Should the U.S. ban real estate lending?
Filed under: Economy
Lending money to people to build and buy real estate is a risky business that periodically costs taxpayers huge amounts of money. Not only do taxpayers lose as a result of all the tax incentives associated with real estate, but they also pay when the banks that make bad real estate loans go bankrupt.
While there are clear benefits to owning real estate, the business of real estate lending costs America so much that I think we ought to let real estate prices drop to a level at which people can afford it without borrowing.
What prompts these thoughts is the news on Friday that the number of bank failures hit 106 so far in 2009, the highest number since 1992, when 181 banks failed. And more are on the way as 416 banks with $299.8 billion in combined assets are on the FDIC's list of "problem" lenders, according to Bloomberg.
The interesting thing is that what caused bank failures back then is the same thing that is causing them now -- real estate and construction loans that developers couldn't repay when they abandoned failing projects, as well as landlords who could not make their loan payments.
How much have these failed real estate loans cost us? The S&L bailout that wrapped up around 1992 took $293.3 billion from the American taxpayer. And the current real-estate-led collapse has cost the FDIC -- to which I consulted in 1982 -- an estimated $25 billion this year -- a cost expected to hit $100 billion through 2013. (As I posted, another major cause of those failures has been the use of brokered deposits -- which came from all over the world in search of higher returns -- to make those real estate loans).
The cost to the FDIC is a tiny proportion of the total. If you take into account the cost to taxpayers of keeping the biggest banks from collapsing -- which resulted from borrowing too much money to buy securities backed by real estate loans -- the cost to taxpayers this time rises to $23.7 trillion. Of course, that includes the costs to the U.S. of bailing out Fannie Mae and Freddie Mac. And let's not forget the $1.1 trillion in credit losses and writedowns that banks have taken since 2007.
But there's an entirely different set of costs we incur to worship at the altar of real estate. I am talking about all the tax incentives for building and borrowing to buy real estate. For example, people who borrow to buy a house can deduct mortgage interest, points, and real estate taxes on their tax returns, costing the U.S. Treasury $75 billion, according to the San Diego Real Estate Market Blog.
People who own rental properties can also deduct a portion of the value of the property as depreciation, as well as the costs of managing the property, such as transportation, insurance, repair, and maintenance. And then there's the tax-free exchange of one investment property for another. These incentives for real estate investment are just the tip of the iceberg, and I don't know how much they cost taxpayers.
While the first wave of the current financial collapse was caused to a large extent by subprime mortgages gone bad, there is another $6.7 trillion worth of commercial real estate loans -- bundled into $700 billion worth of commercial mortgage-backed securities (CMBSs) -- that further threaten the banking system.
Analysts estimate that by 2012, $153 billion worth of these CMBS loans will come due, and since the property values have declined so much, about two-thirds of those loans will not be refinanced, costing about $100 billion in losses when the CMBS cannot be refinanced.
When you take into account all the costs of bailing out bad real estate loans and couple them with the cost to the Treasury of tax deductions to encourage people to build and borrow to buy real estate, you realize that it might be cheaper for society to end real estate lending and let the price of real estate fall until people can afford to buy or rent it without borrowing.
Is it possible to imagine a world where people live within their means when it comes to real estate? Sure. But making it happen would require overcoming a firestorm of opposition from all the people who benefit from the perverse incentives we've created to turn what would otherwise be unaffordable for most into a mass market.
Peter Cohan is a management consultant, Babson professor, and author of nine books, including Capital Rising (due in June 2010). Follow him on Twitter. He has no financial interest in the securities mentioned.
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Reader Comments (Page 1 of 2)
10-24-2009 @ 2:41PM
Al Wunsch said...
Perhaps todays banks are taking bigger risks than those of yesteryear? If we got rid of the current tax system and inplemented something like the Fair Tax, then all these tax breaks/incentives etc would no longer be in play. The politician would have less sleight of hand to play with.
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10-24-2009 @ 2:55PM
Carney said...
I like the idea of a simple retail tax that everybody pays. Everyone would be a taxpayer with a vested interest in restraining the size and scope of government. The rich would still pay more - 30% of a Ferrari is a lot more than 30% of a Daihatsu. By encouraging savings and investment we would ease the retirement crisis. And with a simpler, fairer tax system we would encourage economic growth.
My big beef with the Fair Tax proposal specifically is the provision for a "rebate" - a government check given out to everyone that supposedly reimburses everyone for their essential goods and services. This is frought with major unsolvable problems. First, politicians would be under intense pressure to mandate a bigger and bigger rebate. Second, there would be endless fighting over the formula to determine how much the essential goods are, what they are, and over such issues as regional differences in the cost of living, all sparking intense lobbying. Third, it gets every single American hooked on government and looking to Washington as the source of their basic needs.
Scrap the rebate and just cut the rate a bit lower to adjust.
I realize there'd be whining about the poor paying tax, but our current tax code's complexity adds a great deal to the cost of a loaf of bread for instance. Cutting that out would greatly mitigate if not eliminate the expense of a sales tax. And again, it's good for them to pay something - everyone should help pull the load and have a stake in keeping the size of government limited.
10-24-2009 @ 2:44PM
Carney said...
Without going that far, we could at the very least stop affirmative action lending - the practice of racially and politically motivated lending to borrowers who do not on the basis of the numbers deserve a loan at those terms or at times even any loan at all.
The government needs to repeal laws and regulations like the Community Reinvestment Act and at a minimum needs to explicitly repudiate portions of "civil rights" and "fair housing" laws that ban or in effect ban rational policies with a "disparate impact" on various protected classes and victim groups. It also needs to crack down hard, including with RICO statutes, on groups like ACORN and Al Sharpton's National Action Network that send bullhorn wielding mobs swarming at offices or even people's homes to intimidate, hustle, and extort below-market rate loans for their memberships and the groups they claim to speak for.
Lenders right now have a Hobson's choice.
1) Protect themselves from the high lateness, nonpayment or default rate from high-risk, low-income, low collateral, bad credit individuals and demographics with high interest rates or tough policies and be called "predatory lenders"; or
2) focus their finite loan dollars on desirable, reliable groups and individuals that are more likely to be profitable and then face howls of "redlining"; or
3) give into the pressure, hand out loans like candy to the undeserving and end up with a huge load of bad toxic debt and financial ruin, plus public outrage, lectures from pompous politicians, and a government takeover.
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10-25-2009 @ 11:38AM
vaughnvdg said...
Now give us your plan for NON-MINORITY borrowers who PAID TOO MUCH FOR HOUSES and SPECULATED and GOT BURNED who want the GOVERNMENT to BAIL THEM OUT just like EVERYONE ELSE ya RACIST!!! This problem was not cause by DA MINORITIES!!! EVERYONE had a PIECE OF THIS PIE!!!!!
10-24-2009 @ 3:54PM
ramos said...
No money down and liar loans to purchase real estate is what hurting Banks and of course the Tax payer. If buyer had put at least 10% down payment we would not be in trouble. Buyers were gambling with no money, if prices went up they were there to rip the rewards and if prices went down the Tax payer will pick the tab, how stupid.
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10-24-2009 @ 4:02PM
Vic said...
It has been noted that the difference between the USSR and the free world is Real Estate Ownership.
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10-24-2009 @ 4:25PM
zev said...
vic, i guess you feel "free", but of what?so we have freedom of speech etc. but nobody listens and life gets harder no matter how hard one works.is that real "freedom"?
zev
10-24-2009 @ 5:36PM
Iridium said...
We don't need to get rid of bank lending, we just need to lend at reasonable interest rates. The United States has some of the highest interest rates in the world for mortgages. Lending isn't the problem the problem is the banks. Interest rates make real estate unfordable!!!
In Canada you can buy a home with a 25 year 3.2% interest rate. Japan was lending to people for 1%. In Japan you can get a $500,000 mortgage for less per month than a person can get a $200,000 mortgage in the USA.
Seriously even 5.5% for 30 years is extortion. You are telling me I have to pay the bank $110,000 in interest for a $130,000 loan. Then we have the system where the more money you borrow the higher the interest you pay in the form of the jumbo loan.
I know mortgage interest rates are pegged to treasuries and other aspects but how can the spread on a loan be higher now than when rates were 7.25%? It doesn't make any sense. Coupled with borrowing rates from the Fed at 0% it is insane to think that a consumer has to pay an interest rate higher than 5%.
Here is the problem though. Any reduction in interest rates that would make homes more affordable for the same selling price would only be destroyed by the corrupt system we have put in place. It would create a massive appraised value bubble caused by the banks and the Realtor's Association.
CHECK INTO THIS STATISTIC!!! If you look at home price charts, home values held steady with inflation until the early 1960's when the creation of a nationwide connected realtor network was established. After this home prices went on a tear upwards. Who was it that told you that your home will be worth double what you paid in 5-10 years? Your realtor probably told you that.
REALTORS CONSPIRED WITH BANKS TO INCREASE THE VALUE OF HOMES IN ORDER TO 1) INCREASE COMMISSIONS AND 2) INCREASE INTEREST PAYMENTS TO BANKS!!! Why not it is in their best self serving interest to do so. When you have a nationwide network of people all doing the bidding of a singular entity you will always get corruption.
The simple fact is that corruption and greed have ruined our economy. It is completely ruined and there isn't any way back other than total outright collapse.
We must have some form of loan system. For homes to become affordable enough for the average person to buy them outright, you are talking about $20,000 for a 1500 sq ft home. Very few people can save over $10,000 to purchase a car for cash.
If you make $35,000 a year just food, energy, and taxes takes over half of that away. That is where I will speak about the tax write offs for owning a home.
I pay $951 a month to the bank to cover my mortgage and escrow. My actual mortgage makes up $621 of that. $330 a month goes to pay taxes, points, and insurances including the asinine PMI insurance. OVER 50% OF THE VALUE OF MY MORTGAGE GOES TO PAY FOR INSURANCE AND TAXES!!!!!!!!!!!!!!!!! Within my actual mortgage based on equal payments around $300 a month goes to interest.
SO EVERY MONTH ABOUT $621 GOES TO PAY FOR INTEREST, TAXES, AND INSURANCE WITH $300 ACTUALLY GOING TO PAY FOR THE HOUSE ITSELF!!!
That is the insanity and what needs to change. Not getting rid of lending all together.
If I was a billionaire the first thing I would do is start a private lending practice giving people money for homes at 2% interest. In a few years I would probably be worth over a trillion dollars. My lending business would go through the roof while the banks would all start to fail. I'm sure some people would like to do that but the corrupt system stands in the way.
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10-24-2009 @ 6:00PM
Mike B. said...
First, it just goes to show you that ANYBODY can write a book. Mr. Cohan's liberal bias and socialistic agenda are not hard to glean. Well put by Ramos and Carney; basically, if the government would just stay out of anything that has to do with business in general we would not be in this mess. Obviously, banks got overheated in their lending practices and allowed ridiculous loan to value limits in their loan portfolios. This situation would have been easily prevented via an industry wide mandate of maintaining an LTV of no less that 75% on any balance sheet loan. Unfortunately, that would probably be bypassed via fraudulent appraisals, as was the case during the 1990's S&L fiasco. Unfortunately, this chicken has already flown the coop, with the rest of the flock close behind. Mr. Cohan's idea is sophmoric in its basic sense but, liberals have always been ones to suggest ideas that are destructive rather than constructive. Although I wish I had more to go on regarding his writing before making such political commentary. Nevertheless, dark days await all of us over the next 10 years, and I wish the best for conservatives AND liberals alike; as this Depression will be apolitical in its choice of whose life it ruins.
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10-25-2009 @ 12:10AM
me said...
wrong.....we got here when government cut regulations. cutting regulations = government getting out. capitalism = corruption. capitalism can be good but only with strict regulation to maintain balance.
10-24-2009 @ 7:54PM
Michael said...
I think that the only way a correction of this proportion would occur, is through the world as we know it coming to an end. Aside from this happening, I think Peter Cohen is a moron. I love people that throw out these ridiculus ideas, just to get an article published.
I can throw around the facts as well as anyone, but to think that the economy of housing can become affordable to the masses if only everyone paid cash is absurd. The idea of credit is front and center, and the only people that should be able to borrow credit are those that have used it responsibly in the past.
The current problem is fully the fault of banks lending to untested borrowers, and those that aren't educated enough to understand how to manage thier money. This does not mean that those who have lost their jobs due to the reccession should have planned better, it means that the banks, and those that accepted ARMortgages without understanding the ramifications screwed everyone else.
The world economy will not submit to a cash and carry view of commerce, ever! Peter why don't you use that Melon on your head and come up with a real solution. What a tool box!
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10-25-2009 @ 4:19AM
me said...
true - i agree; however, you are letting the banks off too easy. shouldn't those that lend have the intelligence and foresight to see where that was heading? greed blinds and all they saw was the money.
10-24-2009 @ 8:40PM
Steve said...
Michael, I agree that ignorance is no excuse. There was a game played by the mortgage brokers. They took advantage of uneducated people or maybe educated people just wanting to have their own home. Everyone lost. Are you an educated home owner? If you own your house it depreciated. Whether you understood the rules or not you were deceived. You lost. The banks really screwed us and it's insult to injury to bail them out.
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10-24-2009 @ 10:31PM
garry said...
my thoghts are if the gov. would not have lent all the money (bailouts) to big companies that really did not need it and bought loans from troubled people @ 2 to 3 percent interest
the gov. would have made money off of the interest from the loans. the gov. would have still bailed the banks out because the gov. would now own the loans that the banks owned and the banks would not have failed do to write offs and the people in trouble would have had lower payments making in more affordable for them.
and all would be happy
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10-24-2009 @ 11:57PM
RON said...
i like most of what cohan usually writes.
this article is so off the wall, makes me wonder if he actually wrote it.
he's advocating the complete reversal of an economy based on 60% consumer spending. in one sense he is right. with the driving down of wages, the top 20% already own 80% of the wealth. why not make it that 80% will never be able to accumulate anything.
his rant about housing prices fails to mention that buyers over the years have bought homes, not so much as a place to live, but an investment. it's the buyer that helped drive up the cost. people standing in line to buy hoping 6 months later they could flip it and make 10, 20, 30 and in some markets 50% profit.
another reason for housing costs are local and state regulation. not necessilarily a bad thing, but does increase costs. same with cars. how many thousands of dollars are because of government mandated safety regulations?
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10-25-2009 @ 9:22AM
Luis Vendrell said...
Im not a financial expert, but just a investment home owner because of my military obligations. The thing the gov needs to fix now is the cost of real estate taxes. Real estate taxes keep rising despite the depreciation of real estate property. The local and state gov's are hurting the home buyer even more.
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10-25-2009 @ 1:36PM
Dean Striker said...
Go ahead, no more real estate lending, if what you wish is to destroy the real estate market entirely. Quit Gov mucking around and Forcing everything on the people. Shut Gov DOWN.
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10-25-2009 @ 10:18PM
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10-26-2009 @ 3:01AM
colts fan said...
one should not be allowed to borrow if the agreed upon precentage capital is not fronted for the loan.
proper capital and proper short term & long term investment is the top reason why most loans fail for repayment, which is simply the financial institution's responsibility to require proof and proper documention (read carefully before signing your loan!).
yes, this also falls under real estate for those who do not understand ...your welcome ; )
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