has been centralized as the communization of America moves into full swing (read communization as - the merger of the corporation and the state).
When the state owns everything, you own nothing. The continuous economic swings (largely influenced by the Fed’s policy in conjuction with legislation promoted by corporations in congress) keep consolidating wealth into the hands of the ruling class while us peasants are bled dry, clinging to the promise of the American Dream which is slowly fading away.
Not every person in politics is “in on it” so to speak. Hell, most of them don’t even read legislation they vote for, just do as they are told and follow party lines. However, the people in the know function more like inside traders than elected representatives or public servants. Even the ones not in the know are part of the problem, wasting money on pork politics or worse yet, selfish gain (i.e. Nancy Pelosi’s drunken plane rides or Tom Ridge using PA tax dollars to send his kids to an out of state private school - the state he lived in during his time “representing” us).
It’s all a big cluster fuck of corruption and we’re a big crowd of meandering idiots with no clue what the problem is, let alone how to fix it.
In short, we’re screwed.