[Congressional Record Volume 154, Number 155 (Saturday, September 27, 2008)]
[Extensions of Remarks]
[Pages E2092-E2093]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




                   AN ALTERNATIVE TO THE PAULSON PLAN

                                 ______
                                 

                           HON. VIRGINIA FOXX

                           of north carolina

                    in the house of representatives

                       Friday, September 26, 2008

  Ms. FOXX. Madam Speaker, I submit the following for the Record:

                                   Branch Banking & Trust Co.,

                            Winston-Salem, NC, September 26, 2008.
     Hon. Virginia Foxx,
     House of Representatives, Cannon House Office Building, 
         Washington DC.
       Dear Representative Foxx: Unfortunately, while under normal 
     circumstances there would be a free market solution, given 
     the publicity and psychological mindset which has been 
     created. Congress not acting is extraordinarily risky. 
     Therefore, an alternative to the Paulson Plan must be 
     developed. A much more effective, far less expensive solution 
     to the financial crisis than the Treasury Secretary presented 
     is outlined below.
       It is important to recognize that the fundamental problem 
     is in the real estate market. We have built too many houses, 
     built too expensive houses, built houses in the wrong places, 
     etc. We have an excess of housing inventory. Problems in the 
     mortgage market which are causing the problems in capitals 
     markets are being created by the problems in the real estate 
     market. House prices in many areas have been out of line with 
     peoples income and rental alternatives. In the long term, the 
     price of houses is determined by production costs, people's 
     incomes (affordability) and the relative cost of rental 
     alternatives. Based on these factors, the price of houses in 
     the United States on average need to fall approximately 30% 
     from the peak of the market to sell the unsold inventory. 
     (The numbers used here are rough approximations and vary 
     significantly by individual market, but they make the point.) 
     We have effectively wasted $600 billion on housing which 
     should have been put to more productive uses such as 
     technological investment, education, agricultural 
     advancement, etc. Without Freddie Mac and Fannie Mae and the 
     affordable housing program (sub prime), we could never have 
     made a misallocation of capital of this magnitude.
       However, the mistakes have been made and we have to live 
     with them. Housing prices nationally have already fallen 
     approximately 20%. The good/bad news is approximately $500 
     billion of the projected $600 billion in losses have already 
     been taken by financial institutions, and substantial capital 
     raised to cover some of the losses. House prices need to fall 
     another 10% or approximately $100 billion to clear the 
     market. Ironically, if the market knew that housing prices 
     were going to fall exactly 10%, the market would stabilize. 
     Uncertainty about the bottom of the market is what is 
     creating the disruption in the capital markets.
       The goal is to cut the effective economic cost to the buyer 
     without cutting the price to the seller which will solve the 
     problem in the housing market. Congress can approve a house 
     purchase income tax credit equal to 10% of the cost of the 
     house with some maximum (such as $40,000). This will cut the 
     effective economic cost to the buyer without cutting the 
     price to the seller. The tax credit would be available to 
     anybody and would be a true tax credit in the sense that you 
     would still get the interest deduction. The government would 
     be sponsoring a ``fire sale'' of houses. The tax credit would 
     only apply to existing house inventory, i.e. new houses which 
     were completed or under construction as of September 1, 2008 
     and existing houses which could be proven to be on the market 
     as of September 1, 2008. The tax credit would be available 
     for a limited time, for example until June 30, 2009. In order 
     to motivate rapid sales activity. Congress would approve a 
     fixed amount of tax credit and make it available on a first 
     come, first serve basis. For example, the amount of the tax 
     credit could be $100 billion to the first purchasers of 
     houses. This would force individuals to act quickly. The goal 
     is to entice people to make real estate investments who 
     otherwise would not and clear the housing inventory.
       Let me give you some concrete examples. There is a house on 
     the road which I travel to work that has been on the market 
     for $200,000. I am not interested in purchasing at that 
     price. However, a 10% tax credit of $20,000 makes the 
     effective cost of the house to me $180,000. At that cost, I 
     would be willing to purchase the house. In addition, the tax 
     credit makes it an even better deal since I personally hate 
     to pay taxes.
       Tom, who owns the home, wants to sell his house so he can 
     buy a new home that is a few blocks away. If he can sell his 
     house for $200,000. he would have enough equity to buy his 
     new house. (He sells for $200,000 and yet the house cost me 
     $180,000.)
       I already have a house and do not need to have a second 
     house to live in, so this house would be an investment for me 
     because I think house prices will ultimately appreciate, 
     particularly off of the 10% reduced cost base. I would be 
     motivated to rent the house because having an empty house is 
     not productive. I would rent it based on the $180,000 price 
     or less because any rental income would be better than none. 
     I may rent it to Fred and his family who are moving out of a 
     falling-down mobile home which would improve the quality of 
     their life. Tom would have a better house for himself and his 
     family. Fred would have a better house for himself and his 
     family, and I would have a good investment. The realtor who 
     sold both houses would have more income to pay for her house 
     and the builder would be out from under a financial bind. The 
     bank that financed the new house would have less risk and 
     more capital. Having an empty house is not only a waste of 
     capital, it reduces the standard of living,
       Here is another concrete example. Janet and Jim who live in 
     the northeast have long coveted a vacation/retirement house 
     in Florida. With this once in a life time buying opportunity 
     covered by the housing tax credit, and given that house 
     prices in Florida have already fallen significantly, Janet 
     and Jim would be motivated to buy that dream vacation/
     retirement home in Florida and they can afford to do it at 
     this reduced price. Because they are not ready to retire, 
     they may put the house they have purchased up for rent for 
     vacationers and/or for individuals living in Florida at a 
     lower rental rate based on the cost and the fact that any 
     rental income is better than no income. Again, this would be 
     a good situation in that Janet and Jim would be happy, the 
     builder would be better off financially, the bank that 
     financed the house would be better off financially, the 
     realtor in Florida who sold the house would be able to make 
     her house payments and the renters or vacationers would have 
     a better quality of life.
       This program can all be accomplished for $100 to $150 
     billion and solves the real estate problem and with it the 
     capital markets problem. While expensive, this program is 
     dramatically less expensive than Paulson's $700 billion 
     dollar program.
       Our program would be a huge economic stimulus far more 
     effective than sending people $100 checks so that they can 
     eat out an extra meal. Rich people would benefit from the tax 
     credit (this is not an egalitarian measure), but the country 
     as a whole would tremendously benefit. All homeowners would 
     benefit because this would stabilize housing values 
     nationally. The interesting fact is that there are less than 
     a million extra houses for 300 million people in American. 
     The incentive does not have to impact the decision making of 
     many families to have a significant impact on the U.S. 
     economy.
       To understand the problem in a broader context, it is 
     appropriate to reflect on it from a very basic perspective. 
     My early career in the bank was devoted to financing farmers. 
     An interesting thing happens in agricultural markets, farmers 
     have to guess what to produce based on what they expect the 
     price to be in the fall. Hedging helps but production can not 
     be totally hedged. In the spring, many farmers think that 
     soybean prices will be high in the fall so they grow a lot of 
     soybeans. The weather is very good and soybeans production is 
     good and soybean prices fall because there are so many 
     soybeans. This is an economic miscalculation, and it is an 
     unavoidable calculation because as human beings we are not 
     omniscient. The fact that farmers would have been better off 
     growing more sun flower seeds and fewer soybeans is not known 
     before the process starts. The soybean market corrects almost 
     immediately. The reason this happens is that soybean farmers 
     have an interesting dilemma; they have soybeans which they 
     have to do something with because they can not eat them all 
     themselves. They can sell the soybeans or store them. If they 
     choose to store them they have the cost of storage, the risk 
     of physical damage and the risk that the price will be even 
     lower in the spring. That is a risk some farmers assume and 
     others don't, but the market quickly clears all the soybeans 
     that are for sale, and the people that store them are making 
     a rational economic decision based on the facts. They are at 
     risk if the decision is wrong so they are more likely to 
     sell.
       In theory the housing market should work in the same way, 
     i.e., housing prices should have quickly fallen 30% and we 
     should be through the market correction, particularly given 
     that the housing market has been in a correction for over 2 
     years. Unfortunately. we have factors that prevent the 
     natural free market correction process from working 
     effectively in the housing market. One factor is human 
     psychology in that people tend to make less rational 
     decisions in regards to their home because of the emotional 
     attachment (which farmers do not have for soybeans). There is 
     probably not much we can do about this fact.
       The other factor is structural and it reflects on who is 
     taking the risk. Let me give you an example. You make a loan 
     to James who is someone you know, but not a close friend. 
     James is buying a $200,000 house and he is willing to put 
     $10,000 down and you loan

[[Page E2093]]

     him $190,000. You think you are safe with your investment 
     because you think house prices always go up.
       Then some unfortunate events occur. James develops a 
     drinking problem, loses his job and can not pay his mortgage 
     home payment. Simultaneously, to your and James' surprise, 
     the price of houses have fallen and the home that James owns 
     that you have financed is now only worth $180,000. James has 
     lost his total investment and has nothing else to loose at 
     this point. You have lost $10,000 but you are highly 
     motivated to get the house sold or rented. Since James can 
     not lose any more, he immediately appeals to the legal system 
     and declares bankruptcy and puts the house in foreclosure. In 
     many states like Florida, James can delay the liquidation of 
     his house for 12 months, and effectively live in the house 
     free, while continuing to drink and not go back to work. The 
     combination of the judicial system and ``do-gooders'' keep 
     the housing market from correcting thereby causing additional 
     losses. However. this means that Alfred, who is hardworking 
     and honest, and would like to rent or buy the house from you, 
     continues to live with his family in a mobile home at risk of 
     a hurricane, while James, the alcoholic, gets to live in a 
     nice house. In other words, the legal system acts as an 
     impediment to normal market correction process which happens 
     every few minutes in agricultural commodity markets. The 
     commodity prices are constantly adjusting reflecting 
     expectations for the values of different products and 
     services based on imperfect human knowledge.
       By the way, the reason Bernanke and Paulson can not see the 
     solution is they are making a fundamental epistelogical 
     (thinking) error. Bernanke is thinking from economic theory 
     and Paulson is thinking from a capital market theoretical 
     perspective. To solve the problem, we have to deal with the 
     real physical world, i.e., the fact that there is a physical 
     inventory of houses that needs to be cleared and we must 
     grasp what motivates real individuals (not theoretical 
     collectives) to act.
       A carefully designed housing tax credit and ending Fair 
     Value accounting (as currently implemented) will fix the real 
     estate markets, capital markets and the economy. This program 
     will likely actually increase tax revenue by stimulating the 
     economy by increasing taxable income. There is likely to be a 
     net gain to the government.
       I hope you will give this issue serious consideration.
           Sincerely,
     John Allison.

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