I am getting my thoughts together for a piece on what to do in the long term about financial markets and housing policy. Here are a couple of thoughts on housing policy.
1. Why subsidize home ownership among people who are relatively low on the economic ladder?
2. Why subsidize mortgage indebtedness?
In economics, the rationale for a subsidy is a positive externality. The government taxes me in order to subsidize your actions, because your actions benefit me.
For example, if you own your home, then you may take better care of it, and that may help our neighborhood and raise my property values. So I might want to participate in a program that gives you a subsidy to own your home. But it is worth carefully thinking about how important these externalities are. We have a pretty intensive involvement of government in trying to get people in the bottom third of the income distribution to try buying rather than renting. Are the social benefits of that policy commensurate with its costs?
On point (2), off the top of my head, I cannot come up with any reason to subsidize mortgage indebtedness. How does your having a mortgage loan benefit me? Does anyone have an answer for that? Bueller?
I think that mortgage subsidies emerged pretty much by accident. The income tax deductibility began when hardly anyone paid income tax, and it has been grandfathered in ever since. In the 1930's, government decided to reshape the mortgage market, and that effort evolved into government agencies, such as Fannie Mae, FHA, and Freddie Mac. Fannie and Freddie were subsequently spun out to private shareholders as government-sponsored enterprises, but Congress never let the GSE's forget that they had a "mission" to provide subsidies to low-income borrowers. Whether you blame the privatization or the Congressional pressure, the results were not pretty.
Reshaping the mortgage market away from short-term balloon finance was a good idea. But creating a huge industry built on taxpayer guarantees was not a good idea.
All in all, I would say that the mortgage subsidies have given us systemic financial risk, which is a negative externality. A HUGE negative externality. What it has given us lately is a toxic financial spill, which is very hard to clean up.
I also think that promoting home ownership among low-income households may be something of a negative externality. Home ownership with low down payments poses systemic risk. As I've said before, when buyers don't put down much money initially, their equity has to consist of price appreciation. When prices are rising, everybody can buy. When prices are falling, nobody can buy. Instability is the natural result. If you stick with 20 percent down payments, then the market will not rise as much as it might otherwise, but it will not fall as much as it might otherwise, either.
Instead of handing a low-income home buyer a subsidized mortgage with a low down payment, I'd rather hand the buyer a check to use for part of the down payment. Then the buyer starts out with equity in the house, and we don't pile on so much systemic risk. But before we hand out checks for down payments, we ought to go back and estimate the extent of the positive externality that is involved in switching from renting to ownership.