Buy a Home, (Almost) Destroy the Economy

Hey ladies! Get funky.

I frequently jog by San Francisco’s fabled Painted Ladies, a collection of several Victorian homes along Alamo Square Park, forever immortalized in the delightful opening credits of Full House. For the first time in decades, the biggest sister is up for sale. I’m a halfhearted potential buyer in the highly depressing San Francisco real estate market, and though $4 million is more than I’m looking to spend, I’m enjoying the banter this potential sale is bringing to the city and the neighborhood.

I’m also reading Andrew Ross Sorkin’s Too Big to Fail, a thought-provoking and well-composed yarn. However, I fear that the book unwittingly (or perhaps purposefully) feeds the notion that we’re locked in some momentous, never-ending battle of Wall Street vs. Main Street. There is no Main Street; our society’s insane infatuation with homeownership has driven Joe Sixpack into exurbia to flail against the rising waters of personal debt. There is no castle to defend, or if there is, an undercapitalized, government-subsidized bank owns it.

At risk of sounding like a counterculture bumper sticker, we should question everything we’re being fed about the financial crisis and proposed financial reform.

Common wisdom holds that evil, complex derivatives like mortgage-backed securities and credit default swaps are at the heart of the near demise of the global financial system. But those securities wouldn’t exist without the bazillions of dollars in American mortgages that underlie them.

How did we get all those mortgages in the first place? The government, going back to the postwar 1950s, convinced Americans that owning a home was the linchpin of freedom and independence, and it set up a system of perverse incentives to encourage homeownership. An interesting little WSJ piece points out how Canada differs from the U.S. along these lines , to no relative detriment.

I have smart friends who are good at math who constantly needle me about not owning a home (which, incidentally, is the smartest financial decision I’ve ever made). You need the tax deduction, they say, always failing to grasp that you deduct a small portion of what you throw away in interest (ironically, to the wicked banks we all abhor), which in turn keeps money out of the tax system, money our government clearly needs right now.

It’s the tax-deductibility of mortgage interest that drives irrational decisions to buy homes that drive home prices higher that creates the opportunity for the government-sponsored enterprises Fannie and Freddie (not just fat-cat bankers) to package loans into bonds to free up more money for banks to lend to make it easier for undereducated Americans to enter into more mortgages that they don’t understand and can’t afford which are then made into more securities that are inappropriately rated, upon which clever bankers and insurance companies sell insurance (credit default swaps) which somehow, according to the media, caused the financial crisis.

Derivatives are not evil, and they are not that complex; they are simply contracts to pay or receive cash flows derived from the value or payment streams of other things (stocks, mortgages, etc.). Basic mortgage contracts can be far more complicated than mortgage-backed securities or credit default swaps, which are just contracts that say “I will pay you X cash flow as I receive Y cash flows or if Z happens, plus/minus some interest and/or fees.” That’s it.

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Things go haywire when speculators and boobs play a game they don’t understand, creating untenable imbalances in markets, and this situation is neither new nor unique. It’s happened for centuries, with tulips, gold, Beanie Babies, tech stocks, you name it. I myself (well, my poor mother back in Ohio) still own a closet full of worthless cardboard, a highly flammable reminder of the great baseball card mania of the 1980s.

The government’s role is to intervene when necessary (I think Geithner and team did about as good a job as can be expected, given the circumstances) but make sure financial institutions, automakers, and other industrial firms understand they will not be bailed out if they mismanage their businesses.

The government should act as capitalist, as it has done, generating significant income from its investments. Why do we even call it a “bailout”? The government is really no different than a vulture fund in this situation, with taxpayers profiting handsomely from certain firms’ ill-advised bets. It is the government’s explicit and implicit guarantees—of the value of mortgage securities, of the survival of the banks themselves—that encourage willy-nilly risk-taking.

In praising our current leaders, which is somewhat justified, we’re comparing things now to what could have been, i.e., another Great Depression. That was never going to happen, despite what the good people in Washington and in the media told us. If longer-term government intervention in markets was more thoughtful (I’m talking to you, Greenspan), perhaps unemployment would be 6% and stock prices, a leading indicator of economic health, would be even higher.

Or maybe not. Always keep a little pile of cash under the mattress, just in case. In a true sign that the end of the world is nigh, I think Paul Krugman has some good ideas on reform, although he of course couldn’t resist a childish jab at Republicans who don’t want “any reform at all”.

Can’t we all just get along, and prevent the next impending wave of financial problems together?

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