RSS Feed MenuBarack Obama this week convened a jobs summit to discuss the awful U.S. unemployment numbers. Should the federal government hire unemployed workers directly? Pay money to states so that they can hire people?
If I’d been invited, here’s what I would have advised: Learn from Canada.
America’s situation today resembles Canada’s in 1992-93: a horrific recession, terrifying indebtedness, and gathering doubts about the country’s future.
Fifteen years ago, Canadian authorities made one crucial decision: They allowed the currency to depreciate. The Canadian dollar dwindled to as little as U.S. ¢62.
It was as if all of Canada had been put on clearance sale. Every asset within Canada was devalued, every wage was cut. Median hourly wages in wealthy Ontario tumbled below wages in Mississippi. Canadian purchasing power was slashed. Canadians suddenly had to pay more for almost every internationally traded good and service, from orange juice to software programs to foreign holidays.
Canadians were compelled to consume less. By discounting Canadian assets, they sold more. And because their labor suddenly cost less, they were employed more.
Nobody enjoyed this policy. The policy’s inherent pain was aggravated by the Chrétien government’s simultaneous decision to maintain taxes at very high levels — the government rescued its own finances first, and left Canadians’ personal finances for second.
Whatever one thinks of the Chrétien government’s tax policies, however, the currency policy did its job. Exports jumped, the Canadian growth rate accelerated, and Canadian living standards recovered.
Meanwhile, the Americans were conducting a very different kind of economic policy — a policy that emphasized debt and consumption rather than work and export.
The United States may run the most pro-borrowing public policy on Earth. An American home mortgage is tax deductible, as Canadians know. Americans use this subsidy from the government to buy more house for their money: On the eve of the recession, the average new home in the United States contained more than 2,300 square feet of space, as compared to about 1,850 square feet for the average new Canadian home.
Two other pro-borrower policies may matter even more than home deductibility. An American mortgage is almost always non-recourse. If a home owner does not pay his or mortgage, the lender can repossess — but cannot usually reach the home-owner’s other assets. The home-owner may have a million dollars in the very same bank that holds the mortgage, but the bank account is as unreachable as if it were located in the Cayman Islands.
Non-recourse loans create a one-way option for borrowers. They borrow to buy an asset they expect to increase in value. If the borrower guesses right, he or she gains a windfall. If wrong, he or she walks away, leaving the loss to the lender.
It gets better! Suppose a buyer accepts a fixed-rate mortgage at 5% and mortgage rates rise to 6%. Too bad for the lender: The rate is fixed, the buyer is protected.
Suppose, however, that mortgage rates decline to 4%. The lender is not protected. The buyer has the right to pay off his high-rate loan, usually without penalty, and refinance at the lower rate.
One more thing. Capital gains on the sale of a principal residence are untaxed, so long as the buyer reinvests in another residential property.
Altogether, the incentives combine to invite borrowing, speculation, and property flipping. Supercharge those incentives with no-down-payment, no-paperwork mortgages — and a crisis is made.
Step two after a Canadian-style currency depreciation should be a shift to a Canadian-style approach to home finance. The first shift will encourage work; the second shift will encourage saving.
Unfortunately, the ideas President Obama seems eager to import from Canada are not these right lessons, but instead two wrong lessons: the need for higher taxes and more government control of the health care system.
It’s as your children’s teachers tell you: You can only teach those who want to learn.
Originally published on December 5, 2009 in the National Post.
hormelmeatco // Dec 5, 2009 at 6:16 pm
“…more government control of the health care system.”
Canada spends FAR less of it’s GDP on healt hcare than the US does. It’s outcomes aren’t much better, but it spends far less to get them. Would Canada have been able to get out of the hole it was in if it was spending 17% of its GDP on health care and that was growing every year?
James Cody // Dec 6, 2009 at 12:23 pm
“An American mortgage is almost always non-recourse.”
My understanding is that this statement is very incorrect and it is a myth that American mortgages are typically non-recourse. Most states are recourse or allow lenders to choose an option that includes going after a borrower’s non-real estate assets. However, most lenders don’t choose this approach for two reasons. First, if the home is only somewhat underwater, the expense of going after a borrower’s other assets will exceed the difference between the mortgage and the value of the home. Thus, in this situation, loans effectively are non-recourse even if they really are recourse. So this problem is not the fault of government policy, but just the realities of how mortgage lending works. Second, at least in this crisis, including with the many homes that in this case are substantially underwater, many borrowers don’t have sufficient assets to make up the difference. The fault for this problem is with the lender (for making loans to borrowers who did not have sufficient assets, including Alt-A loans, no docs, low docs, stated income, etc) and not some recourse/non-recourse policy.
Moreover, with respect to the ability of borrowers to re-fi if rates go down, I don’t see how that’s the product of government policy. That’s simply what the original mortgage contract allows, and is not the fault of some government policy, i.e., as far as I know, there’s no government policy that requires, favors, or otherwise induces re-financing. Government prohibition of re-financing would be a significant interference with the markets, not correcting some kind of existing interference.
Now, I do believe that government policies have screwed up the housing market. I have long argued against the mortgage interest tax deduction and the exclusion of home sales from capital gains taxes, and I now doubt that Fannie and Freddie should exist, even if run reasonably well. (That being said, I believe that most of the facts and data show that arguments that the Community Reinvestment Act and Fannie/Freddie low-income housing mandates caused the crisis are largely over-stated and almost completely untrue.) However, my understanding is that recourse/non-recourse rules and the ability to re-fi are not part of the problem.
handworn // Dec 10, 2009 at 5:27 pm
“Capital gains on the sale of a principal residence are untaxed, so long as the buyer reinvests in another residential property.”
As I understand it, the new residential property must be the new principal residence as well, something which should have been mentioned.
GaryG // Jan 11, 2010 at 7:57 pm
The information you are using is only 12 years out of date. It was 1997 that the US rules for exclusion of principal residence gain were completely changed. There is no need to reacquire any property and under IRC 121 you can simply exclude up to $500,000/couple every 2 years.
When you are that far off on the basic details you don’t really sound like you have much of a clue about anything.