patrick.net

The mortgage interest deduction cannot be responsible for the recent increase in home prices either in San Francisco or nationwide. It has been around for decades and prices have risen and fallen (in real terms) over that time. Why didn’t earlier homebuyers bid up prices? Is it different this time and today’s buyers are more intelligent, realize that the tax deduction has a benefit and have bid up prices?

You could use the same reasoning to show that neither prop 13 nor the $250,000 per person exemption was responsible for the rapid rise in home prices recently.

So what explain the rise in home prices in the Bay Area since 1996? The run-up in prices in the last 1990s was caused by the dot-com boom and justified. In the early part of this decade price stagnated or fell slightly because of the crash but the surprising fact is that prices started rising again in 2003 even while jobs were being lost in the Bay Area.

In my opinion the most recent price rise is due to a combination of speculation (purchasers not just buying for a place to live but in expectation of future gains in prices) and loose credit. The easy availability of interest only, negative amortization, low down payment and sub-prime loans allowed more home buyers to compete for housing even with the number of job holders and even population in the Bay Area falling slightly.

Evidence that the last two explanations are valid is the curious phenomenon of falling sales even with a good economy. In January 2007 sales were at the slowest since January 1996. This means that sales in today’s relatively good economy are even slower than during the recession in 2001. The drop in employment in San Jose during the last recession was the worst (as a percent of population) of any city since the great depression. Employment also fell substantially in San Francisco and the east Bay.

What would encourage people to buy during steep job losses but stop buying when there have been job gains? Speculation and easy credit.

I'm certainly not denying the role of easy credit and speculation, but I think that Prop 13 in CA and $250K exemption has played its part in changing the psychology of ownership from consumption to "investment."

Since Prop 13, CA's median prices have been rising faster than the national. You can argue that this is due to CA's other tangible and intangible factors, but none the less, I often hear fixing tax rate as a major reason for holding houses.

$250K exemption has spurred a lot of speculation on the margins, not by the hardcore speculators but lots of younger buyers and baby boomers are buying more house than they need (or buying when they would otherwise be renting) in the hopes of cashing in on the exemption.

justme,

I apologize for my obtuse remark on the previous page. I was listening to Erlend Oye's DJ Kicks compilation and reading a book about pizza at the time -- I can't think of another connection.

I am Chinese. My handle came by the way of a defunct Scottish pop outfit named after the German girlfriend of the fifth Beatle -- it was also short, in all lower case, and I have a thing for A names.

justme,

I'm certain someone could track me down if they made an effort - I've narrowed myself down very small population sets, and I have a very unusual knowledge set. Odds are, the best I can aim for is semi-anonymous and not disclose opinions that could get me fired.

* I agree with Peter P, Eliza and others that the psychology of the mortgage tax deduction is the foremost factor for most home purchasers. Keep in mind that most people either can't or just don't do the math. And a big tax deduction makes people feel smart and shrewd.

* For many people (although not people in the Bay Area so much due to inflated incomes) the home mortgage deduction is the first thing that causes them to "outgrow" the EZ filings. Finally, they have some tax shelter that outweighs their standard deduction. This makes them mentally think they're ahead of the game.

* The financial math of the qualifying mortgage interest deduction is more powerful than a lot of skeptics want to recognize. That is our weakness in this forum. The mortgage interest deduction is a leverage upon the leverage, and the calculation of its benefit to the buyer is iterative. That means a buyer really does get a big financial kick all else being equal. If you knew that your home would not lose any real-dollar value, then using borrowed money that is government subsidized against interest payments is very smart. Of course, no one knows that your home won't lose any real-dollar value.

* Once you draw all the graphs from the math, you come out with the mortgage deduction offsetting a good chunk of potential real-dollar losses for most buyers. But the effect is limited, and diminishing over time.

* So the worst case scenario is you borrow huge amounts of money to buy a vastly overpriced home. It slowly loses real value (let's say it's nominal value stays flat for 15-20 years as compromise "soft landing" case), all the while you pay off 2/3 of your fixed-interest 30 year mortgage. Your early deductions offset your real losses. But every year your losses mount and your tax benefits diminish, making your losses mount even more.

But...

None of that will mean boo to 95% of buyers. They'll just go on about their happy way patting themselves on the back for being shrewd and smart.

Government set to ‘cradle’ girl child

makes sense for an economic and intellectual powerhouse to resort to infanticide.

Ha Ha,

It's no laughing matter. A highly imbalanced gender ratio is historically linked to radicalized young male population. It is very much in American's interest that these boys grow up to marry girls.

Randy,

Yeah, it's the buying IPO factor times fifty or a hundred.

I think PRC's problem will be less severe than that of India. In China, while filial piety traditionally calls for sons, practical reality is stacked in favor of daughters. Chinese marriages usually calls for the groom's family to bear the entire burden of marriage including housing. Women also have an easier time finding work and are less likely to get into trouble.

Amongst my family's Shanghai connections, most elderly widow/widowers live with their daughter's family or lives alone. I can't think of a single current case of a widow/widower living with a son's family.

People don't like to pay taxes.

I know of a couple who DIVORCED on paper so that each of them can carry 2 houses on their individual mortgage deduction, instead of 2 per couple. Well on top of this, they sort of hated the marriage tax penalty. They still lived together with kids after the divorce.

The Superhome series also feature some Californian couples who camp out in Vegas 6 months out of a year to evade the CA state income tax. I mean, they actually change their living behavior to cater to the tax codes. I also know of an ex-colleague who moved to Seattle for half a year before he cashed out his options, so that he didn't have to pay CA state tax, running the risk that the stock price might go a lot lower in the meantime. There were plenty of people during the dotcom time who borrowed money to pay AMT for exercising their options and hold for another 18 months to qualify for cap gains tax treatment (a swap of 40%+ bracket for 20%), without regards to the risk of plummeting stock price in the meantime.

Let's face it, people HATE taxes. They do all sorts of crazy things to avoid paying tax.

The biggest social engineering tool of human history is always TAX.

In the 1800s, Chinese population went through an explosive growth, not that there was effective contraceptive measures before then, but people were f***ing like rabbits to make more babies. Why? There was an important tax code change. Prior to that, Chinese were taxed by their emperor on a per head basis, so more kids you have, more tax you pay. The new tax code had it that a household was only taxed on the plot of land they held, not on the number of heads within the household. So naturally people bred like mad so that they would have more helping hands in the field. It was a disastrous, nevertheless effective tax code that achieved results way beyond expectation.

Ha Ha,

Wishful thinking or not, I've at least attempted an economic/demographic argument for comparatively less gender imbalance in China relative to India. What have you got to buttress your criticism?

Ditto your mind reading prowess. If you followed my previous arguments regarding China, you might have recalled that I'm deeply pessimistic about many aspects of the PRC and has never attempted to cover up its failings.

(Besides, most contemporary Chinese don't really resort to female infanticide. A combination of selective abortions and selective enforcement of the one child policy can achieve gender imbalance just fine).

OO,

That's quite interesting, I've never came across that particular policy. Was that before or after the Taiping Rebellion?

I would considered the agricultural innovations to be the primary factor spurring Qing population explosion. Double cropping rice and introduction of new world crops allowed the preexisting land to support much higher population density than before. I've looked at some anthropology studies from the early 1900s and the main population control appears to be land productivity - people would have many births, but only one or two children would survive to adulthood.

astrid,

that was the tax policy of yongzheng era, it is called tan1 ding1 ru4 mu3, so-called distributing heads into field. You can look up the details on more chinese history website. Sorry that I got the year wrong, it should be around 1730.

It was meant for the simplification of tax codes which would have made tax collection more efficient. It worked for a while, until his people were too financially motivated that the population growth spurred out of control. Many historians point to this tax code as one of the major causes for overpopulation in China, a plight that even modern China has to struggle with.

CB,

Since Canada has no mortgage interest deduction can we do any comparisons with the US bubble markets and what contribution the decution plays into the bubble levels? Does/did Canada have major bubble markets? My guess is Vancouver and maybe Toronto but that is just a guess.

Paul

Vancouver is a essentially a spill-over receptor for west coast America, Hong Kong, Taiwan and China.

I really feel sorry for people who have to make a living in Vancouver and buy a house there. Because Canada has no restrictions on foreigners buying property, and the banks lend almost as generously to non-Canadians, it becomes a parking place for money from relatively well-off Americans and Chinese expats. On top of this, Canada has a weird tax code that favors foreign investment, I know this because I at one point intended to buy a place in Vancouver.

Canadians get no interest deduction on mortgage and pays full income tax to Canadian IRS. As a non-resident foreigner, I will only get taxed on a flat 20% for rental income, while a resident Canadian will get taxed PST + Canadian tax rate for the same income. Therefore, one will be much better off holding Canadian property as a foreigner. This is the same situation in UK. My Hong Kong friends who bought properties in UK are entirely exempted from capital gains, while UK residents / citizens are not. Therefore, London is increasingly owned by foreign money.

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/02/18/REGL7O6FH81.DTL

"So overall, Bay Area housing has always been expensive and over the years it has become even more so. However, there are a variety of financing options available today that are allowing individuals to break into the market. Just realize that you may need to live farther away and more than one person in your household may need to be pulling in an income. The good news is that your property taxes will rise at only modest levels and your homeowners insurance premiums may even decrease.

Also, keep in mind that home appreciation is on hiatus. With interest rates still near record lows and a healthy inventory, that certainly makes for a buyer's market. Of course, if history is any indication, prices will start to climb again before you know it. "

Thanks. I've read a little bit about it, though in rather glowingly positive terms (in PRC publications).

I think contemporary Chinese overpopulation is more the combined outcome of enlightened and ignorant Maoist policies. There were only 400 million Chinese in 1949. My parents were born at the start of a huge post-1945 baby boom. Many of their friends and neighbors had 9 or 10 kids, whom, thanks to improved access to medical facilities and food rations, all survived to adulthood...all living in 10 or 15 square meters of space together.

The ignorance part is that the Maoists didn't realize they created a huge demographic time bomb until the 1960s. They actually believed in "ren do hao ban shi" and thought the bigger the population the better. They wanted more good soldiers available to die gloriously fighting Nationalist/Imperialists.

The people's commune system also perversely encouraged more births - firstly through improved access to food and health care, but also by encouraging individual families to have more kids to lock up their share of the commune's resource and consolidate their family's power within the village power structure. I think people behave quite rationally on an individual basis, it's the collective where the truly irrational patterns arise.

Astrid said: (Besides, most contemporary Chinese don’t really resort to female infanticide. A combination of selective abortions and selective enforcement of the one child policy can achieve gender imbalance just fine).

I guess that accounts for the 1/2 million unaccounted for females in the PRC. Your heart has to go out to all the female babies, in orphanages, whose only hope for a good life is to be adopted by foreigners. My son flew home, through The Netherlands, from Jinan this month and his flight was packed with female babies coming home with their new parents.

Whatever the cause, it's tragic, and an embarrassment to the Party.

Here is my letter to Mr Venezia who wrote the article in the SF Chronicle

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/02/18/REGL7O6FH81.DTL
-----------------------------------------------

Mr Venezia,

Your story in the San Francisco Chronicle on February 18, 2007 is incomplete and potentially misleading. You imply that housing has become consistently less affordable in the Bay Area since 1979. The graph with the article also appears to show this.

But if you use a combination of interest rates, housing prices and income to measure affordability you clearly see three years where affordability was at its minimum, around 1982, 1989 and 2006. In between those years affordability was much better.

By leaving out a key variable, interest rates, you are doing a disservice to your readers.

Gavin

justme -

How funny, I noticed the article you linked right after I read the first one. I had the same exact thought.

I think Mr. Venezia's bio says it all:

Craig Venezia is the author of "Buying a Second Home: Income, Getaway or Retirement."

zidane2,

I doubt there will be many foreign mail order brides in China in the near future (if any, they're likely to come from poorer countries like Cambodia, Burma, and the former Soviet -stans). What happens in this situation is that most men on average end up with "lower"quality female companionship than would otherwise be the case. Only the poorest of the poor will end up with no spouses at all -- they're trouble.

Ha Ha can continue to insist otherwise, but based on what I've seen first hand, I'd say daughters are quite popular in major Chinese metropolises such as Shanghai and Guangzhou. In cities where "quality"dwell, there are a lot more complaints of impending spinsterhood for accomplished young women than complaints of young men unable to find a decent wife.

Back on track,

Here's an EXCELLENT article on pricing:

http://www.nytimes.com/2007/02/18/realestate/18cov.html?pagewanted=1&_r=3

lscharen,

Agreed 100%. I haven't seen you around here before this thread, so let me extend my welcome.

This year there was one thing the pissed me off when I was doing my taxes.
I realized that the amount of my California state tax was almost equal to the amount of the standard deduction. So as a renter in the state of California I can't count on the standard deduction giving me any advantage.
It sucks. I think the state tax shouldn't be a part of "Schedule A" deductions. Any ideas?

The mortgage interest deduction wasn't a big factor in my decision to buy in 2005.

However, I just completed our taxes, and my Wife forgot to change her witholding last year. Now we're looking at $16.5K refund. I'm happy for the refund, but I wish we had been getting interest on the money all last year instead of letting Uncle Sam hold it for us.

Lunarpark,

I was all set to post the last paragraph from that SFGATE article: "if history is any indication, prices will start to climb again before you know it" I remember thinking about how high prices were in 1995. They never did come down. I know someone who bought a $1M place in Los Altos for cash last month. I have some friends who just bought a place last month in San Carlos for $1.6M. As long as that is still happening, don't expect any miracles on the Peninsula. It is still "different" here.

Has anyone checked out Vantage in Palo Alto? What are your impressions?

justme,

Tech is booming in The City. It is getting really hard to hire good system engineers and programmers. I recently switched jobs, to a Director level job, and I am getting head hunted like mad. It has not been like this since 1999.

Unix system engineering, unix operations, WAN network engineers, java programmers, you name it.

The labor market is getting pretty tight. Not just tech, but finance, MBAs, and even experienced marketing and HR.

Tech, finance, MBAs, experienced marketing and HR, the "labor" market?

"I know someone who bought a $1M place in Los Altos for cash last month."

Was it condo or townhouse? We looked at a tiny shack in Los Altos with an asking price of $1,050,000 - after seeing it I would not even rent it, let alone buy it.

Please don't tell our H/R person about the labor market. She's still making less than the admin.

Amen palo alto renter, amen. Unless rents truly "skyrocket" I am happy to stay on the sidelines and accumulate cash.

From the NYTimes piece:

Jane LaFarge Hamill, a 25-year-old painter who lives in a “small, kind of stinky” studio in Chinatown, said she had looked at 60 apartments over three months, trying to take advantage of the lull she had noticed. “We decided to look while sellers were still worried that the market was crashing,” she said.

When she started looking last fall, there was still “wiggle room,” she said. But now, there is frenzy, said her mother, Leita Hamill, who, with her husband, Bill, is helping her daughter search for and buy a new home. The Hamills had gotten into a bidding war, one of many reported by brokers these days, for a two-bedroom co-op in Gramercy Park. They had started bidding above the asking price, but it wasn’t enough.

frickin a:

1) There goes my dreams of ever owning in Manhattan.

2) I totally had the wrong parents.

wtf Says:

Oh! job market is tight now! should I jump-in and buy now?? or else, doomed to be a renter forvever with my meager savings, worth over a quarter million dollars now??? oh god!! help me!!! please, help me!!!!!
_____

You should sit back. Munch on some Cheetos. Slake it all down with a ice-cold glass of Hi-C fruit punch. Belch. Wipe the crumbs off you shirt. Yawn. Click your heals together five times and say, "there's no place like Silicon Valley, there's no place like Silicon Valley, There's no place like Silicon Valley."

Then wait five years before doing anything with your hard-earned $$$.

Just my two cents.

THE END...

I forgot another reason the mortgage tax deduction is so psychologically powerful:

Lot's of regular, otherwise law abiding Americans feel quite comfortable cheating, claiming rental homes, investment homes, vacation homes, etc. as primary residences.

Not just paper divorces, but I know people who cheat with all kinds of paper-ownership family arrangements -- usually involving elder parents and adult children and grandchildren. I read somewhere probably 10 years ago that tax returns show "primary residency" claims in up to half of estimated 2nd homes in the US.

It is sad that you can count on any good economic news whatsoever being immediately knee jerk boo'd down on this blog. Just because there's another nascent tech boom gathering steam doesn't invalidate your decision to not buy an overpriced house. But for some a housing correction isn't enough. They won't be happy until Silicon Valley lies in ruin, and all the overeducated nerds are sent to labor away in the salt mines.

There is a lot of hiring going on in SF and SV right now. Sorry if that is bad news to some people. But, if you enjoy economic masochism so much may I suggest moving to Gary Indiana.

I think Detroit would be just fine, it's depressing as heck right now.

I can rent just about forever, so as long as BA rent stays reasonable, a good job market is fantastic for me.

Randy H.,

I don't see this boom as having been the result of anything other than cheap credit and a bubblehead mentality that took over (get rich quick transferred from dot coms to real estate). I don't think that good economic news will stave off a bubble contraction.

Prop 13 has personally made it far, far less likely that I will ever sell my city condo. Why would I? I like it and it's almost free. I suppose a small number of properties are permanently off the market that would have been sold because the carrying costs are so low, so maybe there is a miniscule contribution to the squeeze in supply?

skibum,
I went on a boondoggle this weekend where we had ski champions ski with us and take us on races at Squaw. Tamara McKinley was one of the skiers we had. She is a Realtor in Tahoe when she isn't skiing.

Lunarpark and Palo Alto Renter,

The place you looked at in Los Altos went for cash. No loan, just cash. I don't know why. If places like that sell for cash, I can't see anything being "affordable" around here anytime soon.