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The Real Solution to the Credit Crisis: strategies to Increase the Savings Rate and Prevent State Budget Deficits

Tue, 29 Jun 2010 06:23:08 +0000

The Real Solution to the Credit Crisis:

Strategies to increase the savings rate and prevent state budget deficits

There has been much debate about how the credit crisis started and which bailout package would seem to be the most effective way to devise a solution. Should we set aside funds for the homeowners facing foreclosure? What about the banks that are teetering on the brink of collapse? Many of us would agree that we need both approaches to be put into affect in order to quell the current financial engineering disaster. However, there are more sound strategies that would be able to fit the task. First, the minimum wage needs to be increased so that households can have more disposable income and therefore be able to purchase assets and increase spending. Second, there must be a wider array of down payment savings programs for low income households that will enable them to purchase a home within their means. Third, state governments must be aware that the solution to their current fiscal dilemma is to increase their tax base by the means of down payment assistance programs.

Trickle Up Economics

Many supplied side economists suggest that cutting taxes will spur productivity and growth, increase employment and result in higher tax revenues. However, what we have seen is an increase in deficits at both the federal and state levels since the late 80s. [1] This is the result of wishful thinking that goes against any teachings within the field of macroeconomics. Macroeconomics textbooks inform students of a balanced budget theory that states if there is an increase in government spending, there must be an increase in taxes.[2] The United States as well as many other governments hasnt implemented such a theory in quite some time if at all. However, what I have seen is immense spending on part of the federal government which has been fueled by credit lines from foreign countries. If the federal government wants to spend money and cut taxes at the same time, they should do so as any sound business manager would, seek a return on its capital.

An effective strategy to achieve this return on capital is to have the U.S. government decrease the corporate tax rate in a carrot and stick fashion in order to increase the minimum wage. For example, companies that pay $7.15 an hour and pay a 35% corporate tax rate should see a 15% tax rate and the minimum wage for the employees become $14.30 an hour. This is the same concept as the financial bailout package for Wall Street. However, this time dollars will be put directly into the hands of consumers and not trickle down to them eventually. Instead, the dollars will trickle up the economic ladder filling the tax coffers of the federal, state and local governments.

Moreover, this increased wage will enable the workers to deposit more funds into savings accounts. This will be beneficial to the banks because it will provide them with much needed deposits at a time when many have suffered terrible losses. Instead a run from banks, there will be runs to the banks which will help return confidence in the banking system. Banks will once again be flushed with cash and be ready to lend money to worthy customers.

What can states learn from HSBC Bank

I paid a visit recently to a local HSBC branch on Staten Island because I was interested in their First Home Savings Program. The program works as follows: potential homeowners are required to save a fixed amount of money every month for a period lasting up to two years. After the saving period, homeowners that have established a good payment history with the bank will see their initial contributions matched at a ration of 4 to 1 which is limited to $7500. The catch you ask? Homeowners must borrow from HSBC. By doing so, HSBC invests $7500 in down payment assistance in which the bank will recover over twenty times that in interest charges over the life of the mortgage.

Therefore, states can use this same strategy that has worked for HSBC and implement it in order to increase the tax base. For example, Frank is interested in purchasing a home but doesnt have enough for a down payment. New York City steps in and says they will match dollar for dollar of the amount saved which will be limited to say $10000. Now Frank purchases a $200,000 home. New Yorks property tax rate is about 12.139% as of 2009. As a result, the funds that the state invests in the form of down payment assistance will in effect crease a return of $24,278 / $1,000 = $24 x $50 = $12000(yearly tax bill).[3] Over the course of thirty years, the property owner will have paid an estimated amount of $36000. However, real estate prices usually increase at a rate of inflation every year which is estimated to be 3% annually. This means that the state will recoup more than five times what they initially invested with the down payment assistance. In addition, homeowners will see their wealth increase and as a result be able to increase their spending. By doing so, local business make more money and hence pay more taxes which further enriches the state.

Damage control

The recent credit crisis has caused massive damage on the cities tax base because of all the foreclosures. This is why we need such a plan implemented as soon as possible. There are already talks of massive cuts to social programs as a result of the budget shortfall. Governor Patterson recently made a trip to Washington to ask for funds to close the $47 billion dollar budget gap that is expected to hit within the next four years.[4] Further erosion of home prices will only throw salt on the already gaping wound of the cities housing market. However, the strategy suggested above can enrich the lower income households and help move them up along the upward mobility ladder.

The increased minimum wage will no doubt increase consumer spending levels. Since consumer spending accounts for seventy percent of Gross Domestic Product, there will be enormous percentage increase in these levels. Along with this increased spending comes increased revenue from sales tax on items purchased in the state. Therefore, states will not only reap windfall property tax revenues but also from sales taxes as well. Business will be able to hire additional workers because of the increased business and expansion will once again seem a possibility for small business. The cycle can keep repeating itself until wealth has been restored to the middle class.

The increase in spending levels resulting from an increase in the minimum wage will help boost both large corporations and small business bottom line. Since the stock market is a forward looking mechanism, stock prices will appreciate dramatically. Investors will once again be able to count on their retirement nest eggs to ensure that their golden years will be just that. Therefore, the increase in both consumption levels and consumer confidence resulting from an increase in the minimum wage is just what the economic doctor should prescribe to eradicate the flu that has plagued the markets. .

[1] Nouriel Roubini, Supply Side Economics: Do Tax Rate Cuts Increase Growth and Revenues and Reduce Budget Deficits? Or Is It Voodoo Economics All Over Again? Stern School of Business, New York University, 1997.

[2] Robert J Gorden, Macroeconomics 10th Edition, Northwestern University, 2006.

[3] NYC Department of Finance and Taxation, 2008.

[4] Rick Karlin, Gov. Paterson outlines more budget woes. Timesunion.com, 2008.

Frank Lorenzo is a recent graduate from the College of Staten Island. He majored in Economics and minored in Political Science. Currently, Frank is employed as a Fraud Investigator with the City of New York.

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Budget 2008 – What Impact on Mortgages in Ireland?

Fri, 19 Feb 2010 08:05:20 +0000

Galway, Ireland, October 13th 2008: With the most difficult budget in decades facing us today, it will be interesting to say the least to see what will happen with mortgages in Ireland.

While the recent half of one percent cut in mortgage interest rates was very welcome, the likely increase in personal income taxes along with predicted increases in a range of other taxes is likely to offset any benefit in reduced interest rates.

Both the residential and commercial property markets continue to fall dramatically, and there continues to be substantial reductions in the growth of mortgages in Ireland.

Only a year ago Brian Cowen was bringing us the following welcome news:

”In the Programme for Government, we signalled that the first time buyer – and recent purchasers – would benefit from further increases in the ceiling on mortgage interest relief.

”Today, I will honour the Government’s pledge by increasing the ceiling on mortgage interest relief for first time buyers by ?2,000 for a single person and ?4,000 for a married couple or widowed person to ?10,000 and ?20,000 respectively.

”This will increase the maximum monthly relief available by about ?33 and ?66 respectively, bringing it to ?166 per month for a single person and ?333 per month for a married couple or widowed person.

”These moves are appropriate in ensuring additional support for a hard pressed segment of the housing market and should provide the necessary direction and certainty.”

These decisions were made in the boom times of the Celtic Tiger and while many expected an economic crash or at the very least a “soft-landing”, few could have expected the sort of disastrous ecomomic perfect storm that has engulfed not jus the Irish economy, but the entire world economy.

One thing is certain, the news will be very different today, and few can see a substantial increase in the number of mortgages in Ireland being taken out in the near future. Indeed, the general trends show that lending for mortgages in Ireland will continue to decrease over at least the short term, and could even continue to decrease for another 12 months, with many viewing it as an even longer range problem.

It will be interesting to see how the Minister decides to treat the different parties involved in the property and mortgage markets. While the general populace resents the amount of money made by property developers during the boom times and would be against giving them any further opportunties to make their fortunes, there must also be a realisation that the construction industry needs to get going again in order to minimise any further destruction to the number of those employed in Ireland.

Similarly, first time buyers will need to be encouraged to come back to the market. However, at a time when unemployment is on the increase, property prices are still falling, stock markets are in roller coaster mode, and taxes are being increased it will take a significant amount of work to encourage the first time buyers back into the market.

Michael Kelly is Managing Director of Mortgage Ireland Marketing Company Ridge Online Marketing. Ridge Online Marketing is focused on helping companies improve their online marketing visibility and specialises in mortgages, insurance and pensions in Ireland. Contact: Michael Kelly at mkelly@ridgebusiness.com. Further information www.mortgage-broker-ireland.com

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