House Arrest - and the Three Little Pigs

I was fortunate to have a lovely conversation with an influential real estate professional in Australia last night.  In our wide-ranging conversation, I was fascinated to hear about his deep passion surrounding the need to improve the professionalism and ethics of his industry and its participants.  On the heels of Jordan Belfort's (the convicted Wolf of Wall Street turned "ethics" motivational speaker) visit to the AREC Conference in the Gold Coast earlier in the year, the impulse to improve the quality of people's behaviors and practices in the real estate market weighed heavily in the evening's discussion.

Writing for Bloomberg, Victoria Stilwell's August 28 article ("Boomer Wealth Dented by Mortgages Poses U.S. Risk") scratched the surface of an economic scab that may be covering an infected lesion on the global economy.  In her piece, she presented the chilling statistics on the number of Americans over the age of 65 who remain deeply indebted to their mortgages - both first and second.  She also pointed out the rather remarkable reduction in home buying among Americans under the age of 35 - down to 35.9% from 43.6% just 10 years ago.  She concludes that this does not only impact the housing market today but has significant implications for the period of time in which the younger generation will be indebted if and when they decide to purchase real estate.  The U.S. Census Department's 2014 report on home ownership shows that the decline in ownership (down from its peak in 2004) is continuing to slide dipping to 64.7% - now in line with levels last seen in 1995.  Less than 50% of families living on income less than the U.S. median income own homes as of the first quarter of 2014.

In his 1931 book Epic of America, James Adams defined the "American dream" as an ideal in which, "life should be better and richer and fuller for every man, with opportunity for each according to his ability or achievement."  Coming on the heels of the Great Depression, dream-inspired policy such as the National Housing Act of 1934 set in motion a costly illusion which has been exported from America's shores across the world.  Real estate purchases, it was argued, were an ideal way for individuals to invest their wealth and provide for a more stable economic environment.  However, a close examination of real estate investment and the public incentives to seduce the public into what amounts to a near permanent indenture of the majority of citizens shows that the beneficiaries of homeownership are those who actually own the mortgages of citizens, not the citizen homeowners.  Look at the ownership of CMOs.  They are banks, hedge funds, insurance companies, the Federal Reserve and the like.  Look at the beneficiaries of mortgage interest deduction.  According to the Treasury statistics, over 64% of the interest deductions for mortgages in the U.S. benefit the top 21% of the income-earners. 

And now, as Victoria points out in her article, one of the fastest growing segments of home finance is the reverse mortgage - the indebtedness of seniors to eradicate home equity value to support short-term, life-style mandated consumption.  It doesn't take an advanced degree in any form of math to see a rather interesting event horizon. 

Within the next 15 years, the double indebted primary and second mortgage holder market (a market that ballooned from 2001 - 2007) will converge with an inventory of up to 20% of the housing market being sold by investors - not homeowners.  These investors, unlike the "American Dreamers", can use a number of mechanisms for capturing returns including selling at a loss to create tax benefits.  They can create regional inventory gluts at a pace that is far beyond the normal elasticity in supply and demand.  In short, we know that the dynamics will change.  We know that they'll create heretofore unseen effects and we know that policymakers are turning a blind eye towards this challenge.

But here's where it lands in last night's conversation.  If you're involved in the real estate business - or any other investment advisory / facilitation role - what do you do when your professional mandate to maximize value for your client flies in the face of a changing economic condition about which a buyer is ill- or completely uninformed?  What does it mean to suggest 30-year mortgage terms as a cash management scheme when you know that employment, market values, and public subsidies for housing incentives necessarily will significantly change in the mid-point of the indebtedness?  Whose job is it to define the economic landscape into which an informed buyer would make an informed decision?

Regrettably, the answer is why we have shocks and boom/bust cycles.  Our ethical and professional standards are to blame for our incapacity to incentivize a fully informed consumer / investor.  And mind you, it's not just homeowners that are getting duped.  The exceptionally wealthy are repeatedly told that they need to adhere to Harry Markowitz's half-century old "modern portfolio theory" despite its out-datedness and invalid assumptions.  Private individuals are routinely asked to surrogate their financial stewardship to "certified" financial managers few of whom actually know the intrinsic structure and risk of the products and services they peddle.  Few actually stop and inquire as to whether homeownership is actually a value or whether it's a not-so-subtle seduction to manufacture mortgages which allow investors to benefit from the income of citizens.  Few pay attention to the fact that 401(k) and pension assets are not liquid assets - they're contractually bound for investor use and any attempt to use them as one's own is laden with significant financial penalty well beyond the tax liabilities associated therewith. 

We cannot begin to remedy this problem if we look to "certified" experts in the financial services industry to come clean on the reality of the investments the public is asked to make.  If we actually called homeownership what it is - perpetual income indenture based on the illusion of sanctuary for the benefit of private investors, banks and insurers - we'd probably have less fanciful illusions around real estate.  If we actually called tax-deferred pensions what they are - multi-decade speculative cash to enrich managers' fee income - we'd probably take the tax hit and invest income ourselves.  As I've written in previous posts, if there's a "tax-incentive" (deductions or deferrals) associated with a financial product, it's probably too weak to stand on its own merits and should be subject to considerable scrutiny.  The Wolf of Wall Street is merely caricature for a system filled with wolves in sheep's clothing.  Most of them are masquerading under the guise of professional management and it’s a few of them that will need to step into the light if we're going to set the market free from its House Arrest.