Thursday, November 11, 2004

Homeownership and Bush's second term



During President Bush's second term, higher mortgage rates are as sure as death and taxes. On other housing-related issues, nothing is so certain.

Many housing topics are likely to arise over the next four years: The mortgage interest deduction could end up with a target on its back. Or it might survive and be joined by a deduction on mortgage insurance payments. Fannie Mae and Freddie Mac probably will be required to serve low-income homeowners more than they do now. The president is expected to push again for a zero-down payment program and possibly for tax credits for first-time home buyers. Home builders will press for reduced regulations.

Of all these issues, the most important in people's daily lives is the direction of mortgage rates: when they will rise, and by how much.

It's the housing-related issue that Bush has least control of: Presidents influence mortgage rates only indirectly, through taxing and spending policy.

Rates will rise, deficit may contribute
Economists and bankers are unanimous that mortgage rates are headed up from today's rock-bottom levels. Mortgage rates are bound to rise as the economy starts to create jobs in earnest and as the Federal Reserve continues to jack up short-term rates, as it did this week.

The wild card is the effect of the federal budget deficit on interest rates. The deficit is expected to hit a record $422 billion this year, about 3.6 percent of gross domestic product. Big budget deficits generally are believed to increase interest rates, yet the Bush deficits haven't had that effect -- at least, not so far.

"I think that from what we can judge from the first Bush term, the implications for mortgage rates are not favorable looking forward. The persistence of federal budget deficits is a situation that adds upward pressure to interest rates," says Richard DeKaser, chief economist for National City Corp.

There are two types of budget deficit: cyclical and structural. The government uses cyclical deficits to smooth out business cycles, especially recessions: It spends more than it takes in to stimulate the economy. Cyclical deficits, when used correctly, benefit the economy.

Why deficits may hurt
Structural deficits, which occur when the government spends more than it takes in, no matter what's happening with the business cycle, stimulate the economy in the short run, and impede the economy in the long run by "crowding out" investment -- money has to be spent on debt rather than on more constructive things. At least, that's the theory. DeKaser cites a Federal Reserve study that concluded that, over time, real long-term interest rates rise one-quarter of a percent as the budget deficit rises by 1 percent of gross domestic product.

In the last year of the Clinton administration, the budget surplus reached almost 2.4 percent of GDP, so the move to a deficit of 3.6 percent of GDP accounts for a swing of 6 percentage points. According to the Fed theory outlined by DeKaser, the 6-point swing implies that long-term rates are 1.5 percentage points higher than they should be. But with rates so low, that obviously isn't the case. So what's going on?

Several things. First, more time probably has to elapse. Second, budget surpluses and deficits are a mix of cyclical and structural. Much of the Clinton surplus was a result of the dot-com boom's overheated economy, and some of the Bush deficit results from the aftereffects of the recession that began around the time Bush took office in early 2001. DeKaser estimates that today's structural deficit is 2.5 percent of GDP, while David Seiders, chief economist for the National Association of Home Builders, puts it at under 2 percent.

Third, there are plenty of jobless people, empty offices, idle trucks, unused bandwidth and shuttered factories. Supply for all these things exceeds demand, and that keeps inflation at bay. "The economy hasn't been growing fast enough to generate the activity to cause crowding out," says Michael Cosgrove, an economist and principal of The Econoclast, an economics consulting firm.

Beijing has more say than Bush
Cosgrove adds that corporations are flush with cash, so they don't have to borrow -- and the low demand for money keeps rates low. And foreigners, especially the Japanese and Chinese counterparts to the Fed, have a tremendous appetite for U.S. Treasuries, keeping bond yields -- and interest rates -- low.

"I think the foreign sector is probably the bigger decision in terms of influence on interest rates, rather than the fiscal situation here at home," Cosgrove says. By buying billions of dollars in Treasuries, Japan and China are parking money in a safe place while lending the money that America needs to buy Asian goods. It's a win-win situation as long as the dollar's value doesn't fall in relation to other currencies.

Although rates are bound to rise, no one can predict exactly when or how fast. You would be crazy to try to guess where rates will be in, say, five years, says Bob Walters, chief economist for Quicken Loans.

"What we do know is that most people are in their mortgage for five or six years," he says. "What we do know is that interest rates are really low. What we do know is that interest rates are on their way up. But there's no reason to think they're going to go sky-high."

In the long run, it would be wise to shrink the budget deficit to prevent the resulting rise in interest rates. Democrats say that higher taxes are needed; Republicans say further tax cuts will stimulate the economy and result in higher tax revenues. Since the Republicans control the White House and both houses of Congress, we will know someday if they are correct.

Mixed messages on tax breaks
Bush and the Republicans in Congress also will have final say over changes in the tax code. Bush has sent mixed messages about tax breaks for homeowners.

A month before the election, speaking in the swing state of Ohio to a gathering of home builders who greeted him with cheers of "Four more years," Bush endorsed the idea of adding a tax credit "to help you build between 40,000 and 50,000 new affordable homes every year." He added, "I believe that the mortgage interest deduction enables more Americans to achieve the goal of homeownership. It is an important part of our tax code."

Two days after the election, the president was talking about another priority: tax simplification. In his post-election news conference, Bush said he wants to change the tax code in a way that's revenue neutral, fair and free of loopholes benefiting special interests. "And so the simplification would be the goal," he said.

What he said next was artfully ambiguous, and has been interpreted in starkly different ways: "One of the interesting debates will be, of course, in the course of simplification, will there be incentives in the code: charitable giving, of course, and mortgage deductions are very important. As governor of Texas, when I -- some time I think I was asked about simplification, I always noted how important it was for certain incentives to be built into the tax code, and that will be an interesting part of the debate."

Is mortgage interest deduction in play?
Jerry Howard, chief executive of the National Association of Home Builders, believes that Bush has signaled continued support for the deductions for mortgage interest and charitable giving. "Obviously, we have to be very, very vigilant as that debate begins," he says.

That word -- debate -- is precisely what got the attention of Howard Glaser, a consultant to the mortgage and real estate industries and a former official with the Department of Housing and Urban Development. If the mortgage interest deduction is untouchable, Glaser asks, why would Bush call it "an interesting part of the debate"?

If there are any attacks on the home mortgage interest deduction, they will come from at least two fronts. First, proponents of a flat tax will argue that homeowners will break even by paying lower rates, but with deductions removed. A flat tax wouldn't necessarily be an income tax; it might be a levy on consumption, akin to a national sales tax.

A more subtle argument, advanced by Cosgrove, goes like this: If the mortgage interest deduction stays in the tax code, but tax rates are cut, the deduction saves less money. It's less valuable.

On the other hand, Ken Wade, chief executive of Neighborhood Reinvestment Corp., points out that many lower-income homeowners take the standard deduction anyway instead of itemizing. They wouldn't miss the elimination of the mortgage interest deduction. Both of these factors could make it easier to phase out the mortgage interest deduction sooner or later.

Given that Bush was talking in October about giving tax breaks to home builders, and talking in November about eliminating loopholes for special interests and simplifying the tax code, industry groups figure that they might as well go for a bite of the tax pie. After all, maybe Bush meant what he said in October.

The home builders want that tax credit for building affordable houses. Everyone in the real estate and mortgage industries wants to keep the mortgage interest deduction. And the mortgage insurance industry plans to try again to pass a tax deduction for mortgage insurance premiums. This year, the provision was removed in the conference committee.

Half of the House co-sponsored the bill to let homeowners deduct the cost of private mortgage insurance, as well as Federal Housing Administration and Veterans Administration mortgage insurance. "It was a popular provision with virtually no opposition to it, and the budget charge was relatively modest -- I think $452 million over one year," says Jeff Lubar, spokesman for the Mortgage Insurance Companies of America.

The president has promised to promote housing in ways that have nothing to do with taxes. His goal is to increase homeownership among minorities and immigrants, and that means making it easier for lower-income renters to buy houses.

Zero down payment program
The centerpiece of that effort is the Zero Downpayment Initiative. Right now, federal law requires home buyers to make down payments of at least 3 percent to qualify for FHA-insured loans. A flourishing down payment assistance industry has grown up to get around that requirement, and Bush has asked Congress to change the law and allow people to get FHA-insured mortgages with zero down.

A zero-down bill was introduced this year, but didn't pass because of uncertainty over the cost.

Another way to meet Bush's housing objectives is to require mortgage giants Fannie Mae and Freddie Mac to fund more home loans for low- and moderate-income buyers. This month, the federal housing department made just such a proposal, which would require the companies to set aside 56 percent of their mortgage purchases for low- to moderate-income loans, up from about 50 percent this year.

Fannie and Freddie have little choice but to acquiesce, because the companies are fighting a war on another front: the Bush administration has proposed a much tougher regulatory structure for them.

The president hews closer to his anti-regulation roots when it comes to home builders, who (unlike Fannie and Freddie) overwhelmingly backed Bush in political donations. In Bush's October speech to the builders, right after he endorsed a tax cut to benefit builders, he promised to get the government off their backs. Regulatory barriers add as much as 35 percent to the costs of new houses, he said.

"I understand there's a need for sensible regulation," Bush added, "but when you have overlapping regulations that send confusing signals, when you have the federal government, the state government, the local governments creating obstacles for home building, it is time to reduce those regulations."

Amen to that, says Howard, head of the Home Builders, who coins a word to describe some regulations: some are duplicative, he says, and some are even "triplicative."

What it all comes down to, says Douglas Magid, chief executive of Century 21 William B. May, a real estate brokerage in Manhattan, is "continuing support for business-friendly policies." Bush believes that rising homeownership is a sign of a strong economy, Magid says, and the entire housing industry agrees.

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