The Bubble and Beyond by Michael Hudson

Author:Michael Hudson [Hudson, Michael]
Language: eng
Format: epub
Publisher: ISLET
Published: 2012-10-03T19:00:00+00:00

Chart 13 follows: Comparison of Capital Gains Tax Rate with Normal Income Tax Rates 1942–1995

Paying out Real Estate Rental Income as Interest

Reflecting real estate’s status is the U.S. economy’s largest asset, by far the most interest in the is paid on mortgage debt (Charts 14, 15 and 16). Rising property prices oblige new buyers turn over most of its rental cash flow or value to mortgage lenders. As long as the Bubble Economy creates land-price (“capital”) gains by enough to cover the interest payments, real estate owners are willing to pay out current income as debt service. But this arrangement cannot last, because adding the interest onto the debt balance year after year entails more and more charges.

As interest rates rose after 1945 to their high of about 15% in 1980, the volume of interest payments increased from just 1% of national income to 12% in the mid-1980s. As mortgage interest rates receded, the ratio of interest payments to national income fell below 8% in 2001, but then resumed its upward trend as new debt markets were developed, headed by subprime lending and the derivatives trade. Falling interest rates since 2000 offset the rising debt burden as the Federal Reserve flooded the U.S. economy with credit, but carrying charges now threaten to skyrocket if interest rates rise back to “normal” levels.

The composition of interest on the economy-wide level has remained basically stable. By far most interest is paid on mortgage debt, whose growth is subsidized by making interest payments tax deductible. The higher the degree of subsidy, the more debt can be afforded. And conversely, ending tax deductibility would reduce the amount of debt that a homebuyer can afford to take on. This would lower the equilibrium price that could be afforded. What seems at first glance to be an economic benefit to homebuyers — making their interest payments tax deductible — thus turns out to be largely illusory. The subsidy ends up being passed on to the banks.

Giving homeowners and property investors a tax subsidy, while maintaining the rule of thumb that mortgage payments should equal 25% or some such ratio of personal income, merely replaces the cost of tax payment with an interest payment to bankers.

Adam Smith suggested as a rule of thumb that interest rates tend to be about half the profit rate. For a commercial or industrial enterprise financed entirely on credit, interest would absorb half the gross profit. But since the 1980s the ratio has risen as debt leveraging has spread throughout the economy. “Shareholder activists” (the euphemism for corporate raiders) are financializing industry along much the same lines as real estate with its high debt/equity leveraging, turning profits and cash flow into interest via buyouts leveraged with high-interest “junk” bonds.

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