SHARMINI PERIES: Michael has a new book out, J is for Junk Economics: A Survivor’s Guide to Economic Vocabulary in an Age of Deception. Michael, so let’s continue our discussion about the various myths that are out there that we need to be aware of in order to understand the economy. Part of the problem is ordinary people, partly because of this terminologies that you described so well in your book, are led to feel that the economy is so abstract, its removed from them. They’re not engaged in it. It’s all about the stock market or the housing market or what the big banks are doing. But we are very active agents in the economy everyday. So in that sense, the real estate market is the only thing that seems to be somewhat real for people because people do buy and sell their house and sometimes its foreclosed on them and they have to move out. They have to then rent somebody else’s house that’s owned by somebody else. So, let’s talk about the real estate market and how it’s mythologies for us.
MICHAEL HUDSON: People have the idea that when house prices go up, somehow everybody’s getting richer. And it’s true that the entry to the middle class for the last hundred years has been to be able to own your own home. From about 1945 to mid-1980, families were able to ride a wave of rising house prices. They thought they were all getting richer. Then prices went even higher up between about 2001 to 2008 as Allan Greenspan flooded the economy with money – that is, credit (peoples’ debt to the banks). People still had the idea that just like their parents got rich off of rising housing prices and were able to put them through school and give they a better life, now they’re getting richer.
What they don’t realize is that the reason house prices go up isn’t simply because population grows or nature makes them go up. There are two factors. One, the public sector pays a lot of money on infrastructure. It builds new schools and parks and roads and sewer systems. Every time it builds a new transportation system, property goes up. When New York City built a subway in on 2nd Avenue, property prices are going up there. So, you have the public sector spending money on transportation. Taxpayers have to pay but the landlords all benefit and their taxes don’t go up.
But most of all, think what a house is worth. It is worth whatever a bank is going to lend against it. The fact is that none of us have enough money to pay down cash for a house. All of us have to take out a mortgage and how much we can pay and whether we can outbid the next guy who’d like that house would be, who’s going to borrow the most money?
When I became an adult in the 1960’s there was a rule of thumb. Families could borrow up to where the mortgage would absorb 25% of their income. They would get a 30-year mortgage that, at the end of 30 years, would pay itself off and they would owe nothing. Then, when they left the job market after having worked for 30 years, they would own their home outright, free and clear.
By 2008 matters had changed drastically. Banks were lending 99% and even 100% mortgage. So you could get a house for nothing. Just sign the 100% mortgage, and in many cases you didn’t even have to pay any interest, or take any of your income for 3 years. That is why housing prices rose. It wasn’t because property was worth more. It wasn’t because people were earning more and population was rising. Housing prices were going up because banks were making junk mortgages. It was all on credit.
Was this really making home buyers richer? Was it helping create a middle class? The proportion of the population owning their homes did rise – but after 2008 it plunged back down when foreclosure time arrived and the Obama Administration re-negged on its promises to write down junk-mortgage debts to realistic prices and carrying charges that reflected actual rental values.
The result was that instead while house prices were going up, they didn’t think about the fact that their debt was going up proportionally. All their increased house price was matched by the increased debt that people were taking on. Instead of paying 25% of their income on the mortgage, which was the rule in 1960’s, the government today, in 2016, will provide a Federal Housing Authority guarantee for mortgages that absorb up to 43% of the borrower’s income. That’s a huge, historically unprecedented ratio, 43%. It’s made the bank rich, not homeowners.
In Germany where I was last month, the average rent is between 10 and 15% of family income. There are very low prices there, for historical reasons. So ask yourself how can you expect American factory workers to compete with German factory workers, when you have to pay 43% of your income for a mortgage and they have to pay only 15% of their income. There’s no way you can compete. So instead of making the U.S. economy richer by housing prices going up, it’s actually made the economy less competitive, leading to more unemployment.
Of course there’s one other facto that makes housing prices go up. That’s property tax cuts.
This is a radical change, and it has helped banks much more than homeowners. Every economy in the world before about 1800 used to depend primarily on the land tax. Ever since the Stone Age, Bronze Age and classical antiquity, the land tax was what was the basis of taxation. That was the criterion for citizenship in Greece and Rome. Governments financed themselves by taxing the land. After William the Conqueror conquered England in 1066, a few years later he had the Domesday Book written up to calculate how much rent tax everyone had to pay on their land.
Water, all of this tax was privatized. The Revolt of the Barons sought to privatize the rent tax instead of making land a public utility.
Fast forward to today. In the United States since the Reagan administration, there’s been a steady cut in the real estate tax. At first glance, many homeowners think that this saves them money and helps the middle class get richer. What they don’t realize is that when the real estate taxes are cut, that leaves more rental value of the land available for new buyers to pledge to pay the banks in interest. The basic principle is that rent is for paying interest. This is true in commercial real estate as well as residential real estate.
Bankers know that every time there’s a property tax cut, they can make a larger mortgage loan against that property. The result is that instead of paying taxes, new homeowners pay interest to the bank. The higher interest payment absorbs the tax cut.
Meanwhile since they’re not paying taxes on real estate, the government – local governments especially – find themselves in a budget squeeze. They’re not getting the real estate tax revenue as before, especially California with its Proposition 13. So, they have to find the tax revenue elsewhere – for instance, by sales taxes on what con summers buy. Some cities and states impose an income tax on labor. But they don’t tax dividends or Wall Street.
The result is that if you are a wage earner, they tax your wage withholding, impose excise taxes and sales taxes on the things people buy. Not houses, not stocks and bonds, not the things that rich people buy, but the things that the middle class and the working class buy. They end up with the tax burden. And landlords get richer, especially commercial property owners.
What this tax shift means is that housing prices have been pushed up by shifting taxes off real estate, off the Donald Trumps of the world, onto homeowners, renters and consumers – the people who are not millionaires. But most people don’t realize why prices for real estate are going up. Most of all, they don’t realize that they’re not really better off if the price housing goes up, if their debt goes up even more. They didn’t anticipate that in 2008, housing prices would plunge and the debts would remain in place. Suddenly many families found themselves in what economists call negative equity. That’s the position that 10 million American families were in when they were foreclosed upon after 2008.
And just now, as soon as the election was over in November, foreclosure rates have gone up sharply. It’s as if Wall Street has said, “Okay, we got the suckers to vote, now we’re going to slam and begin foreclosing on them like anything. That’s exactly what’s happening in New York where I live. Foreclosure rates way up. You’re seeing a transfer of property from debtors to creditors.
PERIES: And Donald Trump in his interview on 60 Minutes on Sunday with Lesley Stahl said the first thing he’s going to do, he has a bill waiting which is going to cut taxes. So what does he mean by this,and what will it mean for us?
HUDSON: Nobody knows what it means because we don’t know whether he’s just going to turn the presidency over to the Republican Party’s lobbyists to write the bill. The implication is that when he talks about cutting taxes, being a narcissist he means cutting taxes for himself. He doesn’t mean cutting taxes on most people. There may be a small token tax cut for other people, but a big cut in the taxes on the highest wealth brackets. So, you can be sure that his constituency is going to get the biggest tax cuts. Not your constituency that watches this show.
PERIES: Here you’re talking about Wall Street getting more tax cuts?
HUDSON: Right.