Monday, July 25, 2011

Why Low Home Prices Can Be Good For the Economy

You know there are severe distortions in the economy when you hear government officials and their media pundits saying things like: “It is a terrible tragedy for the economy that home prices are falling to levels where people can actually afford to buy them.”

Of course, they say it in slightly different words, but the message is the same: the government should try to keep the housing bubble going as long as possible by printing money and handing it out to the homeowners (the top 25% of income earners getting the lion’s share of subsidies) so that prices can again rise to unaffordable levels.

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Ever since the government got in to the home financing business back in the 1930’s, there has not been a single two year period in which average home prices have not risen, making investment in homes the darling of speculators and homeowners alike and creating the single biggest asset bubble in the economic history of the world. As a result, before the bubble collapsed, people considered their houses as piggy banks, creating demand for goods and service by spending “equity” money in the same way as if it were cash in their pockets. Given that all bubbles, like all Ponzi schemes, inevitably collapse—the only question being when, not if—it was only a matter of time before the housing bubble collapsed, erasing over eight trillion dollars of purchasing power.

The reduction of the effective money supply and aggregate demand by eight trillion dollars gave the government a unique opportunity to replace the people’s purchasing power by the simple and effective expedient of reducing taxes. But with almost half of all Americans paying no federal income taxes at all, any such Keynesian reduction in broad tax reduction was vulnerable to attacks that such reductions would be “tax breaks for the rich” (the rich apparently being defined as anyone who actually pays any federal income tax).

The result was that it became more politically expedient to print trillions of dollars and spend it on nebulous government “programs”, rather than replacing aggregate demand by reducing taxes and allowing people to use their purchasing power to create demand for real goods and services, thus stimulating job creation and wealth.

The most disconcerting of the government “programs” was the so-called “quantitative easing” program, under which printed money was used to buy government bonds that few rational people would buy (does anyone really think interest rates won’t rise above 3% in 10 to 30 years?), thus pushing short terms interest rates to almost zero.
As a result those living on fixed incomes—particularly seniors living on returns from government bonds and other fixed instruments tied to them—have been virtually deprived of their livelihood and thrown under the bus. Ironically, while with one hand inflaming seniors against any social security reform that might insure their benefits for the long term, with the other hand the government is depriving seniors of virtually all of their pension income from safe and fixed instruments.

Even more ironic is that the same government policy makers who resist any kind of tax reduction are the first to resist any reform of one of the most potent of the home bubble creators—the home mortgage deduction—which benefits only the top 25% richest Americans, and rewards the most extravagant tax subsidies (mortgages up to a million dollars) only to those who buy the most extravagant and expensive houses. Meanwhile, other countries which give no such tax deduction for the rich enjoy far higher home ownership levels than the 66% in the U.S.—namely the UK (71%), and even lowly Greece (85%).

The real tragedy then is not that home prices have fallen to affordable levels. It is rather that government policy makers have dissipated the once in a lifetime opportunity to replace the lost purchasing power, and instead have reverted to the policies of Herbert Hoover by demanding the kind of higher taxes that ushered in the Great Depression. Most disconcerting of all, perhaps, is the ignorance displayed by policy makers of economic history, even of the fact that individual tax revenues doubled after the Reagan reduction in marginal tax rates from 70% to 28%, and that tax extractions from the top 1% of income earners rose by 51%; or of the fact that when President Kennedy reduced the highest marginal bracket by 20%, annual tax revenues skyrocketed from $94 billion in 1961 to $153 billion in 1968. (Kennedy would doubtless be dubbed a “Tea Bagger” today).

The simplistic notion that higher taxes bring higher revenues, like the notion that printing money creates wealth, is having a devastating effect on the economy. In the few economic courses taught in elementary schools, students learn that raising taxes to 100%, far from increasing revenue, reduces them to zero; and that in countries like Hungary, a 10% tax has wrought high economic growth, whereas a 51% tax rate in Greece has brought that country to economic ruin.

In fifty years, few economic historians will see a delay of several weeks or even months in raising the federal debt limit; but they would see an almost pathological determination to adopt the policies of Herbert Hoover and Greece as the beginning of the end for American economic health.