Give me some leverage and a place to stand...

[mangosteen]

Meta: I haven't posted here in ~2 years, and there are reasons for that, mostly due to using an actual paper journal, and staying away from Facebook because It's Bad For Me(tm). However, there's a gap called "sharing long-form ideas with friends, and actually getting meaningful feedback/discussion."

Context: I'd like to pressure-test an idea. I'm sure that most of you could rattle off ten valid viewpoints on homeownership and the economics thereof... including a values/morals argument on whether a home should be an investment. I'm of many minds on it, although I start from "well, it is right now, at least in the densely-populated parts of the US". So...

Assertion: Purchasing real estate is the only leveraged investment generally available to the middle class in the US.* I mean that both in terms of "opportunity to acquire" and "conceptually comprehensible". I can't think of another type of widely-available investment that allows you 4:1 leverage on your money to buy a class of physical asset that has a history of capital appreciation, and then keep the capital gains for yourself.

I believe that to be true. Sure, the ROI is usually less than investing in (say) an index fund, and yet we're back to leverage. The hardest part of accumulating capital is accumulating enough to have any appreciable return. "The first million is the toughest" is more flip than I'd like, but it's true.

What I'm I getting at? Great question, and I'm glad you asked!

Buying a home is a not-great investment for most people... and thinking of homes as investments leads to a bunch of perverse incentives including NIMBYism and fights over zoning that boil down to "don't touch my property values... this is all I have." Even places where racial discrimination is actually at the root of it, I suspect you'll often find "this is my life savings, and I'm scared" sitting down next to it with a cup of tea.

So... how do we fix that? What does it look like? How do we get there? I don't know, but "making a physical, immobile, illiquid asset be one of the most attractive and legible investment vehicles for the middle class" seems like an aspect of the problem that doesn't get talked about all that much.

---

* Yes, one can do highly-leveraged investments in the stock market, but the amount of individuals who can do that with any reasonable rate of return is negligible, so I'm putting that to the side for now.

Comments

[wotw]

1) I'm not sure I understand your footnote. The historical rate of return on the stock market (after inflation) is in the vicinity of 8%. Are you saying that the average individual can't borrow on terms that make a leveraged 8% investment advantageous?

2) Government deficits are, of course, a way for individuals to borrow at low rates. Instead of taxing you $1 today, they borrow at, say 3% (a rate you could never get for yourself) and tax you in the future for enough to pay back the debt. If you take the funds you would have otherwise paid in taxes and invest them in, say, the stock market , you've made the equivalent of a leveraged investment, borrowing at 3% for an expected return of 8%.

The downside is that if you default on this 3% debt (by not paying your future taxes) you go to jail. But it's precisely the threat of jail that makes govt debt secure enough so they can borrow at 3%. That makes govt debt pretty much an exact substitute for debtor's prison --- if we still had debtor's prisons, you could borrow at much lower rates on your own without needing the govt to do it for you.

3) People overinvest in housing because of the mortgage interest deduction. The solution is to tax all interest at the same rate. But that rate should be zero, which is already the case for mortgage interest. So eliminating the mortgage interest deduction is both good and bad, with perverse incentives either way. You've pinpointed some perverse incentives of the status quo; it's easy to pinpoint perverse incentives of the alternative. I'm not sure which are worse.

4) The quickest and best answer to "How do we fix that?" is to eliminate all caps on IRAs, creating an alternative attractive and legible investment vehicle --- this is, of course largely equivalent to fixing the mortgage interest deduction not be eliminating it but by extending it to a much wider class of investments.

[sethg]

Government deficits don’t allow individuals to borrow at low rates. They allow the government to borrow at low rates, ostensibly on behalf of individual taxpayers—in the same way that commercial paper allows large corporations to borrow at low rates on behalf of their individual stockholders.

[wotw]

Suppose you owe $1 in taxes today. Consider two scenarios:

1) The govt decides to cut your taxes by $1 and borrow $1 instead, planning to tax you in the future to pay back that $1 with interest.

2) The govt collects your $1 in taxes, then lends you back that $1, planning to demand repayment in the future with interest.

These two scenarios affect you in exactly the same way. They both put $1 in your pocket today and require you to pay (say) $1.50 in the future.

So running a deficit is exactly the same thing as making low-interest loans to **individual** taxpayers.

[sethg]

If the government borrows $1, and the effect of that borrowing is to reduce my tax burden, the $1-plus-interest will not necessarily be repaid by me. I might not even be alive by the time it’s paid off!

This is a knife that cuts both ways, of course: when some of the money I pay in taxes goes to paying interest on the national debt, that includes interest on debt incurred before I was a taxpayer, or even before I was born. (The US government hasn’t been completely debt-free since 1835.)

And when the government borrows money instead of raising my taxes, it is not necessarily doing so because I asked it to, or even because the programs it is borrowing for are things I want it to spend money on. In this respect, it is no different than a corporation that issues bonds to pay for some expense, instead of raising prices to customers or cutting expenses elsewhere.

[wotw]

Your first point is well taken: The person who gets the immediate tax cut is not always the person who bears the future tax burden. On the other hand, this point might not be too important as long as people view a dollar for their kids as equivalent (at the margin) to a dollar for themselves. The fact that people contrive to leave positive inheritances is some evidence for this view.

Your second point seems to me to be entirely off the mark, because the right exercise is to compare government spending financed by taxes to exactly the same spending financed by deficits. Whether you love or hate the spending doesn't matter because we're not debating how much the government should spend or what they should spend it on --- we're only debating the financing. So taking it as given that the govt is going to spend $100 of your money on project X, the only relevant effect of deficit spending is that, instead of taking that $100 from you today, it puts that $100 back in your pocket, with an implied obligation that you'll have to pay back (say) $150 some years from now. That is a loan to you. The deficit is not "to pay for some expense" because the expense was going to happen anyway.

The difference between the corporation and the govt is that if the corporation does not borrow, it might not be able to spend --- because corporations cannot tax their shareholders. But your govt can tax you, so its spending does not depend on borrowing. The decision to borrow is not a decision to spend more; it is a decision to defer your taxes. In other words, it is a loan to you.

[sethg]

You have fallen prey to the “ecological fallacy”—the assumption that some property of a group (in this case, US taxpayers as a whole) must also be true of each individual within the group.

If I, personally, saved $100 in taxes because of deficit spending, then who, personally, pays that $100 back with interest? I might not have children. They might be in a different tax bracket, such that their putative repayment is not proportional to my putative borrowing. The country might let in lots of immigrants, thereby reducing my children’s share of the tax burden. The country could in the future derive less federal tax revenue from personal income tax and more from other sources (corporate tax, import duties, lease of mining/drilling rights, carbon fees), muddying the waters further.

It is true that the $100 needs to be paid back somehow, from somewhere within the vast body of the US tax base—as Milton Friedman said, “to spend is to tax.” But that is very different from a debt in which I, as an individual, undertake to spend more now in exchange for spending less later.

[elusiveat]

Why do you think the tax on all interest should be zero?

[wotw]

The answer to this is very long, and I hope (but do not promise) to find time to come back and summarize that answer. But for starters, consider the following two kinds of taxes:

1) A sales tax that grows every year: Today it's 1%, next year it's 2%, next year it's 3%, and so on forever.

2) A tax on interest at a fixed nonzero rate.

For reasons that might not be entirely obvious, these taxes are equivalent in the sense that they incentivize exactly the same behavior, and (if the tax rate on interest is chosen appropriately) either one leaves each individual taxpayer --- not just taxpayers on average, but each individual taxpayer --- exactly as wealthy as the other does.

So option 2) is a good idea if and only if option 1) is a good idea. Most people have an natural intuition that option 1) is a bad idea; if you trust that intuition, it follows that 2) is a bad idea.

Of course this doesn't prove that 2) is a bad idea, because your intuition about 1) could be wrong. But in fact your intuition about 1) is right, and that's where the long story comes in. That story underlies a major theme in the literature on public finance which starts (but by no means ends) here: https://www.jstor.org/stable/1911310

[elusiveat]

All I can think of is universal basic income, so that we all have something else.

[sweh]

I remember having a similar discussion with my Dad about this 10 years or so back. Of course this was about the UK market, not the US, so the incentives are different (eg no mortgage interest relief) but his point was that before the 80s a house wasn't _meant_ to be an investment vehicle. It was meant to be a house, a place to live, a place to bring up kids, a place you can retire in and not have to worry about rental payments for the next 15 years or more.

The 80s perverted this concept, and suddenly people were buying houses as a short to medium term investment. The 2008 crash showed just how over-leveraged this concept can lead to.

So my question is "why _should_ there be leveraged investment opportunities"?

It's just allowing people who have the buffer to gamble and forcing people without that safety net to put everything on the line for something that shouldn't be a gamble. The haves will always be able to play the market safely and if they lose then they shrug it off, whereas the rest of us have to take a risk in order to play (with property it's the "I want a home, not an investment").

[siderea]

his point was that before the 80s a house wasn't _meant_ to be an investment vehicle

This cannot have been true in the US, or the block-busting of the 1960s and 1970s wouldn't have worked – it depended on homeowners' fears of losing property value.

I'm under the hazy impression that the idea of homes as an appreciating asset rose in the 1950s, in the post-war era, but I am not certain of that.

[sethg]

I suspect that homeowners discovered that they were sitting on investment vehicles in the 1970s, because they had the benefit of a debt at a fixed nominal value and rate while inflation was booming. Yay leverage.

As for blockbusting, even if you as a homeowner don’t expect your home to appreciate in value by 10% every year, you don’t want it to drop by 50% in six months because “three of your neighbors on this block are selling their houses and one of the buyers has a cousin who’s moving in next week, as soon as he gets out of jail”—which is the sort of scare tactics that blockbusters were using. (To be clear, the ex-con cousin was no more real than my girlfriend in Canada.)

[dsrtao]

* One can alter the perception of home ownership as an investment vehicle. If "everybody knows" that houses are a bad investment, people will rent more and tend towards buying smaller homes. In order to do that, housing stock in places where people want to live needs to be massively increased, or demand needs to go down. One might reduce the demand for housing by killing people. This is not an acceptable solution.

* One can reduce the desirability of houses as investments by providing alternative investments. I don't know what these would look like.

* One can reduce the necessity for investments. Would the economy be massively boosted if the government guaranteed a middle-class cost-of-living pension for everyone who reaches age 65? I think the arguments for this are similar to that for basic income or single-payer healthcare: you can take a lot more financial risk if you know you're not going to sink into abject poverty if you miscalculate. That significantly improves entrepreneurism and workforce mobility.

[vatine]

Being in the weird position of buying my third property (in my life, not simultaneously), I have never really considered them to be investment vehicles, more a vehicle for paying off something for me, rather than for someone else.

On some level, I like the idea of "slow", "medium" and "fast" money that Charles Stross voiced in Neptune's Brood (which, in turn, was probably cribbed from elsewhere), whereby "day-to-day" currency, "year-to-decade" money, and "decade-to-centuries" money are different, with a sliding exchange rate between them. Not sure it would make a blind bit of difference for this, though, but mortgages reminded me. And if it was actually a thing, it would be a potential investment vehicle on par with buying property.

[sethg]

The only work of fiction which (a) I sold for pro rates and (b) is available online, is this, where the McGuffin involved a society in which men and women use different currencies.

“Why do they have separate money for men and women?”

“Because we buy different things.” It was the answer that her mother had given her years ago, when she barely knew enough arithmetic to make change. Men bought meals in restaurants and women bought groceries to cook; men bought houses and women bought furniture; men bought Time magazine and women bought Life; men bought gas from stations on the highway, and women bought it in the city.

The economy of this particular story involves fixed exchange rates and the consequences thereof, but I dream of someday returning to this world and figuring out how the economy would work if the two currencies floated against each other.

[sethg]

Off the top of my head: replace the current system of government-supported 30-year mortgages with something more like this:

You are a fresh-faced aspiring first-time homeowner. The government looks at your income and decides what monthly payment you can reasonably afford. Based on this figure, you, your local bank, and the government cut a deal regarding the house you want to purchase, whereby you get a seven-year mortgage on 25% of the purchase price, while the government kicks in the other 75%. No mortgage interest deduction.

If you sell the house before those seven years are up, the government gets 75% of the take.

When the seven years are up, you can take whatever equity you have built up in your quarter-house and use it as, effectively, a down payment on a new seven-year mortgage, this time for 50% of the price of whatever house you can afford. If you want to stay in your house and it has appreciated… well, on the one hand, your quarter-house of equity is worth more, but on the other hand, the government is selling the next quarter-house-worth of equity to you, and can rightfully demand a higher price than it did the last time around. If the home has crashed in value, the reverse is true: your equity is worth less, but if you really want to stay in this house, the payments the next round will be less.

Seven years after that… you get the idea. After a total of 28 years you can own your home free and clear, under a regime that is less prone to boom-and-bust shocks.

This requires a certain amount of auditing to make sure that banks and homeowners aren’t conspiring with crooked assessors to cheat the government, but we need that already. Also it may require some system to buy out or pay off the homeowners who already benefit from the current regime.

[bolson]

A random liberal meme made me think: "Housing cannot be simultaneously affordable and a source of wealth". I'm sure that oversimplifies and misses some things, but I think there's something to it. If it's a good enough investment class, Big Money will snatch it up. If it's not an investment, it's an alternative to rent and you pay money to live in a place but with a different structure.

[fenicedautun]

I quibble with your thinking that mortgages are the only leveraged investment. I would say that business loans for small business and college loans are both leveraged investments available to the middle class. I would like to see more people able to evaluate their investments and their loans, so they can weigh how much the investment (business, degree, house) brings joy, how likely repayment of the loan is, and what the likely return of the investment is (or consequences, decision tree style).