The real lessons of the housing crisis have gotten lost. It's portrayed as the financial system run amok; the housing market became a casino. The remedy is to enact rules that prevent a repetition. All this is partly true. But it ignores a larger and more important truth: our infatuation with homeownership, embedded in dozens of government policies, has turned housing—once a justifiable symbol of the American Dream—into something of a National Nightmare.
As a society, we're overinvesting in real estate. We build (and buy) too many extra-large homes. McMansions, if you will. They use too much energy, and their carrying costs, including mortgage payments, absorb too much of Americans' incomes, limiting the ability to save for retirement and other needs. We think everyone should become a homeowner, when many families can't or shouldn't. The result is to encourage lending to weak borrowers who are likely to default. The avid pursuit of a few more percentage points on the homeownership rate (it rose from 64 percent of households in 1994 to 69 percent in 2005) has condoned enormously damaging policies.
Does every house need a "home entertainment center"? Well, no. But when you subsidize something, you get more of it than you otherwise would. That's our housing policy. Let's count the conspicuous subsidies.
The biggest of these favor the upper middle class. Homeowners can deduct interest on mortgages of up to $1 million on their taxes; they can deduct local property taxes, and profits (capital gains) from home sales are mostly shielded from taxes. In 2008, these tax breaks are worth about $145 billion. Next, government funnels cheap credit into housing through congressionally chartered Fannie Mae and Freddie Mac. Perceived as being backed by the U.S. Treasury, Fannie and Freddie can borrow at preferential rates; they now hold or guarantee $5.2 trillion of mortgages, two fifths of the total. Finally, the Federal Housing Administration (FHA) insures mortgages for low- and moderate-income families that typically require only a 3 percent down payment from buyers.
Congress's response to the present crisis is, not surprisingly, more of the same. The legislation nearing final enactment last week adds new subsidies to the old. It creates more tax breaks; first-time home buyers could receive a $7,500 tax credit. It expands the lending authority of Fannie Mae and Freddie Mac. Previously, the permanent ceiling on their mortgages was $417,000; now that would go as high as $625,500. And the FHA would be authorized to support, at much lower monthly payments, the refinancing of mortgages of an estimated 400,000 homeowners in danger of default. The theory of the new legislation is that more subsidies will stabilize the housing market and stimulate a recovery.
This may—or may not—work in the short run. But it poses long-run hazards. Make no mistake: I'm not anti-housing. My wife and I own a two-story brick colonial; I actually enjoy mowing the lawn. I also believe that homeownership stabilizes neighborhoods and encourages people to maintain their property. Generations of social reformers have made these arguments, Alexander von Hoffman of Harvard's Joint Center for Housing Studies recently pointed out. Owning a home "with a garden and trees, and room for the children to play," said one in 1871, "must be a strong motive with any man to regularity, good conduct, and economy."
It's also true, as economist Mark Zandi shows in his new book, "Financial Shock," that today's housing collapse had multiple causes: overconfidence about rising home prices and demand; cheap credit, in part supplied by overseas investors; lax lending practices; inept government regulation; speculative fever, and sheer fraud. Still, the government's pro-housing policies contributed in two crucial ways.
First, they raised demand for now suspect "subprime" mortgages. The Department of Housing and Urban Development sets "affordable" housing goals for Fannie Mae and Freddie Mac to dedicate a given amount of credit to poorer homeowners. One way Fannie and Freddie fulfilled these goals was to buy sub-prime mortgage securities—many of which have now gone bad. Second, government's housing bias created a permissive climate for lax lending. Both the Clinton and present Bush administrations bragged about boosting homeownership. Regulators who resisted the agenda risked being "roundly criticized," notes Zandi. In 2005, mortgage delinquencies were low. Regulators couldn't easily make "the case to lenders that their lending standards were out of whack."
Good intentions have led to bad outcomes: an old story. Fannie's and Freddie's losses impelled the Treasury Department to propose a rescue for the companies; given their size and the government's implicit backing for their debt, doing otherwise would have risked a financial panic. Personal savings have been skewed toward housing. Many Americans approaching retirement "have accumulated little wealth outside their homes," concludes a study by economists Annamaria Lusardi of Dartmouth College and Olivia S. Mitchell of the University of Pennsylvania. Even some past gains from the prohousing policies are eroding; the homeownership rate has dropped to 68 percent.
We might curtail housing subsidies without subjecting the economy to the disruption of outright elimination. The mortgage interest deduction could be converted to a less generous credit; Fannie's and Freddie's expanded powers could be made temporary; FHA's minimum down payment could be set at a more sensible 5 percent. But taking even these modest steps would require a recognition that the obsession with homeownership has gone too far. It would require a willingness to confront the huge constituency of homeowners, builders, Realtors and mortgage bankers. There is no sign of either. When the next housing crisis occurs, we will probably find its seeds in the "solution" to the last.