RF PPT Lesson 2.ppt

Financing Residential Real Estate Lesson 2: Federal Fiscal and Monetary Policy © 2018 Rockwell Publishing Introduction This lesson will cover:  federal government’s fiscal policy  taxation  federal government’s monetary policy  Federal Reserve system  tools for implementing monetary policy © 20...

Financing Residential Real Estate Lesson 2: Federal Fiscal and Monetary Policy © 2018 Rockwell Publishing Introduction This lesson will cover:  federal government’s fiscal policy  taxation  federal government’s monetary policy  Federal Reserve system  tools for implementing monetary policy © 2018 Rockwell Publishing Introduction Federal government affects real estate finance by influencing cost of borrowing mortgage funds. Major cost of borrowing money is interest charged by lender.  Market interest rates = current cost of $ © 2018 Rockwell Publishing Introduction Cost of borrowing money is influenced by federal government in two ways:  fiscal policy  monetary policy © 2018 Rockwell Publishing Introduction Fiscal policy: government’s actions in raising revenue, spending money, and managing its debt. Monetary policy: government’s direct efforts to control money supply and cost of money. © 2018 Rockwell Publishing Fiscal Policy Set by executive and legislative branches (president and Congress), who establish federal tax laws, budget.  U.S. Treasury Department manages government’s finances, carrying out fiscal policy. © 2018 Rockwell Publishing Fiscal Policy Spending and debt financing Federal deficit: shortfall when government spends more than it collects.  Treasury gets funds to cover shortfall by issuing interest-bearing securities. By selling securities to investors, government is borrowing money from private sector. Leaves less money for private borrowers. © 2018 Rockwell Publishing 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. © 2018 Rockwell Publishing Fiscal Policy Taxation Tax policies affect how much taxpayers have left for other purposes:  ↓ taxes = more $ to lend/invest  ↑ taxes = less $ to lend/invest © 2018 Rockwell Publishing Fiscal Policy Taxation Tax policies also affect investment choices:  ↑ taxes = tax-exempt securities preferred  ↓ taxes = taxable investments attractive Real estate, MBS are taxable. © 2018 Rockwell Publishing Fiscal Policy Taxation Taxes implement social policy by providing benefits and incentives:  mortgage interest deductions  exclusion of gain on sale of principal residence © 2018 Rockwell Publishing Fiscal Policy Deduction of mortgage interest Taxpayer can deduct (from taxable income) interest paid on one or more mortgages:  loans for buying, building, or improving 1st or 2nd residence  home equity loans  purchase loans on investment property © 2018 Rockwell Publishing Fiscal Policy Deduction of mortgage interest Loans for buying, building, or improving 1 st or 2nd residence.  Can deduct all interest on loans up to $750,000.  If loan amount exceeds that limit, interest on excess not deductible. © 2018 Rockwell Publishing Fiscal Policy Deduction of mortgage interest Home equity loans – can deduct interest only if loan funds are used for substantial home improvements. © 2018 Rockwell Publishing Fiscal Policy Gain on sale of home Homeowners allowed to exclude from taxation a gain (profit) on sale of principal residence.  May exclude up to $250k ($500k for married couple filing jointly).  Excess taxed at capital gains rate. © 2018 Rockwell Publishing Fiscal Policy Gain on sale of home Taxpayer must have owned and used property as principal residence for two of last five years.  If married, one spouse must meet ownership test; both must meet use test.  If only one spouse meets both tests, maximum exclusion is $250k (if filing jointly). © 2018 Rockwell Publishing Fiscal Policy Gain on sale of home Reduced exclusions allowed under special circumstances when taxpayers have owned house for less than 2 years. For example, if home sold because of:  change in health  change in place of employment  unforeseen circumstances © 2018 Rockwell Publishing Fiscal Policy Depreciation deductions for investors Owners of income property allowed to take depreciation 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. © 2018 Rockwell Publishing Summary Fiscal Policy Fiscal policy Federal deficit Taxation Deduction of mortgage interest Exclusion of gain on sale of home Depreciation deductions © 2018 Rockwell Publishing Monetary Policy Government uses its control over money supply to keep national economy running smoothly. © 2018 Rockwell Publishing Monetary Policy Federal Reserve System Monetary policy is set and implemented by Federal Reserve System (“the Fed”). © 2018 Rockwell Publishing Federal Reserve System Historical background In early 19th century, there was little government regulation of depository institutions.  Security of bank deposits depended on integrity of bank managers. © 2018 Rockwell Publishing Federal Reserve System Historical background In 1863, Congress passed National Bank Act.  Established basic banking regulations/procedures for supervising commercial banks. © 2018 Rockwell Publishing Federal Reserve System Historical background Economic downturns led to financial panics (bank depositors withdrew all their money at once).  Caused even financially sound banks to fail. Public previously resistant to idea of central national bank, but losses from panics of 1907 changed public opinion. © 2018 Rockwell Publishing Federal Reserve System Historical background Federal Reserve Acts of 1913 and 1916 created Federal Reserve System and established modern banking system. Reserve requirements: certain proportion of bank’s deposits must be held in reserve, available for immediate withdrawal on demand. © 2018 Rockwell Publishing Federal Reserve System Historical background Fed is “lender of last resort,” providing short-term backup loans to banks that run low on funds. © 2018 Rockwell Publishing Federal Reserve System Historical background Creation of Fed helped, but did not solve, problem of financial panics.  In 1930s, Federal Deposit Insurance Corporation (FDIC) and Federal Savings and Loan Insurance Corporation (FSLIC) created to boost depositor confidence. © 2018 Rockwell Publishing 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  advisory councils  over 3,000 member banks © 2018 Rockwell Publishing Federal Reserve System Organization Board of Governors: controls Federal Reserve system.  7 members, appointed by President, confirmed by Senate for 14-year terms.  Members chosen from different Federal Reserve Districts. © 2018 Rockwell Publishing Federal Reserve System Organization Board of Governors, cont.  Chairman chosen for 4-year term from among governors.  Sets reserve requirement for commercial banks.  Controls discount rate (interest rate set by Federal Reserve Banks). © 2018 Rockwell Publishing Federal Reserve System Organization Federal Reserve Banks: each district has one main Federal Reserve Bank. Some districts also have branch banks.  Each reserve bank appoints a banker to Federal Advisory Council. © 2018 Rockwell Publishing Summary Federal Reserve System Monetary policy Federal Reserve System Reserve requirements Lender of last resort Board of Governors Federal Reserve Board Federal Open Market Committee © 2018 Rockwell Publishing Federal Reserve System Economic growth and inflation Fed’s goal: maintain healthy U.S. economy.  Economic growth that is too strong or too fast results in inflation.  Inflation: trend of general price increases throughout economy. © 2018 Rockwell Publishing Federal Reserve System Tools for implementing policy The Fed uses three tools to implement its monetary policy and influence economy:  reserve requirements  interest rates  open market operations © 2018 Rockwell Publishing Tools for Implementing Policy Reserve requirements Banks required to maintain percentage of deposits on reserve in own vaults or at district Federal Reserve Bank.  May be as much as 10% depending on amount of deposits at bank. © 2018 Rockwell Publishing Tools for Implementing Policy Reserve requirements Depository Institutions Deregulation and Monetary Control Act of 1980 subjected all commercial banks to same reserve requirements as Federal Reserve members. © 2018 Rockwell Publishing Tools for Implementing Policy Reserve requirements Increase in reserve requirements = decrease in funds available for investment and increase in interest rates. Decrease in reserve requirements = increase in supply of funds and decrease in interest rates. © 2018 Rockwell Publishing Tools for Implementing Policy Interest rates Fed has control over two key interest rates:  federal discount rate  federal funds rate © 2018 Rockwell Publishing Tools for Implementing Policy Federal discount rate Interest rate charged when bank borrows money from Federal Reserve Bank to cover shortfall in funds. © 2018 Rockwell Publishing Tools for Implementing Policy Federal funds rate Interest rate banks charge each other for overnight, unsecured loans.  Banks borrow from other banks to meet reserve requirements. Rate set by banks. Federal Open Market Committee sets target for federal funds rate. © 2018 Rockwell Publishing Tools for Implementing Policy Interest rates When Fed raises or lowers either rate, it’s an indication of overall view of economy. Lenders often make corresponding changes to interest rates they charge customers.  Some lenders change rates in anticipation of rate changes by Fed. © 2018 Rockwell Publishing Tools for Implementing Policy Interest rates Short-term interest rates most affected by changes in discount and federal funds rates. Long-term interest rates (mortgage rates) don’t respond directly to Fed’s rate adjustments. © 2018 Rockwell Publishing Tools for Implementing Policy Open market operations Fed also buys and sells government securities in transactions called open market operations.  Conducted by Securities Dept. of Federal Reserve Bank of New York (“Trading Desk”).  Federal Open Market Committee (FOMC) directs transactions. © 2018 Rockwell Publishing Tools for Implementing Policy Open market operations FOMC is most important policy-making organization in Fed.  8 regularly scheduled meetings per year.  12 members: 7 members of Federal Reserve Board president of NY Federal Reserve Bank 4 other Reserve Bank presidents © 2018 Rockwell Publishing Tools for Implementing Policy Open market operations Open market operations are Fed’s primary means of controlling money supply. Money supply:  increases when Fed buys government securities  decreases when Fed sells government securities © 2018 Rockwell Publishing Tools for Implementing Policy Open market operations Increased money supply is supposed to lower interest rates.  But other factors can put pressure on rates. The Fed uses open market operations and other tools to balance complicated forces. © 2018 Rockwell Publishing Federal Reserve System Changes in monetary policy Monetary policy is experimental, and Fed changes strategies from time to time.  1970s: Fed moderated interest rates by increasing money supply when interest rates rose.  When inflation became a concern, Fed tried to control it by restricting growth of money supply.  Then interest rates soared. © 2018 Rockwell Publishing Federal Reserve System Changes in monetary policy  By 1982, inflation under control.  Fed then focused on preventing large fluctuations in interest rates.  Remainder of 20th century:  moderate inflation  lower, stable interest rates © 2018 Rockwell Publishing Federal Reserve System Changes in monetary policy  New century: economy slowed.  Fed lowered interest rates sharply to stimulate growth.  Growth led to inflation concerns again, so Fed gradually increased rates.  2007: as credit crisis began, Fed started lowering interest rates again.  Rates stayed low for many years, but began to rise in the last few years. © 2018 Rockwell Publishing Summary Implementing Monetary Policy Interest rates Discount rate Federal funds rate Federal Open Market Committee Open market operations Inflation © 2018 Rockwell Publishing