Being rich during a recession can almost be as bad as being poor. The only difference is that the rich have more to lose. RealtyTrak, a research firm that follows mortgage trends, recently reported that the foreclosure rate on homes valued at more than $729,750, also known as the jumbo-mortgage limit, rose 127% in the first ten weeks of this year compared to the same period a year ago. Bloomberg, reports that “about $500 billion of prime-jumbo mortgages are bundled into bonds, according to Memphis, Tennessee-based FTN Financial.” The default rate on those bonds may rise as high as 10%, leaving banks with yet another set of substantial write-offs.
The losses from the bonds held by banks may be covered by the TARP capital they have received from the government or the money that they have been asked to raise as a result of the “stress test” process. That leaves the more important issue of what it means when the financial distress of the wealthy and nearly wealthy begins to look like the money problems of everyone else. The country counts on the rich for a large portion of it tax receipts. The new budget assumes that upper income households will pay an even larger part of their earnings each year from now on.
The fact the rich are now losing their homes is a signal that the real estate market has further to fall and that the projections for receipts to the IRS from individual taxpayers used to create the assumptions for the budget are wrong.
No one working on forecasts about the activity of home sales and home prices has any illusions about the severe problems at the low and middle segments of the market. Real wages are not rising and unemployment may reach 10% this year. Most of the people out of work will be those who earned between $25,000 and $75,000 a year, not the rich. Most homeowners are just that—regular middle class workers. People living on relatively fixed incomes usually do not have the resources to cover their daily expenses for a long time if they lose their jobs or suffer a drop in their earnings. The one thing of value that they had, their home, may currently be worth less than it was 20 or 30 years ago. The wealthy at least have opportunities to make money beyond their salaries whether it is by holding stocks, owning a private business, or being paid a performance bonus. That has probably allowed those people with high incomes who are defaulting on mortgages for expensive homes the reserves to make mortgage payments for a few additional months, if they are defaulting because they are out of work.
The new foreclosure data show that many high-end homeowners are running out of resources for keeping their homes. That means the portion of the home market with the most expensive houses is beginning to collapse. If it follows the pattern of the rest of the sector, prices will correct downward quickly and brutally. The housing crisis will have moved to upper tier property which will push down overall home prices even more. Banks will take back more foreclosed houses. Those that they seize this time will just be larger and more opulent.
The tax consequences of these problems at the top of the housing market cannot be underestimated. Congress and the Administration have decided to push more of the tax burden to the high end of the income brackets. Whether this is morally or economically defensible won’t matter much if the total tax dollars that comes from people making over $250,000 a year is well below budget. Even if the federal government has a perfect track record of holding to its expense plan for the next two years, IRS receipts could be off by tens of billions of dollars.
Local tax authorities that rely on property taxes to cover most of their needs will probably have more trouble than the federal government. In many municipalities, property taxes are the primary source of revenue for schools and local services. Rising foreclosure rates on the most valuable homes will eviscerate local tax bases. The municipalities will only have one place to turn ultimately and that is to the federal government.
As the rich become poor, the federal budget will fall apart.
Douglas A. McIntyre
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