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Tuesday, March 04, 2008

Renting versus Owning and the Flexibility of Job Markets

Dean Baker says the government's plan to intervene in mortgage markets is a bad deal for some homeowners:

The hidden homeowner tax, by Dean Baker, Comment is Free: ...As we know, millions of families are facing foreclosure on their homes... This is a situation where the banks would ordinarily take a huge hit...

But politicians can't resist a bank in distress. They want the government to step in and either guarantee or directly issue new mortgages to these homeowners. When these new mortgages are issued..., they will be giving the banks far more money than they can reasonably hope to get if the houses had gone through ... foreclosure...

This can be viewed as bad policy because it is giving tens of billions of taxpayer dollars to the truly rich. But it should be viewed as even worse policy because it is effectively taxing millions of low- and moderate-income families to live in homes in which they have no equity. ...

Typically, houses sell for about 14 times as much as what it would cost to rent ... for a year. The run-up in house prices in the bubble raised the ratio ... to more than 20 to 1. While prices have begun to fall, in many areas that ratio remains nearly unchanged. ...

Suppose that a moderate homeowner gets a 6% mortgage, and then pays an additional 1% of the sale price each year on both tax and maintenance. This means that their costs of "owning" the house is equal to 8% of the sale price, not counting any payments of principle...

Let's put numbers in this story. Suppose the house would sell for $200,000. The 20-to-1 sale-to-rent ratio implies that it would rent for $10,000 a year or $830 a month. Instead, this homeowner is paying $12,000 a year in interest, $2,000 a year in taxes and $2,000 a year in maintenance for a total of $16,000 a year, or $1,330 per month.

This additional $6,000 a year in housing costs is likely to be large relative to the family's income. ...

Paying extra to own, rather than rent, a home could make sense if the homeowner was accumulating equity in the house. However, this is almost certainly not the case. House prices are falling rapidly and will likely continue to fall until the overhang from the housing bubble is eliminated. The vast majority of moderate-income homeowners facing foreclosure will never see a dime in equity on their home. ...

We need a housing policy that is designed to give people decent housing, not fulfill ideological commitments to an "ownership society".

There's something about owning a home - maybe it's the ability to paint the walls as you please without asking, put a garden in the backyard, have a dog or a cat - and much of it can't be capitalized into the price because it's unique to the individual (that carpet you chose might even lower the value to potential buyers). And if you do get out, especially with a foreclosure, will you be able to get back in later once prices have bottomed out? Wouldn't it be better to find a way to ride it out somehow even if it costs more now? Over several decades, won't I be likely to make money? I understand the financial argument, but there's something intangible about owning a house as compared to renting that the difference in prices doesn't seem to fully capture.

James Surowiecki says there's another cost to home ownership, slower adjustment to shocks, and my kind of thinking - getting a house somehow and then only reluctantly giving it up - makes it worse:

...Homeownership ... impedes the economy’s readjustment by tying people down. From a social point of view, it’s beneficial that homeownership encourages commitment to a given town or city. But, from an economic point of view, it’s good for people to be able to leave places where there’s less work and move to places where there’s more. Homeowners are much less likely to move than renters, especially during a downturn, when they aren’t willing (or can’t afford) to sell at market prices. ...[R]eluctance to move not only keeps unemployment high in struggling areas but makes it hard for businesses elsewhere to attract the workers they need to grow.

This doesn’t mean that the U.S. should become a nation of renters—even if both New York City and Switzerland show that high rates of renting are compatible with great prosperity. With the bursting of the housing bubble, though, it’s time not just to scrutinize the excesses of our home-buying process but to recognize the risks and costs inherent in owning a home. Sometimes the price—for the home buyer and for the economy as a whole—is too high to pay.

I struggle with this one a little bit. Should we, as official policy, expect people to move when things get bad - to leave their family and friends, to move away from the place they grew up and put their kids into new schools - or should government try to find a way to attract new business and provide enough jobs for residents? The latter strategy isn't always feasible, sometimes changes are permanent and nothing can be done about that, and attracting business is difficult in any case. When it isn't feasible, when change that is out of their control forces people to uproot and relocate, shouldn't we do what we can to help with the transition?

But I'm not sure what role the government should play in these cases. The difficulty that comes from leaving a place where you've lived a long time isn't just from home ownership, though that certainly contributes, so simply promoting more renting or even making it easier to sell a home won't fully resolve this "stickiness". If we want to encourage faster adjustment, then to help ease the transition I'd certainly be in favor of generous tax advantages for middle and lower income households who are willing to relocate if we can structure the policies to avoid the distortions that tax breaks for relocating create (e.g., we don't want people moving just to get tax breaks).

But tax breaks aren't the only possibility. Many families won't even move across town while their kids are in school because even if they are willing to provide transportation, the kids cannot stay at the same school due to residency requirements. Reexaming rules such as these could help promote labor market flexibility without costing taxpayers much. The point is that we can do a lot more than we do now to facilitate the transition for families willing to relocate for economic reasons and hopefully, when the administration changes after the next election, domestic issues such as these will receive much more attention than they have in recent years.

    Posted by on Tuesday, March 4, 2008 at 02:52 AM in Economics, Housing, Social Insurance, Unemployment | Permalink  TrackBack (0)  Comments (43)

          

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