OCTOBER 28, 2013
THERE IS A SIMPLE, easy way to solve our current economic crisis: invest in America.
The key to implementing this solution lies within the sector of our economy that, historically, has been the foundation of American prosperity and growth: real estate. For generations, America has built itself from the ground up, most significantly via construction. This sector of our economy holds the answer to how we can directly impact, if not reverse, the economic crisis. We needn’t look to others to do it for us. Americans can fix things themselves when given the tools to do so.
Real estate is the only “product” truly made in America. Construction, especially of homes and small commercial, industrial, and office buildings, is a cornerstone of our economy. Today, we call this valuable American real estate asset “sustainable communities.” These building construction projects generally use American-made products for designs, materials, and installation, which are done by American workers according to local and state requirements, as the U.S. Green Building Council (USGBC) reports annually.
America needs to invest in community projects that are energy-efficient, conserve and also save energy, as well as produce renewable on-site power, and that provide employment and business to the community. This can be done by offering tax incentives for the production of energy-efficient housing and small commercial and industrial property, including structures that incorporate solar energy, water recycling infrastructure, and solar heating of water. This is a risk-free method of stimulating the economy and producing energy-efficient property, and is a classic way to grow the real estate business sector of our economy.
Consider another approach: include financing for “green buildings” in mortgages for homes and commercial buildings, such as shopping malls, retirement homes, and college campuses. The costs for renewable energy, efficiency, and conservation can be built into the mortgages, as well as double-framed windows, LED bulbs, and solar energy. All of the building essentials, such as air conditioning and water, should be coupled with financing for renewable energy and green construction as part of the mortgage to finance the entire building for the owner.
Today, there is an excess inventory of houses and buildings in every part of the country. This excess of unsold, lender-owned property keeps prices down, prevents new housing starts, and devalues real estate properties. Low prices prevent remodeling of existing houses. It is simple economics: when supply is high, then values will remain low. Now is the time to include energy efficiency, conservation, and renewable sources for green building mortgages as people refinance and seek to buy homes and buildings.
Five years after the global financial crisis, little is being done to address its provenance, or the ways in which it has ramified across nearly every sector of our economy. Large housing supplies and low selling prices continue to suppress real estate construction. As long as this economic finance model continues, the real estate market, and thus the entire economy, will not function and expand. There is no motivation or incentive to buy the excess inventory. The government has worked hard to keep interest rates artificially low, which is the problem. This is neither sustainable nor good for the economy. President Obama has even taken steps to phase out Fannie Mae and Freddie Mac.
America needs a different approach. Investing in community real estate construction and sustainable development will not only directly impact the consequences of the 2008 housing collapse; it can give us a chance to remake “Made in America” using the tools that have made America great for generations.
Another recession, perhaps greater than the last, could be on the way if we do nothing. Eventually interest rates must rise. This appears to be what the Federal Reserve is suggesting, as they always do, in vague and non-specific terms in order to test the public and market reactions. When this happens (most likely in early 2014), so-called “market forces” will create another topsy-turvy real estate market. The current market is not founded on real market principles of actual supply and demand. These artificial conditions have caused prices in middle and higher class neighborhoods to rise, leaving empty houses in less affluent neighborhoods.
The problem today is that neither individual homebuyers nor even larger commercial builders drive “market forces.” Instead, the market for real estate construction comprises managers of hedge funds and speculators who buy buildings and homes as rental properties. They are waiting for the value of the buildings to rise, as they had before the 2008 collapse. By early 2014, these high-volume buyers will most likely be near their short-term return on investment (ROI) with their investors and therefore looking to sell.
To help solve America’s current and future economic crises while restoring its growth, let’s focus on the housing sector. It remains one of the last that can still be remade in America.
Today, the auto industry has gone overseas to countries such as Germany and Japan, while China closes in, as well. The second and third industrial revolutions have also migrated to European and Asian nations. The new “green” industrial revolution that started in Germany and Japan is now leapfrogging to China.
We need to steer these advancements back home. New economic forms of funding renewable energy — such as the Feed-in-Tariff (FiT) that started in Germany two decade ago, designed to offer incentives to renewable energy producers — are spreading around the world. These economic methods are not “market oriented,” but come from government programs and policy. Industrialized countries around the world, and now the so-called BRIC nations (i.e., Brazil, Russia, India, and China), all realize that their economic growth was historically, and needs now again to be, based on government policy, economic investment, and support. The implications for the entire building and construction sectors are enormous and worth investigating in more detail.
Participating in such programs here in America should be methodical and progressive. Starting off with the low-hanging fruit is usually a solid initial strategy for creating, measuring, and getting concrete outcomes. When we have measurable results with community housing, the same principles should be applied to all small commercial and industrial real estate construction. From there, other measurable data and results can be investigated. The economic results can then be predictable for future similar real estate housing conditions.
There are plenty of people who would buy one or two houses as an investment or for their families, if they could. All over the country, unsold housing inventory is high. Now is the time to incentivize the market through creative financing like FiT, which provides not just a tax break, but actual financing along with renewable energy measures that make homes and communities sustainable. Such finance methods could absorb the current inventory and stimulate new housing starts that are good for the environment and job and business creation. Meanwhile, this would empower the purchase of houses as a personal home investment, thereby “soaking up” excess inventory. This could be accomplished with temporary changes in the tax code and banking regulations, but primarily with financial methods that build upon historical and well-accepted standards.
Aside from the FiT, there are other financial methods, such as including sustainable technologies that reverse greenhouse gas emissions, that would rapidly stimulate the economy. If the tax and regulatory rules for individuals and banks were changed to allow not just the rich investors, but also middle-income families, to purchase this excess inventory, then the economy would stabilize and grow.
One of the key parts of construction today is making communities sustainable and non-intrusive to the environment, atmosphere, or other areas of pollution. Many homes and buildings have “green” or Leadership in Energy and Environmental Design (LEED) standards set by organizations such as the Green Building Council. LEED certification provides independent, third-party verification that a building, home, or community was designed and built using strategies aimed at achieving high performance in key areas of human and environmental health: sustainable site development, water savings, energy efficiency, materials selection, and indoor environmental quality.
Thus, the financing of all buildings should include all infrastructures from energy, water, waste, transportation (including mass transit, bikes etc), education, telecommunications, and others with new economic models. The need to reverse climate problems is one area of concern, but the current need to rebuild America in those communities hit by Hurricane Sandy, for example, is enormous, and could serve as the basis for a large-scale rebuilding of the United States on the local level with sustainable real estate for homes and buildings.
Successfully implementing these changes requires that we manage the markets with objective, consistent, and ethical oversight from regulatory agencies and limit the term of the regulatory changes so that they do not burden property owners and financial institutions. For example, government oversight has become more and more significant, as recent Federal Energy Regulatory Commission (FERC) settlements with JP Morgan Chase and Goldman Sachs for almost half a billion dollars each make apparent. Cases arise in other sectors as well, where government involvement in the “market” needs to be transparent and open.
The embattled City of Vernon in Southern California is just one example where internal municipal records are only now becoming public, due to the “retirement” (many communities have programs for retirees to come to work at fewer hours and no benefits, or in this case in connection with the city attorney who was fired before his report on the corruption became public. As of the fall 2013, the former mayor of Vernon confirmed most of the legal allegations against him, thus avoiding trial. Now his former city manager (and most likely others will face trial) concede that the city attorney was correct, hence his being fired. Without such legal oversight of government operations at all levels, the full disclosure of operations, vested interests, and conflicts of interest between city employees and companies is lost. Many people today use the term “transparency” for characterizing the need for full government disclosure.
Corporations have similar if not much the same set of issues and concerns about revealing more than what is reported to shareholders and private investors. Issues like retirement, unions, and profits must be reported to the public in the mass and social media via telecommunications, blogs, and wi-fi. The need for “transparency” in corporations is much the same as that needed in government at all levels. The big difference is that most corporations do not have internal or separate groups to monitor the vested interests of their employees and investors. This role usually rests with the Security Exchange Commission (SEC) and other specialized oversight groups (such as Environmental, Energy, and Interior) outside the company or from the federal government itself.
Without extensive and effective oversight, there is clearly the potential for inflation and misuse of public and private funds, and ultimately another economic bubble could explode into an economic crisis. There are numerous cases in the public and private sectors ranging from mismanagement, fraud, and inflated costs to latent defects, failure to manage repairs, and incompetence. While the Federal Energy Regulatory Commission (FERC) has played an important role, the national government agencies in general do not do enough. The Environmental Protection Agency (EPA) and others usually lack enforcement powers and the ability to fine and stop illegal actions. There is a need for stronger federal oversight investigation and enforcement from FERC and other organizations like the SEC.
The basic issue is that such mismanagement (and in many cases deliberate fraud) in the public and private sectors costs the public tens of millions of dollars. JP Morgan Chase and Goldman Sachs are only two of the most recent cases in California. There were ENRON and other energy companies over a decade ago who did the same thing. And most likely there are more that will become know in the near future. Market forces are often the private corporation’s explanation for such behavior that results in costs to the public ranging from legal and court cases to the actual theft of money from the public in fees, interest rates, and profits.
Yet there is a significant and far more time-sensitive role on the local level within cities and states, since many communities have charters and short-term agreements for elected officials, employees, and contractors. Continuity is therefore difficult and expensive, often beyond the budget of most communities.
In Chinese, the word for “crisis” and “change” are identical: “危机”, which is a combined Chinese word of “危”, meaning “crisis,” and “机”, meaning “chance” to change or do something. When there is a tragedy or natural disaster, such as Hurricane Katrina or Sandy, the disaster response should include measures for not only rebuilding communities, but doing so with more sustainable, energy-efficient infrastructures. There are many cities that have demonstrated, in response to natural disasters or otherwise, that this can be done in a preventative and proactive process. Santa Monica, for example, has done this in Southern California by joining other cities around the world that meet the high standards and criteria for sustainability in energy, transportation, and other infrastructures, including Dalian in China, Frederikshavn in Denmark, and villages in Africa. As recent studies are beginning to show, the additional costs for sustainable communities are far less than the price for health care or loss of lives.
To date, we have yet to see the Obama administration or the Federal Reserve implement these much-needed changes. There have been several banking crises over the last 15 years, and certainly more dating back to the Great Depression. But none since the Great Depression have been as disastrous as what happened in 2008 — a crisis that continues into the fall of 2013. The United States and now other nations still find themselves in severe economic conditions. And yet, the administration continues to make a key mistake — attempting to correct the current “depression” through the same “market mechanisms” that caused it.
Consider the doctrine of “too big to fail.” Regulators have used this doctrine to drive policy choices, which have forced small- and medium-sized banks to close. The basic assumption that big is best, and needs to be protected, enhanced, and modeled, was and will again be a mistake. Since the 1960s, the number of small banks declined by almost half. Currently, there is a slight rise in the number of small commercial banks, but not enough to reverse the current economic rules, nor enough to set in motion a new series of rules that creates a different, far more progressive economic model for the future.
While “too big to fail” may be justified on one level, the fact is that small- and medium-sized banks are local and community-based. When any of the large banks are seen historically, they have all started in small and locally defined communities. For example, Wells Fargo and Bank of America were both founded and grew to meet the economic needs of California. Now both are controlled and owned by banks from other regions of the United States: Minnesota and North Carolina, respectively. This creates a series of problems for the construction industry. Small- and medium-sized banks traditionally fund small- and medium-sized construction projects and also loan to small local businesses. Losing the small local banks undermined any support for smaller real estate development including both housing and commercial construction. The small banks had board members, employees, and people familiar with the local communities — but above all these banks were concerned with the local economy in part due to their lending and debt risks. Small banks are in the community and close to the housing market owners with whom they interact, know, and support.
Even after a historic recession that continues to this day, there are no building infrastructures to support the housing market. There are no economic incentives to begin absorbing current inventory and any new inventory. There are no incentives to resurrect housing in the United States at all. Tax breaks and deductions are only useful to profitable corporations and big businesses. Large banks would rather lend to large corporations, which are themselves too big to fail. The model of the rich getting richer violates American core values, but not its history. Even more significantly, large corporations in the finance and economic sectors have crippled our economy and will continue to do so unless it changes.
America needs to reestablish its leadership throughout the world by industrialization based local communities and their environmental, social and regional needs. Every nation and community must have smaller real estate development for homes, business, and local commerce. Furthermore, all real estate development must include measures for responding to impacts on the environment, and climate overall. The future health of people in those communities, as well as the economic stability of the community for future generations, depends on what happens locally.
To stimulate a sustainable community housing and construction sector for our economy, consider the following proposals that state and national governments could implement at the local level:
1) Collateral for existing mortgages in real estate needs to be considered on a performance-basis with measureable standards and criteria, rather than a valuation-basis. In other words, owners of the mortgages should be required only to keep their accounts up to date and current in order to maintain their credit status. It does not matter what the value of the underlying real estate is. This economic model based on established and validated standards would incentivize banks to make real estate loans without fear of penalty, if the value of the underlying real estate declines. Thus, the banks would be protected from fluctuations in real estate values as long as the loan is paid as agreed.
2) Extend the deduction for federal taxes on mortgage payments from one house to five or more houses, especially in the same neighborhood. Place limits on the value of the real estate deduction as a whole package of housing loans. State regulations should allow the focus to be on the part of the housing market that needs help. This would, in a cost-effective manner, allow homes to be purchased and taken off of the market. For example, an individual could purchase five homes, each home costing no more than $300,000, and would own no more than $1,000,000 in real estate. At current interest rates, this person would have a deduction of about $4,000 to $5,000 per month in mortgage payments based on current loan structures.
3) Renew or refinance mortgage loans with measureable performance (such as current payments and credit ratings) for existing real estate loans, without requiring any changes in the terms of the loan. This requirement should be part of the state regulatory finance structures. Thus, the loan is considered performing if the borrower is current on their payments, as discussed in (1) above. However, if the borrower has a record of lateness, overdue fees, and past due records, then the renewable loans would not be made. This would prevent banks from forcing refinance and financial hardship on the borrower who continues to make their mortgage payments, but whose property has declined in value. This would head off the next real estate crisis when commercial large building and/or multi housing loans become due and the value of the real estate has declined.
4) Create new real estate loans that would be considered performing if they were current and up to date in terms of payment and credit. This would continue for the life of the loan, plus any renewals of the loan. Banks should be required to set standards and lend if the regulatory and oversight measurements are successfully met.
5) The refinance of all home loans would be available so that the new mortgage payments are tax-deductible up to a loan amount of $1,000,000 for any single home and up to $2,000,000 for any group of homes. The amount of funds lost for the local and state government would be offset by the larger number of loans made, but in smaller gross amounts.
6) Protect payments through guarantees by the borrower with higher reserves and back-up investments on all current and new mortgage payments that would be deductible as long as the original borrower or family member owns the property. In short, as banks need to have reserve accounts for bad loans, the borrower needs to be required to have the same backup, assets, or economic plan to cover their payment requirements.
7) Add incentives for new construction projects, and specifically incentives for using products made in the United States. Add additional incentives for products and materials that meet U.S. “green building” codes. These incentives could be tax credits to the builder or purchaser.
8) Increase penalties for lying on loan applications. Make forfeiture of the real estate part of the penalty, as well as a prohibition on further borrowing in which the federal government or any of its branches are involved in guaranteeing the loan. This should include the person(s) named on the loan and any person living in the property who knowingly benefited from the proceeds of the loan, with exemptions made for elderly, ill, and underage living on the property. While more details and legal documents are needed, the basic thrust is accountability and full transparency in the loans.
9) Prevent flipping by changing tax rules for the proceeds of the sale of real estate from this program. Real estate sold within three years of purchase is taxed at ordinary income rates. Tax rates should be decreased between three and five years. Long-term capital gain, for this program, would not be available until the property has been held for five years. Flipping is usually a very short-term (e.g., a year or two) practice in which the investor, fund, or other economic source promises its investors a high ROI in a short period of time. With longer-term loans, the funds for the property are set for at least five years and therefore provide fast short-term gains for the finance groups while assuring a longer-term secure and predictable economic basis for the land and buildings. In short, many mortgages for homes and complexes are promoted by hedge funds and finance companies who want to hold the property for a few years since they believe that their purchases and those of others will raise the value of buildings within the short-term. Then, these owners, who in the meantime are renting out their properties, will put them up for sale after the market rises.
Following these rules, which reflect a transparent collaboration between government regulation and banks, would jump-start the housing industry for families and the entire American economy. Even more significantly, such rules are supporting the housing economy now and would do so in the long-term. Some communities (such as Berkeley, California, which is discussed below) have started such plans, and a few states have also implemented similar programs.
The problem in America today is that even basic changes in finance become politicized depending on which political party makes the recommendation. Somewhere over the last few years, the American political system on both the federal and state levels has become constrained by ideology. We must put pressure on obstructionist legislators at all levels who care more about scoring political points than responding objectively, and effectively, to our economic crisis. Changing the local, state, and national rules and standards would protect financial institutions involved in real estate lending, making it more desirable to do real estate lending, and allow borrowers to keep their property. Above all, these codes and standards must be monetized in order to be monitored and measured. Due to the internet, wi-fi, and even growing use of apps for many of today’s transactions, there need to be careful standards with preventive blocks (passwords and codes) to secure all economic transactions. The number of spam and stolen financial accounts is large and growing. Often such governmental actions are not the politically expedient thing to do in America. Today, however, they are the right thing to do.
There is a growing movement underway to put policies like these in action. One example is in Connecticut, which started a program geared to support property owners of all sizes. After the passage of legislation in July 2011, the state established the Commercial and Industrial Property Assessed Clean Energy (C-PACE) program, which allowed building owners to include in their mortgage costs energy efficiency, conservation, and renewable power systems to be paid back to the city through a monthly tax to the owner. In November 2012, voters passed Proposition 39, which now provides more than $500 million a year for each of the next five years to support the smaller and neglected communities most in need of economic support.
The city of Berkeley, California, started a PACE program in 2008, but was later stopped in 2011 because of objections Fannie Mae and Freddie Mac. (They didn’t want local governments to supersede their ability to collect on loans if the building was foreclosed or in bankruptcy.) However, since 2011, there are a number of other California communities using PACE for business and industrial buildings. Now almost 20 percent of U.S. states have similar PACE programs, but issues of foreclosure and bankruptcy still abound since these programs are targeted now mostly to commercial buildings, which have legal concerns than local tax collection by the local government should there be a bankruptcy or foreclosure.
This concern led California leaders to come up with other options that were similar to PACE, but did not have the problem of foreclosures or bankruptcy preventing financing for homes and business buildings. In the winter of 2012, California Controller John Chiang got State Senate support for SB 1130, which went beyond PACE. While the Senate passed the bill, it was not acted upon in the Assembly.
It’s been estimated that the PACE legislation would have created more than 400,000 jobs in California. In January 2013, California Assembly member Anthony Rendon introduced AB 122 with California State Controller John Chiang, which provided much the same language and goals as SB 1130. This bill did not get out of the Assembly Committee, which raises some interesting political questions.
Rendon’s bill mirrors the same kind of legislation that was enacted in Connecticut, but goes further in many areas such as retrofitting buildings, using renewable energy resources, and setting high standards for lowering greenhouse gas emissions. However, the bill does not include home mortgages because of the past problems with Fannie Mae and Freddie Mac. Chiang has outlined and argued in SB 1130 how the process would work using some of the factors identified in this article, including community banks, smaller loans for homes and guaranteed stable economic growth in California.
One of the results of small real estate finance reforms would be to incentivize more people to take equity out of their current home through refinancing and use the money to remodel or purchase homes in their area as investments. This would stimulate people to invest in their own communities by buying houses in their neighborhood. The houses could be used for family or friends or as rental units. Unfortunately, due to the absence and inability for California to enact such legislation for homes due to federal institutions, there needs to be building financing that starts and establishes the process.
In the end, with additional government legislation and leadership, more people would buy homes if they knew that their payments would be tax deductible and were protected from changes in the tax code. Banks would be willing to lend because the loans could not be classified as under-performing just on the basis of a decline in real estate value. Additionally, local governments would issue more building permits in a more focused and expeditious manner as their tax base would increase and cover local and state government costs. The whole process would be up and running in a few months. Finally, real estate prices would rise, demand for new and existing housing would increase, and the housing market would flourish. Changing the tax rules would discourage flipping and create a nation full of sustainable communities.
Government must lead the way to the housing recovery. There are questionable issues about the “market” and what that includes. The hedge funds and large banks prefer large mortgages and thus draws consumers away from smaller bank lenders. There needs to be laws, rules, and measures set by the government for both consistent and enforceable finance mechanisms that are fair for everyone. Smaller banks and home buyers need to be given these financial incentives as they are the basis for what America has stood for in the past — and what it should stand for in its future. This future, however, starts now, not 10 or 20 years from today.