Income inequality is simple math

Simple math is a great way to understand a system’s behavior. I picked up this trick from Warren Buffett’s writing and speaking. Warren often figures out which mathematical elements drive behavior of a stock or industry, and then uses that to set a boundary on his investment decisions. He gave a great analysis in February 2000 of why the first internet bubble had to pop. Three weeks later, it did.

His analysis depended entirely on noting that valuations in the internet companies were assuming profit growth of 15%, while the economy as a whole was growing at 2.5%, and profits were remaining a constant share of the economy. As he put it, “mathematically, that relationship can not continue to hold. I don’t know what will collapse, I don’t know who the survivors will be—and there will be many of them—but I do know that eventually the house of cards will tumble. It has to.”

The Simple Math of Wealth Inequality

Thomas Pitteky’s new book about income inequality is apparently making a big splash. I haven’t read it, yet, but I’ve been told he is very sympathetic to my point of view. Here’s my analysis, before reading the book.

I’ve long held that the driver of wealth inequality is much simpler than policy, philosophy, or ideology. It’s simple mathematical fact, given our tax rates.

I finally ran some numbers.

Starting position: rich own 25%, everyone else, 75%
Overall tax rate on everyone else, 39% (25% federal + 14% FICA)
Overall tax rate on the Rich, 17% (mainly capital gains)
Assuming the Rich can get an average ROI of 15%, while everyone else 10%
(a reasonable assumption, given that the entire class of high risk/high return investments requires one to be an accredited investor. I.e., rich.)

With these assumptions, in 50 years (say, 1960 to 2010), the income distribution goes from rich 25%, everyone else 75% to rich 85%, everyone else 14%.

If we assume that both groups get equal returns on their money, rather than the rich getting higher returns, we still go from 25/75 to 48/51 in just 50 years

The Rich Get Richer, Purely By Virtue of Ownership

As long as the overall tax rate on the rich is lower than the overall tax rate on the poor, even independent of the range of investment opportunities available (and the rich also have enough money to have a portfolio of large-enough bets that a single winner will ultra-increase their net worth), the rich will eventually own everything.

This is independent of whether they work harder, whether they are more committed, whether they “create jobs,” or anything else. It’s purely based on their after-tax rates of return. (And as for them being job creators, note that to the extent that they can lay people off, their rates of return will increase. Hiring decreases it.)

I don’t understand why this simple mathematical fact never comes up in these discussions.

Even If The Rich Allocate Capital Poorly, They Still Win

If you run the numbers, it doesn’t matter if the rich get below-market returns. Berkshire Hathaway, Warren Buffett’s company, has only gotten market-level returns in recent years. But he’s still owning more of the economy than you are, every year.

The tax rate differential is high enough that Warren Buffett’s interest income still has a better after-tax return than you have on your entire income.

Good businesspeople oppose free markets

A friend on Facebook posted an article about New Jersey outlawing Tesla’s direct-to-consumer car sales. My friend was decrying how Gov. Christie is being anti-free-market. And I agree 100%.

From what I’ve been able to see, it’s pretty clear that the big conservative political donors hate free markets. What they love is whatever give them, personally, the ability to get more wealth. By “free market” they mean “don’t do anything that interferes with my personal ability to make money.” For example, the Koch brothers compete by using their money to alter laws so they win. They don’t compete by being better businessmen.

When it comes to competition, they hate it and undermine it at every opportunity, unless they’re the winner.

When it comes to level playing fields (supposedly the bedrock of markets), they hate it.

When it comes to producing the best product at the lowest cost, they hate it.

When it comes to contributing to the infrastructure they use freely that was funded by the public, they hate it.

Business People Should Loathe Competition

It’s a real education to go to business school and ask: how much of this education is devoted to finding ways to gain a market advantage without actually having to do a better job? The answer: most of it. It’s called “business strategy.” We teach our students how to be anti-competitive and anti-free-market, all in the name of free markets.

This works, however. It works because with the right playing field, pitting anti-free-market forces against each other results in more efficient companies through market selection of companies that are fundamentally better than other companies. This produces better ultimate outcomes for the consumers and society who created the markets to begin with.

But never miss the critical point: free markets work because the players are all trying to gain market advantage by doing a better job than each other. The players themselves are not striving to have a fair market, they’re striving to win and eliminate the competition (and thus the market).

It’s the job of government to make sure the playing field is level enough to keep enough market participants that the market continues to function. Players all want monopoly, government wants thriving market participation.

Mr. Christie’s error is that he’s acting as a businessman. That’s not his job. His job is to take care of all his constituents overall, not just the business ones.

Internet: mass manipulation tool?

I’m downloading Trust Me, I’m Lying by Ryan Holiday, about media manipulation on the internet, at the recommendation of a professional journalist friend.

As I read a few of Ryan’s blog articles and PR interviews from the book, I’m struck by how much his experience matches mine. Though I’ve not tried the kind of conscious manipulation he describes, I’ve seen it all over the place and noticed the same lack of basic fact checking in various stories I’ve been involved in.

My most striking example of this was several years ago when a Fortune 500 company revealed to me how easy it is for them to engage in mass manipulation now that the blogosphere lets them leak stories from different sources and have it all build to appear to be a preponderance of independent evidence.

Another Ryan, the amazing and awesome Ryan Allis (founder of iContact, uber-optimist, and serial entrepreneur) and I spoke about this over dinner a few weeks ago. His view is that the internet has evolved to the point where the truth will come out, despite attempts at manipulation. Especially with the rise of social media, manipulation doesn’t stand a chance because the truth will get out via informal networks.

What do you think?

Gun control? Yes.

(Warning: This is long. And I’m sure I’m going to make myself unpopular with this one.)

I favor gun control. Here’s why: guns kill people. “But wait,” you law abiding gun owners cry, “Guns don’t kill people; people kill people!”

Denial is More than Just a River in Egypt

Part of why I find the pro-gun arguments so unpersuasive is that many times, the person spouting them is in obvious denial. They argue about the need to protect themselves, but they’ve never been attacked, and crime stats show they are much safer now than 20 years ago. They say they need the guns for protection against wild animals. That makes sense for those who live in rural areas, but the logic falls down when they “need” dozens of guns or assault rifles. You can only fire one gun at a time to protect yourself against animals. Then they talk about the second amendment. See below for a discussion of that argument. They also say that “if we outlaw guns, only outlaws will have guns.” I say GOOD! See below for why.

But what don’t they say? They never say:

  • I like to pretend I’m Rambo. The fantasy of killing things gives me a rush.
  • I like the feeling of power over other people that my gun gives me.
  • I like the idea I can kill people who disagree with me.

When you have motives that you aren’t willing to say out loud, that’s a good sign that you know those motives aren’t defensible. And while talk of overthrowing a tyrannical government sounds vaguely noble (never mind that the intention of the 2nd amendment was to fight the British when we used militias to fight), motives of liking power and violence are anything but noble.

The discussion I’m happy to have:

I feel powerless and weak, and I’m irrationally scared of everything around me, despite living in the safest time period in human history. I want to be able to kill things in order to feel powerful and safe.”

Great! Let’s talk about that. We might be able to come up with some solutions. But arguments that try to come up with weak, intellectual-sounding arguments without addressing the powerful emotional argument strike me as a near admission that the real reason is too shameful to be legitimate.

(It’s like drug education classes that refuse to discuss the fact that drugs feel good and help people escape from lives they hate. As long as those two very real facts remain unaddressed, users will keep using.)

Guns Are For Defense

The one argument that sounds most persuasive is:

I feel powerless to defend myself, and in my fantasies, owning a gun keeps me safe.

If it weren’t for the statistical observation that guns around the house for self-defense more often end up used for suicide, accidental killings, or murders in a moment of rage, this would be persuasive. The fact is that owning a gun makes you less safe on average. Yes, there are a few exceptional, rare, non-representative cases where a gun is successfully used for defense, but those are dwarfed by the cases where guns do the wrong thing. In most cases, the fantasy that a gun will keep you safe just doesn’t jive with reality.

Even if guns purchased for defense could magically never be used by accident, it still doesn’t justify the need to stockpile guns or buy assault rifles. The chances you’ll be holed up in your house and need a dozen AK-47s to defend yourself seem pretty small.

“Guns Don’t Kill People?” Not according to statistics.

Actually, violent people with guns kill people. If you remove the people from the equation, the chances of death fall tremendously. If you remove the guns from the equation, the chances of death fall tremendously (the Chinese attacker whose attack mirrored the CT attack was armed only with a knife and didn’t manage to kill anyone).

Most gun deaths occur from law-abiding, gun-owning citizens acting in a moment of passion against friends and family. It’s actually THAT group that we have to watch out for. But why would that be true?

The answer involves a slightly obscure kind of statistics called Bayesian statistics. While only a tiny fraction of law-abiding citizens commit murder, there are so many more law-abiding citizens than criminals (yay!) that that tiny fraction outnumbers the criminals using guns.

Here’s a simple example. Assume there are 500,000 law-abiding citizens with guns, and 1% of them commit murder (accidentally or in a crime of passion). Assume there are 20,000 criminals with guns, and 20% of them commit murder.

The murders from law-abiding citizens are 5,000. The murders from criminals are 4,000.

Total murders: 9,000
Percentage caused by law-abiding gun owners: 5/9 = ~ 56%
Percentage cause by criminals: 4/9 = ~44%
The majority of killings come from the law-abiding citizens.

But What About the 2nd Amendment?

I think Lt. Junior Grade Josh Foot responded best to this one. I’m reposting a letter by him I read on Facebook.

From Lieutenant Junior Grade Josh Foot who is currently serving as an Antisubmarine Warfare Officer on USS John S. McCain, DDG-56, :

“My news feed is flooded with people making all kinds of comments about this school shooting. Many are just expressions of sympathy, but there are a lot that fall into one of two other categories, both of which I initially tried to just ignore. So many people are saying these things, though, that I have to say something in response.

The first is the comment, whether said independently or in response to anyone’s attempt to point out the need for legal change regarding gun laws, that “it’s too soon”, or “it’s poor taste to talk politics right now” and “today is about the victims, we can debate later”. If today is too soon, than when, people? This is the same thing everyone said after Columbine, the same thing people said after Virginia Tech, and the same thing people said after the movie theater. When is it not going to be too soon? How about after the next one? In the interest of protecting the future victims, we need to have this conversation now, and if I was a family member of a victim, I would think I’d want some change affected due to these deaths, so that maybe at least somebody else’s life could be saved by this tragedy, instead of just doing nothing to change things and letting it happen again.

The second comment is the tired old rhetoric that the only thing keeping Americans free from government tyranny is our guns, the argument that somehow it’s the knowledge that the Average Joe out there has a rifle in his garage that keeps congress and the president from turning into evil dictators. The first problem with that is that the Second Amendment was written with the idea of using the people to support and defend the government against outside invasion; that’s why it starts with the militia clause.

The second, bigger problem with that argument is that the Second Amendment was written at a time when there was only a tiny gap between military weapons technology and personal weapons used for hunting. I hate to shatter the illusion, people, but your guns won’t protect you from the government anymore. The United States government has the best tanks ever built, the most powerful precision-guided bombs and missiles, jet fighters, aircraft carriers, attack helicopters, warships that could single-handedly conquer small countries. We live in an age where the government has a monopoly on military weapons technology and an overwhelming advantage in terms of monetary resources. Unlike the 18th century when that gap didn’t exist, if the military might of the US government is ever turned against the people nowadays, your guns wouldn’t protect you from anything.

One poster actually brought up Japanese internment camps in WWII and asked what would have happened if every Japanese-American person had had a gun and stood up to the government. Here’s what would have happened: they would have been labeled as traitors and it would have looked like the government was right to put them away, because it would have appeared that they were fighting for Japan, even though that wasn’t the case. In the end we’d have had a bunch of dead Japanese-Americans.

What keeps us free from tyranny in America is the structure of our government and its continued commitment to that founding ideal of freedom. You can’t have a tyranny without an undue amount of power resting in the hands of a single person or very small, united group. The difficulties encountered over every single issue in the past four years ought to make everybody rest assured that Congress is not a small or united group and the President is in no danger of having too much power. The government’s very design protects us from it; that’s the brilliant move that the founding fathers made to protect us from internal tyranny. The reason they gave us guns was to protect us from an outside invader bringing tyranny to our shores. Now that we have a professional, standing military to do that, guns are making no meaningful contribution to the protection of our freedom.

As a member of that military, willing to give my life if necessary to protect that freedom and protect American lives from the wolves outside the gates, it breaks my heart to see the people inside the gates continually killing each other and doing nothing to stop it, because it’s always “too soon to talk about politics”.

In Summary

In short, I support gun control. I won’t go into details about when I think guns are permissible and useful. Those are details that can be hashed out. But until the pro-gun lobby confronts the facts, it’s hard for me to understand why their opinion should be given much weight (other than because they have lots of money). Guns kill people. Most gun violence is committed by the law-abiding portion of gun owners. Basic, animal, fear-driven urges drive gun ownership as much as (or more than) carefully-considered, data-supported logic. A refusal to discuss those facts shows that someone is arguing from a place of irrational, knee-jerk, emotion-filled, fear-driven responses. And when I think about who we should entrust with guns, irrational, knee-jerk, emotion-filled, fear-driven people are not high on the list.

Business, Finance, and Jobs

The economy looms large in this year’s Presidential race. Romney is portraying himself as a Harvard MBA businessman who can bring fiscal responsibility to the nation and restart the ecomony.

There are three concepts that most people don’t seem to understand. I’m hoping this will clarify them.

Business

Business is the activity of developing a product, finding a market, and bringing that product to that market. If a business can sell the product for more than it costs to manufacture and deliver the product, the business makes a profit. If a business spends more than it can make on a product, it loses money and eventually goes bankrupt.

Finance

Finance is the activity of buying and selling money. Banks are financial institutions. Creating loans, packaging the loans into (ironically named) securities that can be bought and sold, and redirecting the flow of money are all finance activities.

Finance does not produce anything directly. Indeed, finance deals in a commodity product (cash). Financial firms are paid by facilitating the exchange of money between two other parties, and being paid as a percentage of the transaction.

After a financial transaction, money that was previous available to produce goods, employ workers, and create tangible products and services is no longer available to the businesses that do those thing. It’s been taken out of the system into the coffers of the financial firm in the form of transaction costs.

(And indeed, there are some actual costs associated with paying the salaries of the bankers who do due diligence, who structure the deals, and who fill out all the necessary paperwork. The percentage-of-transaction-based compensation provides them rewards proportional to the value others have created, not proportional to the work they’ve actually done.)

Business Doesn’t Create Jobs

The misconception everyone seems to have is that businesses create jobs. That’s true in the sense that business provides the mechanism for people to contribute to making goods and services. But businesses don’t create jobs.

A good businessperson tries to reduce costs and run as efficiently as possible. That’s why automation so revolutionized the world—we could do more work with far fewer people. That’s why businesses pursue productivity, so they can scale up their production faster than they need to scale up their headcount.

Any businessperson who is acting in the interest of the bottom line should be trying to slow job growth or actively shed jobs within their company.

Jobs are created when a business experiences so much demand that it has no choice except to hire more people to cope with the demand. The demand drives the business to create more jobs.

Someone with the business experience of presiding over a growing business does not know how to create jobs; they know how to create demand for their specific products and services. This is a great skill for growing an individual business.

Growing a business isn’t the same as growing an economy. As Apple grows demand for its products, it grows demand in no small part by taking business away from its competitors. Apple does well, but Microsoft does less well that it otherwise would. Getting one business to do better is not the same thing at all as growing an overall economy so everyone does better.

Finance Isn’t The Same as Business

Finance skills have to do with sales and deal structure, not with making the people, process, logistics, and marketing decisions that build a business capable of mass production of goods or services. In fact, since financial firms are rewarded as a percentage of other people’s value, the best-run firms from a business perspective can increase their profits by simply seeking out higher-value transaction that require the same amount of work to carry out as lower-value transactions.

The skills needed to put together a money-capturing financial transaction that buys and sells businesses simply have very little to do with the skills needed to build and run the businesses being bought and sold.

It’s possible that in a large-enough financial services firm, the managers must develop business skill with respect to managing the analysts and bankers who put together the transactions.

We Want Jobs!

What most Americans are worried about is job creation. They’re asking “will I be able to make a living and get paid a fair and decent wage?”

That depends on the ability to build the economy overall. To return to the Apple/Microsoft example, what’s needed is for both Apple and Microsoft to grow (along with gazillions of small entrepreneurial businesses, which is where most new jobs get added to the economy).

Stimulating an overall economy is an enormously complicated task. It involves establishing the rules and regulations of business to create a playing field for businesses to compete. Urban planning, architecture, public works projects, and so on, are the province of economic development.

Even if you have the right infrastructure and resources all lined up, you need to get consumers to demand products. Once they demand enough products, businesses will have to hire to meet demand, and the economy revs back up to life. You need both the infrastructure and the demand to get the economy moving.

There are different economic theories on how to kick start consumer demand. It’s way beyond the scope of this article to discuss them. Suffice to say that there are many factors that may be keeping people from spending money: too much personal debt, insecurity about the future, limited earning potential caused by lack of marketable skills, etc. As such, stimulating demand may require approaches that address all of these things.

Neither Candidate Knowns How to Create Jobs

Which candidate will be able to create conditions that create jobs? I have no idea.

What I can say is that neither candidate has experience that inspires confidence in me.

Romney? I’m Not Confident.

Romney earned his money in finance, not in business. He bought and sold businesses, using fancy borrowing techniques to get his money out while saddling the businesses with vast amounts of debt. That isn’t a recipe for job creation.

To the extent that he has direct business experience, he hired and managed people at Bain Capital. But growing a single business isn’t the same as creating conditions for businesses across the board to do better. And if once considers the collateral damage of the debt Bain Capital imposed on the companies it bought and sold, it’s not at all clear that the company is successful from a societal point of view (which is the point of view a President needs to take).

Furthermore, the statements he’s made about reducing taxes, raising military spending, etc., simply don’t add up math-wise.

Romney’s time as Governor in Massachusetts may provide clues to his ability to stimulate an economy, except (a) it’s unclear that a Governor actually does much to influence a State’s economy, and (b) under Romney, Massachusetts did reasonably well in absolute terms, but quite poorly relative to the rest of the country. (In other words, the overall economy seemed to be improving, but Massachusetts improved less than other states. If we do decide that a Governor makes a difference, Romney significantly underperformed other Governors.)

Obama? I’m Not Confident.

Obama’s experience has been in community organizing, not economic development. He is a smart man, and may have a grasp of economic principles that doesn’t come through when he is speaking to a national audience. I’ve been singularly unimpressed with his choice of advisors and equally unimpressed with his reaction to the 2008 crash, which has been to change nothing structurally to insure that it doesn’t happen again.

Congress Won’t Do it

Even if the President has a wonderful plan, remember that it’s Congress that has to adopt the plan. Given the current state of the legislature, it’s hard to imagine enough bipartisan sentiment to pass even the most perfect economic recovery plan.

In summary:

  • Business, finance, and economic development are different. Expertise in one doesn’t translate to the others.
  • Romney’s experience is in finance. Obama’s is in community organizing and law. Neither has much experience in business, and even if they did, it’s not clear business experience is relevant to overall job creation.
  • Romney’s economic track record in Massachusetts was underwhelming, but since Governors have little effect on a state’s economy, that may mean nothing.
  • The economy has improved under Obama by many measures, though I don’t get the impression he really has much of a theory as to how to really get things moving again.

Creative deal structure–could it solve the housing crisis?

One of the most essential negotiating skills is the ability to divide up the risk, reward, blame, and credit properly among the parties in a negotiation. One of the reasons many people are so outraged at the financial collapse brought about by the real estate bubble is that they (correctly) notice that the risk, rewards, blame, and credit were largely divided up in ways that people found unfair.

Many of the proposed solutions also leave a bad taste in people’s mouths. There is the sense that any solution should divide up both the pain and the responsibility for getting real estate back on its feet.

I recently met a remarkable woman, Kelle Sparta, of http://www.spartasuccess.com, who has been a real estate expert for years. She wrote an open letter to President Obama in which she laid out a plan for solving the housing crisis that, indeed, divides up the risks and rewards among all the players who made bad decisions in the first place.

Here is a copy of her letter. It isn’t a quick and easy read. Understanding her solution takes some concentration. It’s well worth it, however. Not only as a specific proposal to solve the housing crisis, but more importantly for our purposes, as an example of how deftly she has structured the solution so everyone involved—the banks, the homeowners, and the government—shares some of the costs and participates in the rewards.

Enjoy!
– Stever

Dear President Obama,

I recently received an email as part of a mailing to the leadership in the real estate industry asking us to consider how to solve the problems of the current housing crisis.

How To Solve The Current Housing Crisis

I spent several weeks chewing on the thought. What would I say to you if you were to ask me how to solve this current crisis? I had mixed feelings on it. What it came down to for me is this: it’s not about saving the banks from bad investments, and it’s not about digging borrowers out of holes that they got themselves into. As a benevolent parent, the governments’ job is to stave off the catastrophic results the housing downturn is having on the economy as a whole and bring it down to just enough pain that we don’t do something this stupid again. At the same time, the government has to remember that not everyone is in the same situation and you have to be responsible to those who were not caught up in this buying frenzy as well. So, with that in mind, here is my thought.

Buy The Land Under The Houses

In most markets, we have fee simple land ownership that conveys with the house. On every street card, there is a value placed on the land and one on the building. If we’re going to bail people out and make things more affordable, then let’s do it by reducing the principle owed on the property without asking the bank to take a hard hit and without the owners losing their houses. The deal works like this:

  • The banks would have to forgive all late fees and rewrite the loans at no cost (after all, they are getting the benefit of not having to foreclose on a bad loan). They also have to agree to continue to collect the taxes on the land from the homeowner and pay them with the taxes on the home.

  • The government issues bonds to investors to raise the capital and then buys the land at current appraised market value.

  • The homeowner gets a deeded option to repurchase the land at a later date at the original price paid by the government or current market value – whichever is greater.

  • The money paid by the government would go to the bank to pay down the principal balance of the loan, allowing the bank to convert an impaired asset into a performing asset which boosts the bank’s asset rate and lessens reserve requirements, strengthening its balance sheet. This makes the bank more stable, reduces the stress on government resources, and ultimately increases the availability of funds for consumer loans.

  • The homeowners would then get a new loan issued by the bank for the lower principal amount and have to pay a reasonable monthly lease (1% per year) on the land. The homeowner would also still be responsible for paying the taxes on both the land and the home.

  • The bonds issued by the government for the purchase of the land would be backed by the land with dividends provided by the lease payments.

Here’s how it would work in an example case: Harry Homeowner has a house that he is behind on his payments on. He is in danger of foreclosure. The bank has charged him hundreds of dollars in late fees and there is no way he’s going to get on top of things again. What he needs is a fresh start.

Harry’s loan is for $300,000, but the property is only valued at $225,000 in the current market and he can’t sell it. The government offers to buy the land under Harry’s house. The land is valued at $85,000. Harry sells the land to the government and pays down his loan to the bank, leaving a balance of $215,000. The bank agrees to forgive the late fees and rewrite the note. It issues a new loan to Harry on the house only in the amount of $215,000 at a lower interest rate taking Harry’s principle and interest payment from his previous payment of $1871.61 at 6.375% down to a new payment amount of $1073.46 at 4.375%. Harry pays an additional $70.84 per month (1% per year of the purchase price of the land) in addition to his mortgage to cover the lease costs on the land. This makes Harry’s total monthly payment (not including taxes and insurance) $1143.51, saving him $728.81 per month. This savings allows Harry to keep his home and the bank to avoid foreclosure.

Ten years pass and Harry wants to sell his home. He puts the house on the market and finds a buyer who agrees to pay $350,000. Harry then exercises his option to repurchase the land from the government. Current appraised value for the land is $110,000. Harry’s attorney does a simultaneous closing on the property, with Harry purchasing the land back from the government for $110,000 and conveying the house and the land to the new owner for $350,000. The bank gets its loan of $215,000 paid off, the government gets the $110,000 and Harry Homeowner gets the balance of $25,000 (less closing costs).

The Results

Win: The bank didn’t foreclose and got the full amount of its loan repaid.

Win: Harry didn’t lose his house to foreclosure, saved his credit and came out the other end with a little money in his pocket.

Win: As an investment for the taxpayers and bond holders, the $85,000 has matured into $110,000, for a $25,000 increase. In addition, the government has also received interest in the form of lease payments on the land in the amount of 1% or $850 per year. Over ten years, this totals an additional return of $8500 for a total profit of $33,500, an ROI of 3.38% per year which is a better return than the 10 year Treasury Bond rate which was 2.77 as of close of business Friday last week. (Obviously, this is a little more complicated than this, but you get the idea.)

What Happens If Harry Homeowner Still Forecloses? In many areas, affordable housing is a big issue. It’s all local towns and municipalities can do to get developers to include affordable units in their developments. Those towns could change their local regulations to state that the affordable housing unit doesn’t have to be in the development itself – it can be provided in the same town but in a different location within that town. This would make developers tremendously motivated to buy any of the properties served under this plan that go to foreclosure since they would cost the homeowner up to a third less than the local area prices. Even if the builder had to take a loss on the purchase and resale of the home to get the monthly payments into the “affordable” level, it will likely be less than the gain of an extra new unit selling for full price. It’s a good trade.

The Sparta Plan Has Several Benefits

  • It will reduce the principle of the loans for the current homeowners allowing them a payment level they can afford to sustain.

  • Banks only have to eat the cost of refinancing the loans at a lower interest rate and forgiving the late fees, not the cost of foreclosing and reselling.

  • The payments from the land purchases to the banks would allow them to convert impaired assets into performing assets. This boosts the banks’ asset rates and lessens their reserve requirements, strengthening their balance sheets. This makes the banks more stable, reduces the stress on government resources, and ultimately increases the availability of funds for consumer loans. Freeing up additional funds for new loans and opening up credit lines for new spending would be a boon for the economy overall.

  • Property values won’t suffer as a result of the plan since any subsequent purchase of the property would be made including the land when the current seller exercises his/her option to purchase the land back prior to conveying it with the property.

  • It’s a purchase backed by real estate, which means it’s not going to contribute to the deflation of the dollar.

  • It provides a stable investment for older investors who need some way to hedge their bets in this uncertain economy.

  • For the purchases that don’t get paid for by bonds, the tax payers will see a return on their investment as the economy recovers and property values improve. At the very least, we are guaranteed to get our money back with the land lease payments as interest. At the best, the appreciation and the land lease costs will provide a tidy profit for the use of taxpayer monies.

  • It’s not a free ride for anyone. The banks lose out on the refinance and late fees as well as taking only a slightly more than break-even interest rate. The homeowners lose out on the appreciation of their land and have to pay conveyance taxes and closing costs on the land multiple times. In short – those who made bad decisions get a chance to pay for those bad decisions without being destroyed by them.

So, that’s the crux of the idea, Mr. President. It seems to me that it would work. I’d welcome the opportunity to discuss it with you. I also have some ideas on how to make it easier to be self-employed if you’re interested.

Sincerely,

Kelle Sparta
Author of The Consultative Real Estate Agent 
National Speaker, Trainer and Coach for the Real Estate Industry