The Decline and Fall of the American Dream

I suppose you'll have to forgive me for waxing philosophical (which isn't necessarily under my purview as a Financier and Economist - though I also have a degree (well, a minor) in Philosophy), but there's something that I've just now come to realize that's almost beyond disturbing to me. Unlike my normal, data-centric posts, this one is an opinion piece, but one that I beg you to read.

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Home Ownership's Recent, Twisted Introduction to the Concept of the American Dream

The idea of the American Dream can be traced back to an autobiography written by a fellow Philadelphian, Ben Franklin, who documented his rise from "poverty and obscurity into which [he] was born and bred to a state of affluence." The story tells of how Mr. Franklin effected his meteoric rise to fame and fortune through hard work, stubborn perseverance, inventiveness and God-given talent (which you and I may or may not have). Horatio Alger wrote countless books on the topic, and the ideal still rings true in the ranks of a good portion of the 3,000,000 millionaires alive in America today.

The American Dream, by the very two words which make up the phrase, is above all an ideal that should sit at the very core of what it means to be American. It is supposed to represent all of our hopes and dreams rolled up into one - the sparkling flagship of noble ideas in a land of limitless opportunity. Instead, the mighty American Dream, the powerful force that roused my grandmother and millions of others to leave their homes behind in search of better lives, is now synonymous in the mainstream psyche with the purchase of a single material good.

In a sign of the times, this once-sacred ideal has been twisted by the titans of industry into a mere slogan, its beautiful melody perverted into a siren song, relentlessly luring unsuspecting passersby into its grasp. The promise of prosperity and a better life has been cruelly twisted by the forces of unfettered consumerism and the dire certainty of debt.

The ultimate concept has been displaced by the ultimate asset. The permanent and sublime has been replaced by the transient and tangible. What's more, I didn't even realize that it had happened until today. To those in the real estate industry who managed to pull off this masterfully insidious feat, I can only tip my hat to one of the greatest marketing movements in recorded history. The very idea of the American Dream has been turned against us.

This, folks, is the American Dream: No matter where you c0me from, or who your parents are, if you got the goods, you can make it. No, folks, "making it" does not mean entering into a ruinous financial commitment to purchase a large, pretty box that slowly rots away over a period of 100 years (I put it in such terms to highlight the absurdity of the notion). In fact, under the loose lending standards up to this point, you needed hardly any "goods" at all to achieve that dream. The American Dream is certainly not confined to ownership of a house, as its new common usage implies. This narrow definition so tragically shortchanges the phrase's meaning that it's nearly comical and wholly demeaning. In fact, it's true that the American Dream includes owing a house only coincidentally, a choice (not a requirement) that's part of a much larger success. Millions of overextended families flailing at water's edge on a financial waterfall, or simply crushed under a mountain of debt, hardly fits anyone's definition of success - except for the lenders, agents and brokers who reap the obscene profits from this darkening field.

The actual country that we live in may not be all that its cracked up to be. We all certainly don't have an equal shot at fame and fortune, and we all may not be treated equally under the eyes of the law, yet, but a dream is supposed to be something truly great, a paradigm toward which we strive and will one day perhaps transcend. What's always made America great is certainly not its reality, but the unique set of ideals, including democracy, liberty, opportunity and equality, toward which that reality has slowly marched over the past 230 years. If those ideals now include the newly redefined American Dream, then we're marching the wrong way.

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- eternitus

In examining the NAR's existing home sales report from Friday, March 23, the real big news, in my opinion (and how the headlines should read), is the 7.6% slide in median home prices since July 2006, when the median price was $230,000. That's $18,000 in "equity" that has gone up in smoke. (Just assuming, for simplicity, that the "mix" of homes sold in the data is little changed - we're talking about a set of large numbers, so this tends to be so).

If you bought then, with no money down, and assuming closing costs of $3,000, you could be $21,000 in the hole right now. If you factor in real estate placement fees of 6% (another $12,700), you are looking at a median loss of $33,720 on the sale of your "median" home right now! OUCH! That's a tragedy on a massive scale. For the 605,000 who bought then, that translates to an approximate loss of $12 billion in "equity" (without consideration for real estate fees). For all who bought in 2006, the number could be as high as $75 billion... OUCH (again)!

Courtesy of the Wall Street Journal (After a Few Rants)...

I plan on keeping this blog weekly, but people have to see this article... It's important that we have full knowledge of the actual data on housing, especially given the provider (NAR - National Association of REALTORS) ) ... and especially when seasonal adjustments and other manipulations come into effect, such as the NAR's phantom downward revisions of year-ago data (curious, because usually these revisions occur within one or two months... seems convenient that, when they wanted to keep the train rolling, prices were "higher" and now, at damage control time, "oops, they weren't really that high after all!").

I'm not anti-home ownership... I think it's a great thing when you can get even a moderately reasonable price. However, prices aren't reasonable at the present (by any sane measure), and as such, I'm against making a first-time home purchase in the Northeast and the West at this time. (I will provide a post on the detailed calculations behind it in the future, but suffice it to say that, given the differences between prices and rents, if they persist, then renters are better off renting for the rest of their lives). As I've said on this blog before, NO INVESTMENT IS GOOD WITHOUT FIRST CONSIDERING THE PRICE. That's just common sense. There are plenty of great assets out there, but paying too much can turn a great asset into an atrocious investment (see: stock market bubble).

What I am against is the NAR... One should always be somewhat suspicious of any information received from a group whose motives are driven not by public service, but by PROFIT OFF OF YOU! No, they don't lie, but they do want to paint as rosy a picture as possible (it all depends on what data you throw out, and what you keep - learned that in Investment Banking, where EVERY client we visited was undervalued compared to their comps - how do you think we did that?). A REALTOR has a vested interest in keeping the overpriced party going. They would much rather get 6% of $300,000 than 6% of $150,000 (Remember that's YOUR MONEY they are taking, and, in a $300,000 house, that's an extra $18,000 in appreciation and pay-down of debt principal, on top of your closing costs, that you have to make up to break even).

As a primer, the true rate of home sales was 4.6 million annually in February... The extra two million is a seasonal adjustment that is determined by a statistician... a very subjective number... we'll learn more in the coming months, when the "seasonal" factors go away.

And now, the article as promised...

Home-Sales Surge May Not Reflect Subprime Woes

By MICHAEL CORKERY
March 24, 2007

Sales of previously occupied homes rose unexpectedly last month, but economists said the increase was partly driven by unseasonably warm weather and didn't fully reflect the current turmoil in the subprime mortgage market.

The recent surge in defaults on subprime mortgages, those for people with weaker credit records, has forced lenders to tighten their standards. That is expected to eliminate many potential home buyers, damping sales in the months ahead.

The National Association of Realtors said sales of existing homes increased 3.9% in February from a month earlier to a seasonally adjusted annual rate of 6.69 million units. That sales rate was 3.6% below the year-earlier level.

The latest data reflect completions of home sales in February that resulted from purchase agreements that were mostly signed in December and early January, when unusually warm weather in the Northeast may have enticed more people to shop for homes. The Northeast led the nation with a 14.2% surge in sales in February from a month earlier, while sales increased 1.6% in the South and 3.9% in the Midwest. They were unchanged in the West. Economists also cautioned the unusually warm weather may have confounded seasonal adjustments meant to compensate for lower activity in winter.

"This was purely a fluke number," said Joshua Shapiro, chief U.S. economist at consultancy MFR Inc. "You can bet dollars to doughnuts that next month this number is going to come right back down."

The national median home price dropped to $212,800, a 1.3% decline from a year earlier. Without a downward revision in the year-earlier median, the decline would have been 2.1%, said Thomas Lawler, a housing economist in Vienna, Va. Mr. Lawler said it was the second month in a row that the NAR has revised the year-earlier median price downward. NAR chief economist David Lereah said such revisions are automated and "happen all the time."

Some analysts say price cuts and low interest rates are bringing buyers back into the market, which helped boost sales in February and in the previous month. But the outlook for the housing recovery is clouded by the meltdown in the subprime mortgage market that is beginning to stymie many borrowers with poor credit from obtaining financing.

Mr. Lereah predicted Friday that credit tightening will reduce home sales by 100,000 to 250,000 annually over the next two years. Most economists say this winnowing of home buyers is only now emerging and could drive down home sales in the coming months.

"Our view had been that sales were going to turn around in middle of '07," said Patrick Newport, economist at consultancy Global Insight. "But I don't think that is going to happen because a segment of the home-buying market is not going to be able to borrow money."

The inventory of homes for sale rose 5.9% to 3.75 million at the end of February, which represents a 6.7-month supply at the current sales pace. That's down from a 7.4-month supply in October.

Economists say the number of homes on the market typically increases in February as the peak spring selling season kicks off. In some markets, rising foreclosures threaten to worsen the glut of homes offered for sale. Credit Suisse analyst Ivy Zelman estimates that foreclosures could add as much as 20% to the current inventory of existing homes.

Deductive Reasoning - Tax Time

I had to change my layout to get this to fit! Don't be alarmed!

We'll employ a little reasoning on this post to understand how tax deductions benefit some more than others, and why, aside from business expenses, I believe we should switch to credits.

Our tax system is insanely complex for ordinary people to understand. Large corporations and wealthy individuals may have armies of lawyers and accountants whose sole purpose in life is to find the single combination of deductions and credits out of tens, hundreds or maybe thousands of combinations that results in the lowest tax liability. One estimate claims Americans spend as much as $350 billion each year filing personal and business income taxes. H&R Block alone collected $2.5 billion in tax preparation revenue in its last fiscal year.

The most widely misused and misunderstood creation of the tax code has to be the deduction. An overabundance of deductions is one reason why the code is so complex in the first place.

To be sure, tax deductions are a good thing for taxpayers. They get better and better the more money you make, as a matter of fact. What that means, however, is that the highest earners among us (who usually aren't the demographic that the deduction targets in the first place) benefit the most.

Further, because of the complexities of the tax code, many don't fully understand a deduction's effects, and stop at "it must be a good thing." What's more, slime balls who do understand the implications, and know that you don't, will take advantage the fact and will lead you to believe you're benefits are greater than they are. First, some basic math: a deduction of $1000 yields only $250 in tax benefits to someone in the 25% bracket. To get to the answer, simply multiply the deduction by the tax rate.

Now, we examine America's favorite deduction: Mortgage Interest - We're assuming that these five happy families pay exactly the same amount of mortgage interest each year (For simplicity's sake, I'm leaving out the AMT, but, with only the deductions mentioned, its effect isn't material to the discussion).

	Average		Yuppy		Corporate		Big		Corporate
	Joes		Puppies		Climbers		Timers		Executives
Family Income (Married):	$55,000.00		$110,000.00		$165,000.00		$220,000.00		$5,000,000.00
Tax Bracket	15.00%		25.00%		28.00%		33.00%		35.00%
Mortgage Interest	$12,000.00		$12,000.00		$12,000.00		$12,000.00		$12,000.00
Tax Savings:	$1,800.00		$3,000.00		$3,360.00		$3,960.00		$4,200.00

Why do the Corporate Execs get more than twice what the Average Joes get on the same amount of itnerest? Answer: Deductions benefit higher earners disproportionately.

Let's take this analysis one step further. In 2007, to be able to deduct mortgage interest, you have to give up the $10,700 standard deduction and itemize.

	Average		Yuppy		Corporate		Big		Corporate
	Joes		Puppies		Climbers		Timers		Executives
Family Income (Married):	$55,000.00		$110,000.00		$165,000.00		$220,000.00		$5,000,000.00
Tax Bracket	15.00%		25.00%		28.00%		33.00%		35.00%
Standard Deduction Given Up	$10,700.00		$10,700.00		$10,700.00		$10,700.00		$10,700.00
Taxes Savings You Give Up	$1,605.00		$2,675.00		$2,996.00		$3,531.00		$3,745.00
Actual Tax Benefit of Home Ownership	$195.00		$325.00		$364.00		$429.00		$455.00

Fortunately, the homeownership deduction is not as bleak as it looks - By itemizing, you get to deduct state & local taxes and property taxes that you wouldn't otherwise (and maybe a few other things, but those are the biggies for most of us.). Let's assume 5% state & local taxes and $2500 for Property Taxes. (Remember, Benefit = Deduction * Tax Rate).

	Average		Yuppy		Corporate		Big		Corporate
	Joes		Puppies		Climbers		Timers		Executives
Family Income (Married):	$55,000.00		$110,000.00		$165,000.00		$220,000.00		$5,000,000.00
Tax Bracket	15.00%		25.00%		28.00%		33.00%		35.00%
Actual Tax Benefit of Home Ownership	$195.00		$325.00		$364.00		$429.00		$455.00
Add: State & Local Tax Benefit	$412.50		$1,375.00		$2,310.00		$3,630.00		$87,500.00
Add: Property Tax Benefit	$375.00		$625.00		$700.00		$825.00		$875.00
Total Benefits From Itemization	$982.50		$2,325.00		$3,374.00		$4,884.00		$88,830.00

When it's all said & done, the Average Joes make out with just $1000 in tax savings (or about $80 per month), while the Corporate Execs save almost $90,000, almost twice what Average Joe makes in a year, before tax!. If we switched to CREDITS, which are based on what you spend, eliminated all deductions, which are based on what you make, and eliminated itemization altogether, you get a situation that's much more "on the level." Also, you get one that's much, much simpler, and less open to deception by those who stand to gain from our collective ignorance.

	Average		Yuppy		Corporate		Big		Corporate
	Joes		Puppies		Climbers		Timers		Executives
Family Income (Married):	$55,000.00		$110,000.00		$165,000.00		$220,000.00		$5,000,000.00
Mortgage Interest	$12,000.00		$12,000.00		$12,000.00		$12,000.00		$12,000.00
Tax Credit	15.00%		15.00%		15.00%		15.00%		15.00%
Total Tax Savings:	$1,800.00		$1,800.00		$1,800.00		$1,800.00		$1,800.00

This way, the Average Joe saves just as much as Bernnie Ebbers and the Enron Execs, we don't have to worry about "giving up" the standard deduction, and we probably spend less preparing our taxes.

Great Idea! Why don't we change it now! One thought to leave you with:

Where do you think the incomes of the folks who write the tax laws fall in our "spectrum" above? Do they have more in common with the Average Joes, or the Corporate Execs? Further, who funds their campaigns?

Hint Below....





To be fair, I can't blame them (the status quo would be just fine for me, too). They won't reform until we demand it, and, besides, what would the tax preparers do?

-eternitus

Is New Century the New Sock Puppet?

This is directly from the Wall Street Journal, but I think everyone should see it... Seem's eerily similar to the dot-com crash... (dot com's are only a small part of the market... subprimes are only a small part of the market)... etc. Enjoy.

Is New Century this decade’s Pets.com, with their pitch of home loans for all? Stephen Roach at Morgan Stanley thinks so.

“Sub-prime is today’s dot-com — the pin that pricks a much larger bubble,” he wrote in a recent report. Roll back the clock to 2000, and Mr. Roach reminds us that “the optimists argued that equities as a broad asset class were in reasonably good shape,” with any excesses confined to about 350 of the “so-called Internet pure-plays,” which he says accounted for about 6% of the total capitalization of the stock market at the time.

“That view turned out to be dead wrong,” he says. “The dot-com bubble burst,” and the S&P 500 — a broad measure of the market — fell nearly 50% over the next two and a half years and the U.S. economy slipped into a “mild recession, pulling the rest of the world down with it.”

Could it be déjà vu all over again? “Fast-forward seven years, and the actors have changed but the plot is strikingly similar,” says Mr. Roach. Of course, this time, it’s the subprimes instead of the dot-coms. The housing bubble burst, borrowers with poor credit failed to make payments and the mortgage lenders got squeezed as the big banks they count on for financial backing turned their backs.

“How far will the ripples spread?” Mr. Roach think he has the answer, and like last time, it isn’t pretty: “As was the case seven years ago, I suspect that a powerful dynamic has now been set in motion by a small mispriced portion of a major asset class that will have surprisingly broad macro consequences for the U.S. economy as a whole.”
–Worth Civils

Issues Surrounding a Massive Subprime Bailout....

I think it is very important that such a program is not undertaken hastily (see “Katrina Cards”).... Below are some issues that need to be resolved (I don't think they can be resolved, but we'll see) regarding any sort of massive mortgage bailout...

1. How would Congress vet such a program to avoid abuse (see “Katrina Cards”)? What are the costs associated with vetting these loans, and how many dollars will be allocated to bail out consumers? Further, how can we stop any bailout money from going to people who fraudulently misrepresented themselves in order to get loans that they couldn’t afford (thinking they could cash-out at any time for a profit)?

There is at least $40 trillion in Mortgage Debt Outstanding (as of 9 months ago). An overall delinquency rate of 5% puts $2 trillion worth of mortgage debt at risk.

For the $2 trillion in endangered loans, that translates to approximately $170 billion in mortgage payments due just this year… a potential worst-case scenario balloons the Federal budget deficit from $250 billion over the next twelve months to $420 billion.

2. Further, do we segregate “subprime” borrowers from “prime” borrowers, and only help those in the subprime category, even though prime borrowers are in trouble nonetheless?

3. While a bailout can work as a stopgap measure, how do we solve the problem of the basic fact that these people still can’t afford a mortgage on their own? If we subsidize, “until they sell,” then what incentive do they have to sell in the first place? Are we going to subsidize these borrowers permanently? What will that cost? $1 trillion, $2 trillion? If we put a time limit on the subsidy, then we are just delaying the inevitable. This might be the worst case, where billions in tax dollars go to no good end.

4. Finally, the question of fairness… I don’t own a home, and refuse to buy irresponsibly (i.e. borrow more than I can afford to repay if things go south). Now my tax dollars will go to subsidize someone else’s poor decisions to keep them in a house, while folks like me are still renting? One could argue quite successfully that those facing foreclosure should not be, and have no right to be, in the homes they’re in.

Keep in mind, that the market will correct on its own… the glut of subprime loans will be wiped out through foreclosure, and the lenders will probably suffer the most (the borrower will be freed of the obligation, in the end).

No Bailout for Irresponsible Borrowers

First, I'd like to introduce myself as this is my initial blog.

My name is Ryan, and I am a 25-year old financial analyst living in Philadelphia. My professional background includes Investment Banking (formerly) and Private Equity (currently). Prior, I graduated from Swarthmore College in 2004 with a Degree in Economics. Many of my posts will be directed, for now, toward what I believe to be an enormous and growing problem in the U.S. - Housing and it's lack of affordability.

I'm writing in staunch opposition to any legislation that offers a bailout to irresponsible borrowers who over-levered themselves in order to purchase a home. All borrowers have a choice before signing on the dotted line. If a bailout occurs, it seems that once again congress will penalize the financially prudent with higher taxes (or a greater budget deficit) in order to reward the profligate few.

If money isn't involved in a bailout, legislation that makes foreclosure more difficult will penalize the lenders, who followed through on their contractual agreement in the first place and provide a valuable service to the economy. Much like onerous European labor laws that discourage hiring, I believe that such an action will discourage lending to a greater extent than any of us would like.

I believe we all have a right to the American Dream, but we have a duty to follow through on our obligations as well.

"Predatory Lending" is merely a symptom of a larger problem, that being a lack of affordable housing. The median income, in many areas of the country, cannot begin to afford a median house. Does anyone not see a problem here? This is what drives borrowers to take on more debt than they can afford. Housing must be allowed to correct in an orderly manner so home ownership is a reasonable proposition for all Americans.

Please keep in mind that there is a large and growing class of losers from the housing bubble that has nothing to do with mortgages and delinquency. It is the youth of this nation, ages 27 and younger, who never had the chance to buy a house during more affordable times (A "starter" house in many parts of this nation costs $1500 per month (more in others) , or more than half of the average person's take home pay. Keep in mind that much of this demographic is already saddled with debt from ever higher education costs. Just to add insult to injury, these are the lucky few who will bear the brunt of our burgeoning social security "time bomb." It is truly a great time to be alive.

It's not quite the Grapes of Wrath at this point, but frustration and discontent is growing among this group, myself included.