October 13, 2008
Politicians from both parties have spent decades trying to subsidize the "American dream" of home ownership. This always has been a misguided effort, but the Wall Street meltdown illustrates that government intervention sometimes can have truly catastrophic consequences. Policy mistakes caused the bubble, and those mistakes largely were driven by political decisions to boost home ownership (now that the bubble has burst, additional government policy mistakes are making a bad situation worse, but that's a separate issue).
The fundamental issue, at least from an economic perspective, is whether it is a good idea for government to distort the allocation of labor and capital. This sounds like arcane economic jargon, but it is the key issue because the long-term prosperity of a nation -- and the living standards of its people -- depends on whether resources are channeled to their most productive uses. Hong Kong has enjoyed astounding economic success because government rarely interferes in the market, whereas France suffers from economic stagnation because of burdensome levels of taxes, government spending and regulation.
The United States is somewhere between Hong Kong and France. We generally allow markets to operate, which is why disposable income in America is so much higher than it is in France. But our government does intervene in some areas (such as housing), and this hurts our competitiveness and explains why we don't grow as fast as Hong Kong.
Government intervention in housing is pervasive. Let's start with the policies that encourage over-investment in housing and then focus on the policies that contributed to the market meltdown. A number of government policies are designed to steer people toward housing, including:
* The home mortgage interest deduction, which provides a tax preference for middle-class and upper-class people to invest in housing.
* The Federal Housing Administration, which subsidizes home ownership for lower-income buyers.
* Traditional Fannie Mae and Freddie Mac subsidies, which tilt the playing field so that investors put more money in residential real estate.
These policies sound good, which is why politicians put them in place, but they are economically harmful because they encourage people to put money in residential real estate instead of other forms of investment. There is nothing wrong with having lots of nice housing, of course, but when government interference makes housing excessively attractive, this necessarily means less money is available for other purposes -- such as providing capital for future economic growth. This is why scholarly research generally has found that housing subsidies hurt long-run growth.
Other housing subsidies, put in place in more recent years, played a key role in causing the current turmoil. A bipartisan push to increase home ownership resulted in laws and regulation that dramatically expanded the activities of government-sponsored enterprises (Fannie Mae and Freddie Mac) and put them on a mission of funding loans to people with poor credit. Combined with too much liquidity, thanks to the Federal Reserve's lax monetary policy, this "perfect storm" of bad policy created a housing bubble. Now the bubble has burst, and we are suffering through the consequences.
As a stereotypical house-in-the-suburbs American, I certainly appreciate the value of home ownership. But sometimes there can be too much of a good thing. Government subsidies have hurt our economy in the long run by reducing business investment, and they have slammed our economy in the short run by causing an unsustainable bubble. Maybe it's time to replace government mistakes with market forces.
Daniel J. Mitchell is a senior fellow at the Cato Institute, where he is an expert on tax reform and supply-side tax policy.
If only there were what you call "too much of a good thing" for Americans needing an affordable place to live. On the contrary, nearly 95 million Americans -- roughly one-third of us -- are paying beyond their means for shelter, spending more than 30% of their income on rent or mortgages. According to Harvard's Joint Center for Housing Studies, more than 43 million Americans pay upward of half of family income toward housing, and 42.6% of all working families still cannot afford "an appropriately sized housing unit."
The home price plunge of the last 24 months should help some future home buyers in the short term, but even if prices roll back to 2004 levels, a huge ownership affordability gap would remain. And millions of former homeowners are being thrown back into the rental market, putting pressure on rents to increase.
Moreover, it has been during periods when government is run by free market ideologues bent on getting government out of the subsidy business that this gap between affordability, average incomes and housing costs has been getting worse, not better. So while I agree that "policy mistakes caused the bubble" and led to today's dismal situation of nearly 5 million households in default or foreclosure, we see different policy mistakes as the root causes. In a nutshell, there has been an unrelenting push to slash the government regulation necessary for a good mortgage market, which had served us well until 2000, to function properly. That market has been replaced with unregulated, private-market "products" and mortgage companies, bringing us to today's meltdown. But more on that tomorrow.
Let's look quickly at the last 60 years of government policies that you say have made things worse.
Prior to the Great Depression, when unregulated markets completely determined the allocation of capital to housing, home ownership rates hovered around 45%. The stock market crash of 1929 and soaring foreclosure rates resulted in banks owning nearly 10% of all private homes. In response, the federal government in 1938 launched the original version of Fannie Mae to create a secondary mortgage market and pioneer the 30-year fixed-rate mortgage.
Add to that the GI bill for returning veterans, the Federal Housing Administration insuring loans for moderate-income buyers and the explosion of the home-building industry to meet demand, and by 1968 home ownership rates had climbed to 65%. Many families, including mine, regard the post-World War II access to government-aided affordable mortgage products as a turning point on their road to the middle class. These programs helped millions of returning GIs create wealth and start businesses. How many Americans really believe that returning to a pre-Great Depression, free-market home finance system would be better for America?
Now, not all subsidies and programs are created equal. The home mortgage interest deduction, for example, continues to be touted as a critical aid to ownership when it mostly funnels more than $75 billion in tax breaks to those who need it least. Only about half of homeowners itemize deductions, thereby getting no savings. Of those who itemize, the annual individual tax savings for the vast majority is probably less than $2,000.
For the high-bracket borrower with a $1-million mortgage (the highest amount on which interest is tax-deductible), the annual tax savings could be well over $20,000. The main impact of the deduction is not greater home ownership rates; the American rate is roughly equivalent to Canada and European countries that do not have a mortgage interest deduction. Instead, the deduction makes high mortgage debt less expensive.
This inflates homes prices, especially among higher-end homes, and may have contributed to the financial overextension of some higher-income American homeowners so evident these last few years. These flaws led a bipartisan presidential commission in 2005 to conclude that the mortgage interest deduction does not achieve its supposed purpose. That commission recommended that the mortgage interest deduction be abolished.
The tax revenue lost because of this subsidy is roughly twice the budget of the Department of Housing and Urban Development (which only equals little more than the potential cost to taxpayers of the Bear Stearns rescue -- remember that?). That department helps families earning less than 60% of median U.S. income (roughly $30,000 annually) pay for housing. But with federally assisted housing in short supply, only about 25% of eligible households are actually reached. For the large number of American households in the middle, our current system has been producing neither widely accessible mortgage products and programs that let moderate-income households buy without playing interest-rate roulette, nor an adequate supply of quality, affordable rental options.
So, Dan, if your comments target subsidies that fall short of what they promise, we have a point of agreement. But your approach seems premised on an idealized vision of a market whose outcomes are by definition the right ones, regardless of whether they produce the basic goods that Americans need at prices they can afford.
Experience has shown that we have plenty of models that are in fact effective at expanding the American dream through programs that work for those in the middle. One example is the Massachusetts Affordable Housing Alliance, which has assisted more than 11,000 families of modest means in buying their first homes. Families that benefit from the Massachusetts program have a long-term delinquency rate roughly half that of conventional mortgage borrowers. Self-Help in North Carolina has aided tens of thousands of low-wealth families become homeowners, with foreclosure-rate results comparable to Massachusetts.
But don't expect the home mortgage interest deduction to go quietly into the night; it has too many politically strong allies, and at a time of collapsing home prices, it would be unwise to simply shut off the spigot. But as we embark on the necessary task of rebuilding our entire home ownership system, we should reduce the mortgage interest deduction cap from the current $1-million loan level to perhaps half that over five years. Subsequently converting to a uniform credit amount would be an enormous step in the right direction.
David M. Abromowitz is a lawyer and a senior fellow at the Center for American Progress Action Fund.
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