December 19, 2008

The Law of Unintended Taxiquences

Hatched by Dafydd

Well, we told you so!

The New York Times waits until after the election to drop yet another bombshell, one which may very well go unnoticed by the rest of the elite media (falling into the memory hole alongside the brief and cryptic reporting on Barack H. Obama's illegal fundraising). Under the headline "Tax Break May Have Helped Cause Housing Bubble" -- conjuring up images of yet another Bush giveaway to corporate fat cats -- we read the following:

Ryan J. Wampler had never made much money selling his own homes.

Starting in 1999, however, he began to do very well. Three times in eight years, Mr. Wampler -- himself a home builder and developer -- sold his home in the Phoenix area, always for a nice profit. With prices in Phoenix soaring, he made almost $700,000 on the three sales.

And thanks to a tax break proposed by President Bill Clinton and approved by Congress in 1997, he did not have to pay tax on most of that profit. It was a break that had not been available to generations of Americans before him.

Wow, what a great gift President Bill Clinton gave the American people! Except, half a mo... Didn't that staggering "housing bubble" have something to do with the subsequent financial collapse? Well, as a matter of fact, the Times itself now, after November 4th, is willing to admit as such:

The benefits also did not apply to other investments, be they stocks, bonds or stakes in a small business. Those gains were all taxed at rates of up to 20 percent.

The different tax treatments gave people a new incentive to plow ever more money into real estate, and they did so....

By itself, the change in the tax law did not cause the housing bubble, economists say. Several other factors -- a relaxation of lending standards, a failure by regulators to intervene, a sharp decline in interest rates and a collective belief that house prices could never fall -- probably played larger roles.

But many economists say that the law had a noticeable impact, allowing home sales to become tax-free windfalls. A recent study of the provision by an economist at the Federal Reserve suggests that the number of homes sold was almost 17 percent higher over the last decade than it would have been without the law.

Vernon L. Smith, a Nobel laureate and economics professor at George Mason University, has said the tax law change was responsible for “fueling the mother of all housing bubbles.”

Of course, this being the TImes, they quite predictably get a number of points wrong. There was no "failure by regulators to intervene;" in fact, the "relaxation of lending standards" was precisely in response to Clinton regulators interpreting the 1977 Community Reinvestment Act to require banks to make subprime housing loans to poor people who couldn't possibly afford the mortgage payments.

But they do get the basic point: When government intervenes in the market, the unintended bad consequences often overwhelm whatever good was intended. This is why economist Milton Friedman coined the phrase "the invisible foot" of government as the antiparticle to the "invisible hand" of the market.

In this case, Bill Clinton decided that homeownership was good for the country -- which it is, of course; homeowners are more firmly a part of society, so they tend to be more conservative, more productive, more stable, more responsible, and consequently raise better-adjusted kids. But Clinton went further, deciding that if homeownership was good, it was up to government to push more people into it, ready or not.

To that end, he pushed for (and the Newt Gingrich Congress gave him) a huge tax break to steer people away from other investment instruments and into real estate. When those pesky bankers got in the way, demanding standards of income and collateral and down payments that were barriers to poor people owning their own homes; so once again, Clinton decided the federal government would more or less take over the mortgage industry, using the CRA as a bludgeon.

And once again, after a feeble attempt to fight back -- remember, Republicans controlled both houses of Congress still, and could have stopped this interpretation of the CRA by vigorous opposition -- the GOP caved yet again.

The Times now thinks this government intrusion was a bad idea after all:

Referring to the special treatment for capital gains on homes, Charles O. Rossotti, the Internal Revenue Service commissioner from 1997 to 2002, said: “Why insist in effect that they put it in housing to get that benefit? Why not let them invest in other things that might be more productive, like stocks and bonds?”

Amusingly, then-Sen. Blob Dole, running against Clinton in 1996, gave a speech that appears to have precipitated Clinton's housing tax-break proposal; but Dole had actually called for an across-the-board cut in the capital-gains tax, without singling out any particular instrument over the others. (Grover Norquist agreed with Dole.) Had Clinton followed Dole's advice, we might very well not be in the current financial crisis.

But, well, here we are. At least, however, we have the enormous satisfaction of seeing the New York Times admit that a Bill Clinton domestic monetary policy was naive and foolish, and give a pretty good explanation -- after the One is safely elected -- why in future we should run our economic and monetary policy on the basis of Capitalism, not liberal fascism. (One wonders whether this new-found fiscal conservatism will ever translate into opposition to specific Obamic policy.)

Better late than never, I suppose; but even better in time than late.

Hatched by Dafydd on this day, December 19, 2008, at the time of 2:52 PM

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The following hissed in response by: wtanksleyjr

A few things...

First, do you have any information on the actual effects of the CRA enforcement? I've tried to dig it up, and all I can find is that it lasted for a very short period of time. It seems extremely unlikely to me to have more than a glancing relationship with our problems now.

Second, I can't read the Times' mind, but if I were to complain about regulatory failure, I'd be complaining about how the regulators allow banks to lend on 20% reserves for security reserves, but require 30% reserves for loan reserves; this means that banks are encouraged to sell their own loans (which they originated, control, and understand) and buy securitized loans instead.

Of course, the Times failed to even mention the most important component of every bubble -- an inflated money supply.

The above hissed in response by: wtanksleyjr [TypeKey Profile Page] at December 20, 2008 11:41 AM

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