Do we really have a homeownership problem? One lesson many have derived from the financial crisis is that U.S. regulatory, economic, and tax policies put too much emphasis on homeownership.
But I'm inclined to think that what many see as a homeownership problem is really a credit problem. Subprime lending started in the 1990s not as a way to put lower-income people into houses, but to turn people's equity in their homes into cash. Subprime lending was never really about the purchase of a home. As late as 2004, Ameriquest, the country's largest subprime lender, didn't actually make loans people could use to purchase a house; it just offered refinancing. Even in the late stages of the bubble, most of the business at the mega-lenders like Countrywide and New Century came from cash-out refinancings—adding to your mortgage in order to get cash to spend now—rather than home-purchase loans. "One of the major sparks on the kindling that become the housing inferno was the ability for borrowers to extract larger and larger shares of home-equity without any real cost or consequences," wrote David Zervos, head of global fixed-income strategy at Jefferies, in a recent email. Replacing equity with debt is replacing ownership with borrowed money. That's the opposite of homeownership.
Zervos went on to note that in the old days, the cost involved in getting a new mortgage—from application fees to title fees and closing fees—was so high that the interest rate on the existing loan had to be 1.5 to 2 percentage points higher than the prevailing rate for a refinancing to make sense. That was a high bar. But as the technology boom of the late 1990s shrank those costs to zero, the friction in refinancing went away, thereby negating what had been a built-in restraint.
Time to reestablish some limits. One idea Zervos has to limit the amount of mortgage debt would be to cap the amount of equity people can take out of their homes. Another idea I've heard bruited about is that instead of the mortgage interest deduction, why not give people a tax deduction based on the amount of equity they've accumulated have in their homes? Now, those are policies that would reward homeownership!
Do we really need to start spending again? A few weeks ago the Wall Street Journal ran a front page story that said the reduction in American consumers' overall indebtedness—our debt burden has shrunk to its lowest point in six years—meant that we could start spending again. (Or, as the Journal put it, we can "make a big contribution to the world-wide recovery.") But I'm not convinced that a return to previous bad habits is the path to prosperity.
Start with the fact that baby boomers, who even before the financial crisis hadn't saved enough for retirement, must now contend with a drop in the value of their houses, stock portfolios, and 401(k)s. I'm not sure a buying spree is what the doctor ordered for them. Then there's the federal budget deficit, which will necessitate cuts to entitlement programs like Social Security and Medicare. Then there are the cuts to state and local pensions. Add in that home prices are sliding again. Unemployment is still high at 8.8 percent, and more than 13 percent of the U.S. population is on food stamps. Even the Journal piece conceded that the overall decrease in debt hardly meant that borrowers had sworn off the bottle. More than half of the drop was due to defaults!
Instead of pumping up debt, I say let's try living within our means. If we don't create debt, then Wall Street won't have anything to package up and sell off. Granted, this may not be realistic. Warren Buffett had this to say in his most recent letter to shareholders: "Leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices."
Why do we pay CEOs so much more than they deserve? "Ratchet, ratchet, ratchet," Buffett said in his interview with the Financial Crisis Inquiry Commission (transcript, audio). "That's the name of the comp[ensation] board." He continued:
You've got this envy factor, I mean, you know, the same thing that happens in baseball. I mean, if you bat .320 you expect to get more than .310 and nobody knows in business whether you're batting .320 or not so everybody says they're a .320 hitter. And the board of directors has to say, well, we've got a .320 hitter because they couldn't be responsible for picking a guy that bats .250. So you have this ratcheting effect.
In other words, most boards of directors don't want to even consider the possibility that they would ever hire anyone who wasn't first-rate. (Lake Wobegon has nothing on corporate America.) And if a company's executives are first-rate, well, they clearly need to be paid like they're first rate, so that the world knows that the company has first-rate executives! So the board—at the urging of compensation consultants—sets the executives' pay at the high end of what other star performers make. But of course, if everyone is paid at the high end of average, then the average goes yet higher.
Until we really pay for performance incentives will be messed up. (So-called "clawback provisions," which are in vogue now, and which allow regulators or companies to demand repayment of compensation in the event of disaster, are well-intentioned. But they only go so far, because most bad performance doesn't result in a catastrophic failure, but rather a slow drain.) If a CEO can make a lot in the short-term, regardless of what happens in the long-term, then he would require superhuman integrity to care sincerely about the long-term. A system that requires superhuman integrity on the part of CEOs is not a system that's going to focus much attention on the long-term.