Housing the poor

Here are two real cases of the poor in the United States and the current housing crisis.

Case one is a single mother from Nicaragua who has lived in the Miami area since the 1980s. She used to live in a modest one-bedroom apartment, paying $900 per month for rent. She works as a receptionist, speaks good English and makes a decent living, in the range of $2800 per month before taxes. She was pretty thrifty and had about $20,000 in savings (including some money given to her by her former husband). During the housing boom in 2005-2006 (when houses were increasing in value in Miami at 30 percent a year) she took an offer to buy a $200,000 townhouse with no money down. The bank gave her a loan without really looking at her income (yes, this did happen in those days). Once she had the house, she needed new furniture, so she bought a new living room set, bedroom set and new big screen TV.

Those of you with a mortgage are doing the math and seeing that a before-tax income of $2800 per month with a $2000 per month housing payment (including taxes and insurance) does not add up if she wanted her and her two kids to eat and pay utilities, car insurance, car payments, etc. But this woman saw real estate increasing at 30 percent a year and thought, worst case, she could hold the house for a few years and then sell it at a profit. She thought her savings would help her make up the difference until she could sell.

Well, you can imagine what happened. By 2007, her townhouse was worth $180,000, then by 2008 it was at $150,000. The woman’s savings were completely blown. She delayed foreclosure for months but was finally kicked out of the house. She is now in a smaller apartment and has had to sell most of her furniture. The $20,000 she had in the bank is gone. She still has her job but her future is considerably more grim than it was before she decided to take up the dream of home ownership.

The second family involves a husband and wife (also from Nicaragua) who both work. They also live in a small $900 apartment. Neither of them speak English, so they have more modest jobs. Together, they earn about $3000 per month before taxes. They have been able to save about $15,000, which they keep in the bank. A lot of their other savings are sent to family members in Nicaragua.

I talked to these people when the housing boom started and asked them if they were going to buy a house. They said, “no way, we couldn’t afford it.” They stayed in their apartment and missed the boom, and continued to save a few hundred dollars a month. They kept their savings and did not put their kids through the mental torture of buying a house they couldn’t afford, moving and then being kicked out of the house.

So, you say, why did the first woman make such a bad decision? Well, we are all responsible for our own actions, and this woman is responsible for hers. But there is an important point here. It was government policies intended to “help the poor” that caused the woman to buy a house she could not afford. One lesson we learn here is that the best way to help the poor is to let them work and save and not offer them free handouts. Free usually ends up being very expensive indeed.

The source of these government policies to “help the poor” with housing go back decades. This Wikipedia history of Fannie Mae provides a good summary. The point is that in our fervor to provide the dream of home ownership to the poor we have pushed government policies that force banks to give loans to people who otherwise would not be able to afford them. These (admittedly well-intentioned) policies started with the Community Reinvestment Act in 1977 and continued into the second Bush administration. Both Democrats and Republicans signed on to these policies.

To continue to push home ownership for the poor, government agencies began to guarantee loans given by banks. To the bank, there was relatively little risk because of these government guarantees. This gaves banks a huge incentive to create all kinds of new mechanisms (subprime mortgages, ARMs, etc) to get more people to buy mortgages.

There is plenty of blame to go around for the current foreclosure crisis. Both political parties are to blame. Well-meaning government bureaucrats are to blame. Greedy bankers are to blame.

But from the perspective of pure economics, there is an interesting question worth exploring. Are people always better off owning their own home? Well, actually no. A lot of very smart money managers have been saying for a long time that renting is a better investment than buying. So government policies that encourage people to get out of their rented apartments and into their own home seem to be encouraging people to make a bad investment.

From the perspective of the gospel, the Book of Mormon warns about the pride cycle of wanting the newest, biggest and best. Modern-day prophets constantly warn us about getting into debt. I still remember the talk President Hinckley gave when he said President Faust was the happiest guy he knew because he had paid off his mortgage. So, government policies that encourage the poor, middle class or anybody else to covet things beyond their means also appear to be just plain wrong and immoral.

I hope we have learned our lesson. The examples of the two families mentioned above provide a very cautionary tale for all of us.

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About Geoff B.

Geoff B graduated from Stanford University (class of 1985) and worked in journalism for several years until about 1992, when he took up his second career in telecommunications sales. He has held many callings in the Church, but his favorite calling is father and husband. Geoff is active in martial arts and loves hiking and skiing. Geoff has five children and lives in Colorado.

25 thoughts on “Housing the poor

  1. Perhaps not the best article to have read while I’m in escrow, but oh well. We prayed long and hard before choosing to buy, and we selected a place within our means. We also picked a place we knew we could stay in for at least five years – the point at which the benefits of buying begins to outweigh those of renting.

    One correction: the prophets warn us against /unnecessary/ debt, not all debt. They have called out a modest home and education as two acceptable debts. Both can be done wisely or foolishly. The housing bubble burst, as you mention, and the education cost bubble looks ready to burst soon.

  2. Probably the biggest subsidy to home ownership is the income tax deduction for mortgage interest. Are you prepared to see that eliminated or at least greatly reduced?

  3. Jim W, good point. I don’t think it’s unreasonable to want a house with a modest mortgage and to have education debt. Prophets have said both kinds of debts are reasonable.

    LL, I favor a flat tax with no deductions, so the answer to your question is “yes.” Add in the property tax deduction and you have a veritable cornucopia of unhealthy subsidies.

  4. Minor detail (perhaps): Your first story isn’t about home ownership, it’s about poor investing: “she could hold the house for a few years and then sell it at a profit. She thought her savings would help her make up the difference until she could sell.”

    She wasn’t in it for a home, she was in it for a 30% payoff.

  5. BrianJ, partially true, but she was also in it for the dream of “owning your own home.” This dream, for good or bad, is also the reason government policies were set up to subsidize such behavior. In this case, the dream turned to a nightmare.

  6. The situation you described was not just limited to the poor. People in the middle class went in over their heads buying McMansions with low monthly payments with a big balloon payment in the future. These individuals tried to keep ahead of the game by refinancing before the big balloon payment was due. They often fell into the same trap of not realizing the higher cost of utilities and keeping up with the Joneses. Then of course when the maket fell, they lost it all too.

  7. Some of the blame has to go to the banking and mortgage industry who made loans to people who couldn’t afford them in the hopes that the boom would continue and the value of homes would increase.

  8. Joanna, true. But the govt subsidies that caused the problem were hailed as “helping the poor get housing.” The poor then morphed into “middle class” and even, in many case, “upper middle class” and, dare I say, “rich.” There were plenty of rich speculators taking out loans on the cheap so they could buy a house and flip it. Classic mission creep.

    CC, yes, as I stated in this post, some of the blame goes to the evil bankers. But you need to remember that there are two important trends going on from government: 1)increased pressure on banks for “politically correct” reasons to loan to the underpriviledged and 2)Fannie and Freddie back-stopping and guaranteeing the loans. From the bank’s perspective, they were just following the laws that called on them to loan to the poor, and there was very little risk because they had govt guarantees. This is a class case of (well-intentioned) government intervention resulting in unintended consequences.

  9. I’d just like to add it’s not the fact that government is so bad and the private sector is so great. It’s that the private sector can’t screw things up on such a massive scale without government interference (these mortgages could not have gotten so out of hand to the degree they are if we did not have mortgage securities being gobbled up by government owned corporations).

    But the broader point is, the things we work for are things we value. If you don’t work for it, the chances of valuing it are less. And conversely, the things we value are things we are willing to work for. The woman in the first example could have indeed had a home and been secure in it. Except for pernicious government intervention bolstered by greedy banks (and who among us would not be so greedy if you could double your income by doing what the government “desires” you to do).

  10. The collusion of government and big bankers in this, and the after collapse bail out (you notice that foreclosures are going at a quick pace still? So much for helping the little guy!), shows that Isaiah and Nephi had lots of foresight. When the wealthy and powerful collude to make themselves more wealthy and powerful by “grinding the faces of the widows” and taking the houses until there is no more room; is a perfect description of what has happened here.

    I have no problem with businesses being big. I have a problem when they are big because we’ve artificially bolstered them in both good and bad times. And then they pay us back by giving kickbacks to Congress.

    There is a great evil in all of this. While these people see themselves as good and decent members of society, in reality, they demonstrate how Gadianton Robbers performed once they obtained governance.

  11. While government policies may make the path to home ownership slightly more tantalizing, the real source of pressure to get in over your head is the “ownership society” that discounts your voice unless you own a stake in the community.

  12. I enjoyed reading the article.

    We hear the president always talking about the ‘middle class’. It seems like he is talking about 2 groups of people– the rich and the middle class. He doesn’t say anything about the poor or working class. There was a time when our nation had 5 economic classes. Now it is shrinking daily.

    I took a graduate level education class in early 1998. We were talking about the the economic status/ levels of our country. The professor said we will eventually be into 2 classes– the haves and the have nots. Here is what they ‘have’ or not have: education. He said that the more educated one is, the more in demand one will be. He said that the time will come that people will be so uneducated that they they will have to hire somebody to write a love letter for them because they will not be able to write it themselves. This is slowly coming. Many of our youth cannot write anymore. It is almost like dentistry to have middle schoolers write a paragraph.

    Here is something else I want to bring up. People will never be free and clear on their homes even if there is no mortgage. People are under the bondage of the HOA and the government for property taxes. At one time, all the land in this country was free. In a sense, one sells the land again and again. Look at all the profit that has happened on the original land in the east! I say no more property taxes. Land has been taxed enough over the decades and centuries.

    People buy and buy. This is what happened in the housing boom. Does one really need to buy a house of 3500 square feet with only two people. I think that is a little too much. People who bought houses like that lost them to the evil banks. These banks do receive money from the government for all of the foreclosures. Remember the banks own all the houses that have mortgages. Some were lucky enough to do a loan modification on those large homes– and then receive a new loan (of 40 years).

    If we look historically at homes, they were small for many many years. The average home in the days of Joseph Smith would make the houses of the 21st century look like mansions. They probably had 1000 square feet if they were lucky. Over time, the house size became larger and larger. Has it really helped society? Probably not as people have become more and more disconnected (even within families). Remember that people who are sitting next to each other still have to text each other to talk.

  13. “Does one really need to buy a house of 3500 square feet”

    True. And this is a problem that does not lie just with the consumer. Although it is definitely fueled by consumer demand.

    But take a developer. He has a plot of land to develop. He has to spend 5-10 years getting everything approved and worked through the system. Enormous fees. He can then decide to build houses 125k small houses, or build 400k houses.

    Governmental “profits” add in an extra and weighty marginal cost to a project. What happens to any business, with middle men, that has it’s costs increase by 30%? The consumer costs increase by 60% (at least). Costs just don’t get passed onto the consumer, they get multiplied.

    To the extent fees, etc. are necessary and good I do not mind them, but it should be clear for most of us, that the cost of new housing construction, the costs of infrastructure construction, and the costs of energy exploration and development within the USA is prohibitively high.

  14. What is consumer demand? Is it something where millions wake up one day and say, “you know, I need a BIGGER house!” Or is it that the media fed system we’ve developed has brain washed everyone into thinking they must have it?
    Why must we all have an IPhone 4, when the previous model did 95% of what the newer model did? Because Steve Jobs puts on a very tantalizing media circus.
    D&C 38:30 –
    “30 I tell you these things because of your prayers; wherefore, treasure up wisdom in your bosoms, lest the wickedness of men reveal these things unto you by their wickedness, in a manner which shall speak in your ears with a voice louder than that which shall shake the earth; but if ye are prepared ye shall not fear.”

    Why are TV commercials louder than the programming? We are literally bombarded with messages every day that have a voice that can shake the earth. Our brains are rewired into hearing and following what we’re told on television. Most cannot think for themselves anymore.

    Why so many addictions? Because they are all packaged in an enticing way. You didn’t get enough violence in Video Game 1.0, so you have to get 2.0 as soon as it comes out. Television teaches us that promiscuous sex is not only harmless, but beneficial. In fact, we are told if you are not watching pornography, there must be something wrong with you! Shows like GLEE, which began as a popular teen show is now displaying lesbian and gay teen sex on it. How’s that for trying to manipulate young minds?

    Can you blame all those people who wanted the American dream, who were told they could afford that 3500 sq foot dream house, for trusting their real estate agent and banker? How were they to know that they were sub prime, or that the banks were playing risky investment games? Many are losing their homes because they first lost their jobs, because the banks were gambling with the economy and lost. And those same people (and their grandchildren) will now have to pay the trillions of dollars spent for the non-recovery recovery, health care, etc. It just isn’t fair.

  15. One of the joys of ownership, on the other hand, is just not being at the mercy of the landlord, who may just decide that he wants to sell your residence, or whatever, and you’re given X number of days to get out.

  16. Mark N, agreed. That’s why I own. But it is worth pointing out that in theory you could negotiate a long-term lease with the owner asking for more favorable terms. I can tell you as a former landlord that just about evrything is negotiable for a reliable renter with good references.

  17. increased pressure on banks for “politically correct” reasons to loan to the underpriviledged

    Let’s not forget the source:

    “Under 50 percent of African Americans and Hispanic Americans own a home. That’s just too few, as far as I’m concerned. You see, owning a home is part of the American experience. And so I’m promoting policies that will encourage homeownership.

    And we’ve set this goal, by the way, that we want there to be 5.5 million minority families owning a home over the next 10 years, which means Government ought to have a policy that helps people with a down payment. People take a look at owning a home, and they realize the downpayment is a frightening thought. We ought to have a downpayment assistance program out of Washington, DC.”

    George W. Bush
    August 13, 2002
    Public Papers of the Presidents of the United States: George W. Bush, 2002, Book 1, January 1 to June 30, 2002

  18. “Add in the property tax deduction and you have a veritable cornucopia of unhealthy subsidies.”

    I don’t consider the government taking a little less money than it would otherwise a “subsidy”.

  19. Comments are stale, but I just had this thought occur to me on seeing this topic again, re: externalities of government involvement in housing markets.

    A few years ago we had a new home construction project bid on in Utah, and we also compared it with a sister’s new home construction in California. If I’m remembering right, the CA house was about 1000 square feet bigger and cost less to build as far as materials, labor, contractor, subs, etc. were concerned. But the overall house cost twice as much. Why? Land and Fees. Everything was itemized, I wonder if I can dig the old spreadsheets up. But the fees were ~ 50k more and the land was easily double.

    It should not be surprising in a competitive market like CA the material and labor prices were better as would be predicted by economic theory. Land was dramatically more, which had to do with developing fees as well as reduced development due to zoning or other obstacles which increase prices (look around the hills outside of San Diego. There is a LOT of undeveloped space, why? because it would cost a fortune to develop it. But must it or is that just a result of the way government interferes there?) And then the fees… 50k extra. I wonder how much better off your house is or you are or your school is in CA as opposed to UT as a result of those fees?

    I’m not a governmental boogey man. There are huge issues behind the mortgage mess and while part of is sub primes, the real answer is everyone wants a piece of the pie and those who could stick their finger in it easiest grabbed the largest piece. It just so happens that government could do this pretty easy… so could banks, and mortgage brokers, title insurers, appraisers , etc. etc.
    As it turns out I’ve the same house appraised 4 times in the last 4 years, each time it was $350. All the work was done on the first time. The next 3 times he just came out looked over and saw nothing changed and billed the same rate. Stuff like that just kills me but it was happening all over the place in the housing market.

  20. I don’t consider the government taking a little less money than it would otherwise a “subsidy”.

    If a tax provision causes the burden of funding the government to pass to other taxpayers (in a way that a neutral economically efficient tax system would not) it most definitely is a subsidy.

    These days a number of tax credits are “refundable” which means you get a check back from the government even if you do not own any taxes. There is no difference between a refundable tax credit and any other kind of welfare payment. They affect your financial standing in the same way. One just sounds better. A non-refundable tax credit is just a limited version of a refundable one.

  21. Speaking of housing for the poor, the Department of Housing and Urban Development budget for FY2010 was $43.6 billion. About half of this goes to Section 8 rental subsidies, which covers the cost of rent above 30% of the recipients income in the form of direct payments to landlords. The rest go to other forms of housing subsidies.

    The pros and cons of such welfare programs on the long term prospects of the recipients aside, this sort of thing is positively rational in cost, scope, and sustainability compared to what is going on in the mortgage market. We are paying ~$200 billion a year to keep Fannie Mae and Freddie Mac afloat for example, and that is just the direct cost.

  22. Geoff,

    While I recognize that there’s some truth to this idea that the government had some role in producing the housing crisis by subsidizing home ownership, I think blaming Fannie and Freddie for it is largely misplaced.

    Read the wikipedia entry that you link and you’ll notice that what happened wasn’t Fannie and Freddie, it was investment bankers:

    “The market shifted away from regulated GSEs and radically toward Mortgage Backed Securities (MBS) issued by unregulated private-label securitization conduits, typically operated by investment banks. The shift occurred as financial institutions sought to maintain earnings levels that had been elevated during 2001-2003 by an unprecedented refinancing boom due to historically low interest rates. Earnings depended on volume, so maintaining elevated earnings levels necessitated expanding the borrower pool using lower underwriting standards and new products that the GSEs would not (initially) securitize. Thus, the shift away from GSE securitization to private-label securitization (PLS) also corresponded with a shift in mortgage product type, from traditional, amortizing, fixed-rate mortgages (FRMs) to nontraditional, structurally riskier, nonamortizing, adjustable-rate mortgages (ARMs), and in the start of a sharp deterioration in mortgage underwriting standards.[34] The growth of PLS, however, forced the GSEs to lower their underwriting standards in an attempt to reclaim lost market share in order to please their private shareholders. Shareholder pressure pushed the GSEs into competition with PLS for market share, and the GSEs loosened their guarantee business underwriting standards in order to compete. In contrast, the wholly public FHA/Ginnie Mae maintained their underwriting standards and instead ceded market share.”

    So, the housing crisis in actuality had little to do with Fannie and Freddie. Rather it had a lot more to do with private investment firms who saw an opportunity to make a lot of money off of the housing crisis. And as they did so, they took market share from Fannie and Freddie which (due to share holder pressure) caused them to jump in (late) as well.

    To say this housing crisis had anything to do with a governmental program to expand home ownership which, as you admit, has been in place for decades, has a sliver of truth to be believable, but on the whole really misreads the cause of the crisis.

    It had much more to do with the fact that bankers took advantage of the opportunity to leverage public money to line their profits and ultimately risk the global economy while doing so.

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