Risk the Credit of the Republic for Homeowners

Yesterday, I was contacted by UrbanDigs, one of my regular readers, and he asked:

UrbanDigs Says:

December 3rd, 20087:10 pm at Edit

David, Can you please email me, its provided on this comment.

I would like your opinion on an alternative to stimulate housing instead of the govt meddling with rates to 4.5% and buying up loans from GSE’s..

Its such a bad idea and they are digging this country into a debt ridden hole.

Why not tweak the tax code for investors from a 1031 deferrement to a 5 YR qualification primary residence like exemption?

http://www.urbandigs.com/2008/12/instead_of_meddline_w_rates_wh.html

GRANT THE PRIMARY TAX CAPITAL GAINS EXEMPTION BENEFIT TO INVESTORS AND CHANGE THE QUALIFICATION TERMS SO THAT THE PROPERTY PURCHASED BY THE INVESTOR MUST BE HELD FOR A MINIMUM PERIOD OF 5 YEARS

Thoughts? As an alternative to help the hoousing supply problem without the unintended consequences of govt meddling, moral hazard, taking on more risky assets, and trying to convince people to buy for the wrong reasons, like 4.5% rates.

Okay, here are my thoughts:

1) Regarding taxation, my view is that all income should be taxed equally and regularly.  I’m not generally in favor of deferring or exempting taxes on asset classes of any sort.

2) The Federal Reserve is buying up mortgage assets.  Now the Treasury is thinking of subsidizing mortgage rates.  Don’t we do enough in the US to overinvest in housing?

Call me a skeptic here.  In credit crunches, the value of the collateral is far more important than the rate charged.  I care more as a lender about the return of my money, than the return on my money.  Lending to entities where the loan-to-value is high is fraught with peril.  Losses occur with little regard for the interest rates charged.  Life events matter more: death, disaster, disability, divorce, and dismissal from employment.  Negative life events cause borrowers to choke on interest payments when refinancing is impossible.

Lowering the mortgage rate to 4.5% will subsidize borrowers who can refinance through conventional mortgages, but will do little good elsewhere.  The subsidy will also add to the financing needs of the US Treasury, which is getting stretched.

The efforts of the Fed and Treasury may lower mortgage rates for a time, but as the government borrows more, there will be pressure for rates to rise.  For now, it may seemingly work, but it will eventually fail, and the outcome will be worse than if they hadn’t acted.

So I’m not crazy about government action here.  Why should we risk the credit of the Republic over homeowners?  Let real estate prices find their levels where ordinary people con afford ordinary homes without incurring a boatload of debt.