Michigan's Home Ownership Savings Trust: A Closer Look

Synopsis

When Michigan voters approved an $800 million bond issue for the environment and recreation in November 1988, little did they know that the state would use a portion of the bonds to create a program – the Home Ownership Savings Trust (HOST) – for first-time home buyers.

HOST purports to provide first-time buyers a guarantee against rising housing prices, but the program will actually have the effect of forcing taxpayers to subsidize savings for the purchase of expensive homes in wealthy, upper-income areas. Under HOST, residents purchasing homes in upscale areas such as north Oakland County, Ann Arbor, Grand Rapids, Livingston County, Macomb County and western Wayne County would have their purchase underwritten by the state, including taxpayers who live where housing prices have increased less than an annual housing index. First-time buyers planning to purchase homes in upscale areas are likely to take advantage of HOST.

For first-time buyers in Battle Creek, Detroit, Downriver, Flint, Holland, Jackson, Kalamazoo, Lansing, Midland, Monroe, Saginaw and other middle class areas, HOST is an illusion: an ill-designed concept that substitutes a political promise of home ownership for the traditional American notions of thrift and savings. From an economic perspective, HOST is unnecessary because investments such as money market accounts, certificates of deposit, zero coupon bonds, tax-free municipal bonds and stocks provide after-tax rates of return greater than housing price increases in many middle-class areas.

Furthermore, there are serious questions about the existence of secondary markets for HOST bonds. Will other first-time buyers be able to purchase HOST bonds in secondary markets? Can a HOST bond be sold by a first-time buyer to a home owner? What happens if housing prices statewide increase at a rate faster than the rate of return on tax-exempt securities? The guarantee to HOST participants would then have to be fulfilled at the expense of the general fund. Why should Michigan voters pay more than necessary for environmental and recreation programs they approved at the ballot box in order to underwrite a housing program they never had the chance to vote on?

By using a bond issue intended for environmental and recreational purposes to promote a housing program and guaranteeing a rate of return to a narrow spectrum of buyers which could be higher than the state would have to pay to attract buyers from the general public, HOST seems to run counter to the spirit, if not the letter, of the acts which created the voterapproved bonds in the the first place.

The Economics of HOST

HOST will provide an "interest rate guaranteed to equal or exceed the annual increase in Michigan home prices," according to promotional literature. The program promises "a right to early withdrawal without penalty," and is "tax exempt for federal, state and local taxes." HOST is "backed by the full faith and credit of the State of Michigan," and is "flexible, with low monthly payments."

Under HOST, "any family or individual will be able to guarantee funds for a down payment on the home of their choice. They will be able to pre-select the value of the home they want to save for, the length of time they wish to save for their down payment, and the down payment percentage they want to have when they buy." The program guarantees that "each down payment investment will grow each year at the annual housing inflation rate throughout Michigan. This unique guaranteed rate of return," according to promotional literature, "will provide peace of mind to these young people that their hard earned savings will not be eaten away if the price of housing rises faster than normal savings rates." [1]

For first-time buyers purchasing homes in upscale areas such as north Oakland County, Ann Arbor, Grand Rapids, Livingston County, Macomb County and western Wayne County, HOST means that their savings for the purchase will be underwritten by the state, whose "full faith and credit" includes taxpayers residing in locales where housing price increases have not been a concern. Home prices statewide have increased at an average annual rate of 8.1 percent since 1984, according to the Michigan Association of Realtors. But another picture emerges when examining housing in upscale areas, where prices have increased at greater rates: [2]

Average Annual Rate of Increase

Area	1984	1989	%
North Oakland County	$49,533	$87,397	15.3+
Ann Arbor	$73,659	$116,205	11.6+
Grand Rapids	$50,515	$73,951	9.3+
Livingston County	$58,167	$105,225	16.1+
Macomb County	$51,603	$78,626	10.5+
Western Wayne and Oakland County	$57,731	$91,225	11.6+

First-time buyers planning to purchase homes in upscale areas are likely to take advantage of HOST, which could conceivably have the perverse effect of boosting demand and prices for homes in these areas.

Home prices statewide have increased at smaller average annual rates in middle-class areas:*

Average Annual Rate of Increase

Area
Battle Creek	(1987)	$48,129	(1989)	$50,194	2.1+
Detroit		NA	NA		NA
Downriver	(1986)	$51,788	(1989)	$63,113	7.3+
Flint	(1986)	$50,737	(1989)	$60,778	6.6+
Holland	(1984)	$58,233	(1989)	$81,718	8.1+
Jackson	(1986)	$46,072	(1989)	$57,293	8.1+
Kalamazoo	(1984)	$51,518	(1989)	$66,854	6.0+
Lansing	(1984)	$52,772	(1989)	$68,389	5.9+
Midland	(1984)	$60,500	(1989)	$72,000	3.8+
Monroe	(1985)	$53,400	(1988)	$65,400	7.5+
Saginaw	(1984)	$45,384	(1989)	$56,203	4.8+

* Percentage figures are expressed in terms of average annual rates between the years indicated. Housing prices for 1984 were unavailable in Battle Creek, Downriver, Flint, Jackson and Monroe. A 1989 figure was not available for Monroe. All 1989 figures are inclusive through Nov. 30. Source: Michigan Association of Realtors.

For first-time buyers in middle-class areas, HOST is an illusion: an ill-designed concept that substitutes a political promise of home ownership for the traditional American notions of thrift and savings. Assuming low inflation and stable interest rates, HOST is unnecessary for many prospective middle-class buyers because investments such as money market accounts, certificates of deposit, zero coupon bonds, tax-free municipal bonds, and certain mutual funds, stocks and bonds provide after-tax rate of returns greater than housing price increases in most middle-class areas. (See Appendix) All of these investments have established secondary markets.

Serious questions, however, exist about secondary markets for HOST bonds and the program's overall legality. Will other first-time buyers be able to purchase HOST bonds in secondary markets? Can a HOST bond be sold by a first-time buyer to a home owner? Or will the secondary "market" consist entirely of the state Department of Treasury?

Unresolved Legal Questions

In September 1988, the state Legislature passed PA 326-29, which placed two questions on the ballot concerning state general obligation bonds issued under Article 9, Section 15 of the 1963 Constitution. Both bond issues were approved by voters, allowing the state to sell $660 million in general obligation bonds to finance environmental protection programs and $140 million in general obligation bonds to finance state and local public recreation projects. Though not known at the time, this was HOST's beginning.

The language in the two bond issues states they may bear interest at a rate or rates specified by resolution adopted by the state Administrative Board. The language was included to allow the Department of Treasury to issue securities at competitive market rates, and which provide the least cost to taxpayers. The state is now using this language to establish HOST, a program that has not been granted legislative authority in the normal manner.

Rather than sell HOST bonds through standard channels, the state will sell variable rate zero coupon bonds, in small denominations and on a monthly basis, to first-time home buyers. The bond's interest rate will be tied to an index of statewide housing prices. Bond purchasers are guaranteed a rate of return equal to "the annual housing inflation rate throughout Michigan." They would receive the tax exempt rate if housing prices rise more slowly than the interest on one-year tax exempt securities.

However, what happens if housing prices increase at a rate faster than the rate of return of tax exempt securities? The guarantee to,HOST participants would then have to be fulfilled at the expense of the general fund.

At this point, the natural question to ask is, "Why should Michigan voters pay more than necessary for environmental and recreation programs they approved at the ballot box in order to underwrite a housing program they never had a chance to vote on?"

While HOST appears to be a home down payment guarantee program, it is really just an investment vehicle restricted to first-time buyers. But if one accepts the hyperbole that HOST is a housing program, one faces a separation of powers question. [3]

Though the legislature passed a statute which gave the state the power to sell general obligation bonds at a rate to be determined by the state administrative board, it did not give the panel the authority to implement a housing program. The executive branch will violate the spirit, if not the letter, of the acts which created the voter-approved bonds.

A HOST proponent might respond, "This is not a housing program, but merely the issuance of variable rate zero coupon bonds." The state has the authority to issue such bonds under Section 3 of the Environmental Protection Bond Implementation Act, and Section 3 of the Recreation Bond Act. [4]

But this argument leads to two further legal questions with regard to the program. The first is the ability of the state to restrict the issuance to first-time home buyers. While Section 3 of each Act states that the state administrative board may subject the issuance to restrictions, it specifies that these are to be "as necessary to insure the marketability, insurability, or tax exempt status" of the bonds. It would be surprising if the courts held that the restriction to first-time home buyers met this requirement.

The second issue is related. Section 4 of each implementation act states that bonds issued under the acts are to be fully negotiable under the uniform commercial code. [5] How can the HOST bonds be fully negotiable under the restrictions of the program? Neither the bond implementation acts nor the uniform commercial code define "fully negotiable." In Nicholas v Michigan State Employees Retirement Board, 144 Mich App 70,74:372 NW2d 685 (1985), the rule of statutory construction that "specific words in a statute are given their ordinary meaning unless a different interpretation is indicated" was concisely set forth. "Fully negotiable" would seem to indicate a secondary market in HOST bonds. But how can this market operate fully if the only one who can buy the bonds in the first place must be first-time home buyers? Can a HOST bond be sold by a first-time buyer to a home owner? Or will the secondary "market" consist entirely of the state Department of Treasury? It is difficult to imagine how the bonds can satisfy the Section 4 requirement.

Voters might be willing to take on the extra tax burden of HOST, but that is not what they were asked to do in November 1988 when they voted on an $800 million bond issue for the environment and recreation.

Is HOST really needed? Common sense suggests that HOST bonds will be purchased primarily by those with higher marginal tax rates who are wealthy enough to diversify their portfolio. These are likely to be first-time buyers planning to purchase a home in Bloomfield Hills, East Grand Rapids or Troy, not Detroit, Flint or Pontiac. Although this may be where the votes are, it is not the home of the middle-class taxpayers who could be forced to underwrite HOST.

While HOST is not really a housing program, it does represent a trend in state government which is worth noting – the use of the state's borrowing and investing power to serve political goals. This recent trend was foreshadowed by the 1982 revision of PA 314 of 1965, which dealt with the investment of assets of public employee retirement systems. [6] PA 314 originally restricted the investment of these assets. For example, investment in common stocks was limited to 10 percent of total ledger assets, and no more than three percent of total assets was to be invested in common stocks in any one year. Severe restrictions were placed on the kinds of stocks in which the pension fund could be invested. There was no provision for the purchase or taking of equity interest in realty. The rewritten act broadened the scope of investing to allow up to 60 percent of the system's assets to be placed in common stock, five percent in venture capital improvements, and, if the state treasurer is the investment fiduciary, more than five percent of the assets in investment in real or personal property.

The old law substantially reduced the ability of the pension funds to earn a reasonable rate of return on assets. The provision of PA 55 allowed the state to make spectacular gains in the rates of return of the pension funds through the 1980s. There is little question of the benefits from the passage of this act. However, these amendments make it more necessary for the citizenry to ensure that the provisions of subsection 13(3) are followed. This subsection requires an investment fiduciary to discharge his or her duties solely in the interest of the participants and beneficiaries of the funds. The temptation to make investments which are politically, rather than financially sound, will be great. Investment in a new firm that promises jobs in a politically key district should be seen in financial, rather than political terms. This is difficult to do because the legislature included a stipulation that the venture capital provisions may be used only to invest in firms which have 50 percent of their assets or employees within Michigan. Such action comes close to political motivation for investing, rather than investing "solely in the interests of the participants and beneficiaries."

Creation of the Michigan Education Trust (MET) in 1986 is further evidence of this trend. MET utilizes the state's investing capacity to act as a competitor to private sector investment programs. The state purports to guarantee tuition at its colleges and universities to those state residents who invest their funds in a state trust. MET puts more than 4,000,000 state taxpayers in the position of possibly guaranteeing tuition for less than 50,000 families.

The philosophy underlying HOST forces state taxpayers to continue down this dangerous path. Use of public funds to achieve political outcomes goes far beyond what is "just law" as defined by the 19th Century French political philosopher Frederic Bastiat. Once government exceeds its primary function, Bastiat wrote, "you will then be lost in an uncharted territory, in vagueness and uncertainty, in a forced utopia or, even worse, in a multitude of utopias, each striving to seize the law and impose it upon you. This is true because fraternity and philanthropy, unlike justice, do not have precise limits. Once started where will you stop? And where will law stop itself?" [7]

Where will the State of Michigan stop in its use of assets and taxes to benefit select groups who are deemed politically important? When will the state stop playing philanthropist with the taxpayers' money?

Appendix: Other Investments

Assuming low inflation and stable inflation rates, HOST is unnecessary for many prospective middle-class buyers because investments such as money market accounts, certificates of deposit, zero coupon bonds, tax-free municipal bonds, mutual funds, stocks and equities provide after-tax rates of return greater than housing price increases in most middle-class areas.

A first-time buyer in Battle Creek, Midland, Saginaw or any other area where housing prices are increasing at an annual rate of five percent or lower could obtain a sufficient after-tax rate of return through a money market account, certificate of deposit or taxable zero coupon bond.

Buyers in portions of Downriver, Flint, Kalamazoo, Lansing and other areas where housing prices are increasing at an annual rate of five to seven percent could obtain a sufficient after-tax rate of return from tax-free municipal bonds. A portfolio of eight AAA- and AA-rated tax-free bonds maturing in 1995, 1996 and 1997 was paying 6.23-6.86 percent in late December.

A first-time buyer in Holland, Jackson, Monroe and other areas where housing prices are increasing at an annual rate of seven to eight percent could obtain a sufficient after-tax rate of return from certain mutual funds, stocks and bonds.

Buyers in certain upscale areas where prices have exceeded the state housing index could also obtain a sufficient after-tax rate of return from certain mutual funds, stocks and bonds.

All of the aforementioned investments have established secondary markets.

Addendum

Of course, any prospective buyer sophisticated or lucky enough to equal or exceed the five major market indices on a regular basis would have no need for any of these investments:

12 Month Change, Dec. 22, 1989

Standard & Poor's 500	25.03+
Dow Jones Industrial Average	25.01+
Wilshire 5000 Equity Index	23.07+
New York Stock Exchange Composite	23.00+
NASDAQ Composite	17.82+

However, such an accomplishment is virtually impossible for small, and even most large investors.

Endnotes

HOST, Michigan Department of Treasury, December 1989.
Michigan Association of Realtors
Article III, Section 2 of the 1963 Constitution provides that the powers of government are to be divided into three branches, and that no person shall exercise powers properly belonging to another branch.
Mich. Comp. Laws 299.673 and 318.573.
Mich. Comp. Laws 299.674 and 318.574.
PA 55 of 1982.
Frederic Bastiat, The Law, Foundation for Economic Education, 1987, p. 69.