Why help to buy your home is no help at all to the economy

A foreclosure/price reduced sign stands at a home for sale in Miami, Florida.

A foreclosure/price reduced sign stands at a home for sale in Miami, Florida.
A foreclosure/price reduced sign stands at a home for sale in Miami, Florida. Photograph: Joe Raedle/Getty Images

At the end of the first quarter, according to the Federal Reserve Bank of New York, American consumer debt for the first time exceeded its previous peak (in dollars), reached in the third quarter of 2008, just as the global financial crisis erupted. Although car loans and student debt have been rising especially rapidly, housing debt remains more than two-thirds of the $12.7tn total.

As a share of income, household debt is nothing like the threat to the national economy that it was 10 years ago. But the new statistic is a reminder that American households don’t save enough.

Some would attribute Americans’ tendency to spend – while Asians, for example, tend to save – to cultural factors. But there is an important policy component as well. US government policy is designed as if to encourage Americans to take on as much housing debt as possible.

Economists hesitate to explain to people that they should borrow less. The advice sounds too schoolmarmish. It seems to lack empathy for those whose incomes are not keeping up with the standard of living that historical trends had led them to expect. But it does no one any favours to encourage over-indebtedness as a matter of policy, as the millions who lost their homes in the aftermath of the 2008 crisis discovered.

Owning your own home is said to be an essential part of the American dream. There is nothing wrong with dreaming. But there is nothing wrong with renting, either. Buying a house is typically a consequence, not a cause, of a family’s prosperity.

Advocates of an “ownership society” argue that homeowners take better care of their property than renters, with positive externalities for the neighbourhood. But public encouragement of homeownership also weakens labour mobility. In the last US recession, many who lost their jobs could not move to other parts of the country where jobs were more plentiful, because they couldn’t sell their homes. There is good evidence that the housing crisis boxed in jobseekers.

Encouraging home ownership isn’t cheap. The overall effective annual subsidy to US housing debt has been estimated at roughly 1% of national income. The largest component of this subsidy is the tax deductibility of home mortgage interest, which costs a lot of revenue and is hard to justify on distributive grounds: the benefit goes only to those with incomes high enough to itemise deductions.

If President Donald Trump manages to get any economic legislation passed at all in the coming year, it is likely to be a tax cut. Congressional Republicans say they want revenue-neutral, efficiency-enhancing tax reform, which is properly defined as lowering marginal tax rates but simultaneously eliminating distortionary deductions, thereby keeping revenues and the budget deficit stable. In that case, the deductibility of home mortgage interest should be among the first targets for reform. Yet the Trump administration has explicitly ruled out curtailing it.

Particularly suspicious in the case of Trump is his support for giveaways in the tax code that benefit only real-estate developers like him. One such loophole lets developers deduct losses that exceed their investments. Another is the use of “like-kind exchanges” to avoid capital gains tax.

But the problem goes well beyond Trump or the Republicans. The policies that favour mortgage debt are extremely popular. Virtually all politicians of both major political parties have long supported them, taking the goal of maximising homeownership as self-evident.

Beyond the deductibility of home mortgage interest, borrowers are permitted to make down payments of as little as 5% (or even less) of the value of the house they buy, rather than the more standard 20%. Many other countries, such as South Korea and Singapore, have regulations – loan-to-value ratios, for example – limiting how much households can borrow. They even manage to tighten the loan limits or tax measures counter-cyclically, which is the recommended way to help stabilise the housing cycle.

But the US is not the only country with measures that tilt toward excessive housing debt. In the UK, for example, the help to buy initiative has subsidised home purchases with down payments of only 5%.

Another way the US has long subsidised housing debt is through the huge quasi-government mortgage underwriters Fannie Mae and Freddie Mac. Both were privately owned but had an implicit government guarantee from taxpayers, a classic case of moral hazard. Sure enough, they were put in federal conservatorship in 2008. Congress could easily repeat the mistake of privatising them while failing to eliminate the implicit guarantee. Their capital standards should be raised, just as regulators have appropriately forced banks to do.

The Dodd-Frank financial reform bill, signed into law by President Barack Obama in 2010, contained many provisions to reduce the chances of another big financial crisis. But the law would have moved the financial system further in the right direction if many in Congress had not spent the last seven years chipping away at it.

Here is one example. The Dodd-Frank law wisely required banks and other mortgage originators to retain on their books at least 5% of the housing loans they made, rather than repackaging every last one for resale to others. The loan originators need to have “skin in the game,” in order to have an incentive to verify borrowers’ creditworthiness. Under heavy pressure from Congress, that requirement was gutted in 2014.

Ironically, the encouragement of housing debt in the US doesn’t even succeed in raising homeownership rates relative to other countries: even at the peak of the housing boom, the subsidies drove up the price of housing more than the quantity. Homeownership was no higher than in many countries with more sensible mortgage policies (no tax deductibility), such as Canada. The 2007-09 crisis lowered it from 69% to 63%. And of course the housing debt distortion was itself a key contributor to the crash.

Most economists have long frowned on US policies that subsidise homeownership. But most held their tongues. And now many Americans no longer want to hear from experts. When did that loss of faith happen? Wasn’t it when the economy was hit by a housing and financial crisis, which economists were supposed to predict?