Lesson 4:

1. Lesson 4: Government Policy and Real Estate Finance

2. Introduction • In this lesson, we will cover: • federal government’s fiscal policy • taxation • federal government’s monetary policy • Federal Reserve system • tools for implementing monetary policy

3. Introduction • The government affects real estate finance by influencing the cost of mortgage funds. • The major cost of borrowing money is the interest rate charged by the lender.

4. Introduction • The government affects real estate finance by influencing the cost of mortgage funds. • The major cost of borrowing money is the interest rate charged by the lender. • Market interest rates = current cost of $

5. Introduction • The cost of borrowing money is influenced by the federal government in two ways: • fiscal policy, and • monetary policy.

6. Introduction • Fiscal policy • Government actions in raising revenue, spending money, and managing its debt. • Monetary policy • Government’s direct efforts to control the money supply and the cost of money.

7. Fiscal Policy • Set by the government’s executive and legislative branches (President and Congress), who establish federal tax laws and federal budget.

8. Fiscal Policy • Set by the government’s executive and legislative branches (president and Congress), who establish federal tax laws and federal budget. • U.S. Treasury Department carries out fiscal policy, in managing government finances.

9. Fiscal Policy Spending and debt financing • Federal deficit • The resulting shortfall when the government spends more money than it takes in.

10. Fiscal Policy Spending and debt financing • Federal deficit • The resulting shortfall when the government spends more money than it takes in. • Treasury covers the shortfall by issuing interest-bearing securities.

11. Fiscal Policy Spending and debt financing • Federal deficit • The resulting shortfall when the government spends more money than it takes in. • Treasury covers the shortfall by issuing interest-bearing securities. • This borrows money from private sector, leaving less available for private borrowers.

12. Fiscal Policy Spending and debt financing • Some economists believe federal deficit has little effect on interest rates. • Others believe federal borrowing pushes interest rates up.

13. Fiscal Policy Taxation • Low taxes = more $ to lend and invest • High taxes = less $ to lend or invest

14. Fiscal Policy Taxation • Low taxes = more $ to lend and invest • High taxes = less $ to lend or invest • More likely to invest in tax-exempt securities, instead of taxable investments.

15. Fiscal Policy Taxation • Taxes also used to implement social policy by providing benefits and incentives, such as: • mortgage interest deductions, and • exclusion of gain on sale of principal residence.

16. Fiscal Policy Deduction of mortgage interest • Taxpayers allowed to deduct (from taxable income) interest paid on mortgage of home.

17. Fiscal Policy Deduction of mortgage interest • Taxpayers allowed to deduct (from taxable income) interest paid on mortgage of home. • Can deduct all interest paid on loans for buying, building or improving 1st and 2nd residences: • Up to $1,000,000 loan total (or $500,000 for married taxpayer filing separately).

18. Fiscal Policy Deduction of mortgage interest • Taxpayers allowed to deduct (from taxable income) interest paid on mortgage of home. • Can deduct all interest paid on loans for buying, building or improving 1st and 2nd residences: • Up to $1,000,000 loan total (or $500,000 for married taxpayer filing separately). • Can also deduct interest on home equity loans of up to $100,000.

19. Fiscal Policy Gain on sale of a home • Homeowners allowed to exclude from taxation a gain or profit on the sale of a principal residence.

20. Fiscal Policy Gain on sale of a home • Homeowners allowed to exclude from taxation a gain or profit on the sale of a principal residence. • May exclude a gain of up to $250,000 (or $500,000 if married and filing jointly).

21. Fiscal Policy Gain on sale of a home • Homeowners allowed to exclude from taxation a gain or profit on the sale of a principal residence. • May exclude a gain of up to $250,000 (or $500,000 is married and filing jointly). • Excess is taxed at capital gains rate.

22. Fiscal Policy Gain on sale of a home • To qualify, the taxpayer must have owned and used property as principal residence for at least two of the last five years.

23. Fiscal Policy Gain on sale of a home • To qualify, the taxpayer must have owned and used property as principal residence for at least two of the last five years. • If married, one spouse must meet ownership test, and both must meet use test. • If only one spouse meets both tests, maximum exclusion is $250,000 (if filing jointly).

24. Fiscal Policy Gain on sale of a home • Reduced exclusions are allowed under special circumstances when taxpayers have owned the house for less than 2 years. • For example, if home sold because of: • change in health, • place of employment, or • unforeseen circumstances.

25. Fiscal Policy Cost recovery deductions for investors • Owners of income property are allowed to take cost recovery deductions. • Deduct cost of buildings and property improvements that will eventually have to be replaced.

26. Fiscal Policy Cost recovery deductions for investors • Owners of income property are allowed to take cost recovery deductions. • Deduct cost of buildings and property improvements that will eventually have to be replaced. • Cost spread out over number of years, not deducted all at once.

27. Fiscal Policy Fiscal policy Federal deficit Taxation Deduction of mortgage interest Exclusion of gain on sale of home Cost recovery deductions

28. Monetary Policy • Government uses its control over the money supply to keep the national economy running smoothly.

29. Monetary Policy Federal Reserve System • Monetary policy is set and implemented by the Federal Reserve System (“the Fed”).

30. Federal Reserve System Historical background • In early 19th century, there was little government regulation of depository institutions. • Security of bank deposits depended on the integrity of bank managers.

31. Federal Reserve System Historical background • In 1863, Congress passed the National Bank Act. • Established basic banking regulations and procedures for supervising commercial banks.

32. Federal Reserve System Historical background • Economic downturns would lead to financial panics where depositors of a bank would withdraw all of their money at once. • Made even financially sound banks fail.

33. Federal Reserve System Historical background • Economic downturns would lead to financial panics where depositors of a bank would withdraw all of their money at once. • Made even financially sound banks fail. • Public resistant to idea of central national bank. • Losses from panics of 1907 changed public opinion.

34. Federal Reserve System Historical background • Federal Reserve Acts of 1913 and 1916 created the Federal Reserve System and established the modern banking system.

35. Federal Reserve System Historical background • Federal Reserve Acts of 1913 and 1916 created the Federal Reserve System and established the modern banking system. • Reserve requirement • Certain proportion of bank’s deposits must be held in reserve, available for immediate withdrawal on demand.

36. Federal Reserve System Historical background • The Fed is “lender of last resort,” providing short-term backup loans to banks that run low on funds.

37. Federal Reserve System Historical background • Creation of the Fed helped, but did not solve problem of financial panics. • In 1930s, the Federal Deposit Insurance Corporation (FDIC) and Federal Savings and Loan Insurance Corporation (FSLIC) were created to boost depositor confidence.

38. Federal Reserve System Organization • Federal Reserve System is made up of: • 12 regional Federal Reserve Banks in 12 Federal Reserve Districts,

39. Federal Reserve System Organization • Federal Reserve System is made up of: • 12 regional Federal Reserve Banks in 12 Federal Reserve Districts, • Federal Reserve Board,

40. Federal Reserve System Organization • Federal Reserve System is made up of: • 12 regional Federal Reserve Banks in 12 Federal Reserve Districts, • Federal Reserve Board, • Federal Open Market Committee,

41. Federal Reserve System Organization • Federal Reserve System is made up of: • 12 regional Federal Reserve Banks in 12 Federal Reserve Districts, • Federal Reserve Board, • Federal Open Market Committee, • Federal Advisory Council,

42. Federal Reserve System Organization • Federal Reserve System is made up of: • 12 regional Federal Reserve Banks in 12 Federal Reserve Districts, • Federal Reserve Board, • Federal Open Market Committee, • Federal Advisory Council, and • over 5,000 member banks.

43. Federal Reserve System Organization • Board of Governors • Controls Federal Reserve system. • 7 members, appointed by President, confirmed by Senate for 14-year terms. • Chosen from different Federal Reserve Districts. • Chairman chosen for 4-year term from among governors.

44. Federal Reserve System Organization • Board of Governors • Governors set reserve requirements for commercial banks and control the discount rate set by the Federal Reserve Banks.

45. Federal Reserve System Organization • Federal Reserve Banks • Each district has one main Federal Reserve Bank. Some districts also have branch banks.

46. Federal Reserve System Organization • Federal Reserve Banks • Each district has one main Federal Reserve Bank. Some districts also have branch banks. • Owned by member banks.

47. Federal Reserve System Organization • Federal Reserve Banks • Each district has one main Federal Reserve Bank. Some districts also have branch banks. • Owned by member banks. • Make discount loans.

48. Federal Reserve System Organization • Federal Reserve Banks • Each district has one main Federal Reserve Bank. Some districts also have branch banks. • Owned by member banks. • Make discount loans. • Set discount rates with Board approval.

49. Federal Reserve System Organization • Federal Reserve Banks • Each district has one main Federal Reserve Bank. Some districts also have branch banks. • Owned by member banks. • Make discount loans. • Set discount rates with Board approval. • Appoint bankers to Federal Advisory Council.

50. Federal Reserve System Organization • Federal Reserve Banks • Each bank has 9-member board of directors. • 6 directors elected by stockholders. • 3 directors appointed by Fed’s Board of Governors. • Directors appoint president of reserve bank, subject to Board of Governors approval.