Arnold Kling  

Subsidizing Mortgages

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One prominent proposal comes from Glenn Hubbard and Christopher Mayer.

In support of their mortgage subsidy idea, Brad DeLong writes,

I am, however, gobsmacked to see Glenn Hubbard proposing it.

What has me gobsmacked is that DeLong, who usually has the good sense to dispute Hubbard, fails to do so in this case.

The Washington Post quotes me stating the obvious.

"The problem with subsidizing mortgages is you're subsidizing people getting into debt. You're putting people into houses with no equity," said Arnold Kling, a former economist at both the Federal Reserve and Freddie Mac. "The goal should be getting people to own homes on a sound basis."

Among the many problems with the Hubbard-Mayer idea is that trying to prop up home prices is crazy when so much overbuilding has taken place and so many housing units are unoccupied. We need another two or three years of record low housing construction to get rid of the overhang.

Comments and Sharing

COMMENTS (14 to date)
Susie orman writes:

The problem with subsidizing mortgages is you're subsidizing people getting into debt. You're putting people into houses with no equity," said Arnold Kling, a former economist at both the Federal Reserve and Freddie Mac. "The goal should be getting people to own homes on a sound basis.

johnleemk writes:

I ask this here only because I see no way to email Arnold or any of the other Econlog bloggers: what do you guys think of the EFCA (card-check bill)? I imagine it's a negative opinion, and I would tentatively agree, but most of the commentary I've read on this issue comes from rather biased and polarized sources; it's either from the industry, the unions, the "progressive" left, or Mickey Kaus. It would be really really nice if we got some impartial and clear analysis of the issue at stake from an economist blogger.

Marcus writes:


It is my understanding is that the plan you refer to is about refinancing existing mortgages. That basically, everybody with an existing mortgage can refinance to the lower interest rate.

Does it also apply to buying a new house?

Also, I'm not clear on what happens to the loss on mortgages which are underwater and refinance. My understanding is that the loss is equally divided between the lender and the government.

But I've also heard that that loss will result in an equity stake in the house? Is that true?

Can you please elaborate on this plan and explain it in more detail for us lay people? Thanks.

richard writes:

The plan would apply to everyone, whether they are looking to refi or buy a new house. There is a bailie mae provision in there too, I think. Actually something along the lines of what Arnold had mentioned in a previous blog post, where the lender writes down some of the principal for those underwater and the "owner" loses out on the upside.

winterspeak writes:

Totally agree, Arnold.

I made exactly this point on Brad's site, but Brad DeLong, as we all know, deletes comments he does not agree with.

That's intellectual diversity at U Cal Berkeley for you.

RobbL writes:

Winterspeak, it is probably your breath. There are actually plenty of comments on DeLong's blog that he does not agree with.

Arnold, How can we stop the downward spiral of the economy if we don't untoxify all these housing based assets? Do you not agree that we are heading for a very bad time? Or do you not see a way to prevent it? I am confused.

Brad Hutchings writes:

The question to ask the proponents of "stabilizing" housing prices or keeping them otherwise high is: Why? I can think of two reasonable answers off the top of my head. (1) A continued or more drastic slump will leave more people upside-down in their mortgages and lead to more foreclosures. Foreclosures are like nuclear IEDs in the housing market, so a price slump would lead to complete chaos. (2) Lower property tax revenues will strain state and local governments.

But the only hope the proponents of propping prices up have is that doing so hides nasty market undercurrents (like people unable to pay their mortgages and a glut of worthless opaque financial instruments) until prices can recover naturally. The problem they introduce though, is that they create more of the problem they purport to solve. People can't pay their debt because they have too much of it, so the solution is to make them take on more! Step 3. ????? Step 4. Profit!

(BTW, props to "Susie Orman" above. So funny. But so true!)

RobbL writes:


People already have debt. Lowering the interest rate lowers their payment and maybe fewer default. Also it gives more money to people who can pay their mortgage now to spend as they see fit. Lowering the mortgage rate also slows or stops the fall in house prices. I doubt the economy can even begin to recover until we hit bottom on housing prices.

The trick is of course to only keep doing this until prices stabilize...

Brad Hutchings writes:


But lowering the interest rate also jacks up prices. Perhaps the root of the problem is that most home buyers do not buy a $400K house based on the sales price. They buy it based on the monthly payments. When rates get lowered or are otherwise subsidized, prices go up. The initial payments usually aren't the problem. It's the debt that people are on the hook for that becomes the problem when rates reset, jobs are lost, couples divorce, careers stagnate, etc.

The net result of all the subsidies (including mortgage interest tax deduction and capital gains exemption) and home ownership initiatives and all that seems to be that newer homeowners have ended up with about the same payments they would be making on the same houses they would have with tons more debt. Doing more of the same in hopes of getting out of that hole seems folly to me.

It might make a lot of sense to go back to the 30 year fixed mortgage as industry standard. I would prefer that the market just rediscover it rather than it happens by government fiat or industry collusion. But at the very least, such a standard prices in and normalizes the borrower's focus on payments rather than debt. And then maybe we can get closer to pricing that reflects supply and demand for housing.

winterspeak writes:

RobbL: Brad DeLong may dislike my breath. But I'm not the only one, he's notorious for doing this.

As for the economy, the damage was done when real resources were allocated to malinvestments (extra houses no one wants, extra malls with no shoppers, etc.)

The economy is contracting because a couple of huge drivers of aggregate demand (consumer spending, business spending etc.) have shrunk. Overall, as credit is shrinking, money supply is shrinking, which is why people say were are in "deflation".

Two things need to happen to reverse this spiral.
1) The Government should increase money supply by increasing aggregate demand. They will need to run a larger deficit. The best way to do this is for the Federal Government to pick up payroll taxes until CPI starts to tick up.

This extra money can be used to pay down debt, buy new stuff, etc.

2) The Government also needs to let the economy reallocate goods and services in a way that is useful. Propping up prices etc. stops this process dead, and puts us in the same zombie land Japan has been in for 25+ years.

Niccolo writes:

Did someone really suggest we "prop up prices"?

Really? Did you really bypass the whole part of wage propping during the 1930's?

Dan Weber writes:

I would personally enjoy a nice refi to 4.5% with no points. That doesn't make it good policy.

If we need to "prop up home prices," then how about making building all new housing illegal?

Okay, maybe that's too severe; someone might really really need/want a new house and be willing to plow money into it. So let's back off and create a $10,000 fee to start building any new house.

I don't think these are good ideas; but if the idea is to increase the price of housing, this is a much more direct way to accomplish that goal.

Matthew C. writes:

We should prop up housing prices by creating a "housing lottery".

Two out of every 10 housing units will be destroyed, as decided by a random "lottery" process. We can use some of the military assets rotating out of Iraq to do this cheaply using artillery, and it will also provide useful training for our troops in urban combat. The owners / renters will be given 24 hours to evacuate before shelling begins, and will be compensated out of TARP funds. Housing prices will go up, YAY!

Marcus writes:
I don't think these are good ideas; but if the idea is to increase the price of housing, this is a much more direct way to accomplish that goal.

I think part of the goal is to get the 'toxic' assets of the banks' books. Refinancing means paying off the current loan which then takes it off the books.

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