Just when the bank bailout is looking like it will cost taxpayers much less than previously estimated, the cost of bailing out the government-backed Fannie Mae and Freddie Mac mortgage brokers has skyrocketed to an estimate of over $350 billion. And yet, the government continues to provide all sorts of misguided tax breaks and subsidies for home owners to the tune of over $230 billion per year.
This is one area where I agree with the serious conservatives (and a few liberals) who say that these policies need to end.
In graduate school I teach about the five primary conditions under which government intervention in the market may be necessary to avoid “market failure” and promote better social outcomes (these conditions are common in the environmental realm, which is my specialty, and why even free market enthusiasts acknowledge that the government has a strong role to play in environmental protection).
1. Imperfect information
In areas where information is poor the producers and sellers of goods may not make well-informed decisions. With housing, the information is close to perfect; sellers know exactly what they are selling, and the buyers can get homes inspected, get their histories, as well as detailed information about the neighborhoods. There is essentially close to zero information asymmetry in the housing market and the information is close to perfect. (It is true that many consumers are poorly informed about special types of adjustable-rate mortgages, which is the impetus for the new Consumer Protection Agency being debated in the financial reform bill conference committee, but this has nothing to do with information about physical homes).
2. Externalities
In situations where the production or consumption of a good imposes costs or benefits on those outside of the transaction (pollution is the classic example), then the price may not fully reflect its true social cost and the government may want to intervene (to either raise the price of goods with negative externalities or lower the price of goods with positive externalities).
Some make the argument that homeowners take better care of their property than renters and therefore create positive externalities for their neighbors (thus justifying a subsidy), but this is based largely on anecdotal evidence and is vastly overblown. In the nations of Europe, where renting is much more common, there is little evidence that renters let their homes deteriorate anymore than home owners. In fact, artificially increasing home ownership may have negative externalities. Not only does it increase the likelihood of default, which then produces terrible blights in a neighborhood, but people tied to mortgages have a much harder time moving, which stalls economic recovery in down times when home prices are low and jobs may be more plentiful in other areas.
3. Lack of secure property rights
Where there are unclear property rights, investment is stymied because people can’t be sure of ownership (and natural resources will be subjected to a “tragedy of the commons”). Home ownership rights couldn’t be more secure in America; when you buy the house it’s yours as long as you pay for it.
4. Lack of competition
When there is lack of competition, monopolists can charge artificially high prices and price discriminate. The housing market is extremely competitive, with millions of buyers and sellers and no one with significant market power.
5. Lack of insurance markets
In areas where insurance is lacking this may lead to under-investment because people don’t want to risk losing everything. There are plenty of home insurance options in America (which are actually required for bank loans); and in fact, the government often perversely promotes the construction of homes in unsafe disaster-prone regions by subsidizing flood insurance where the private insurance market deems it too risky.
What all of this makes clear is that there is absolutely no economic rationale for subsidizing home ownership. Not only is it extremely expensive (at a time of record budget deficits) and has negative unintended consequences—which made the financial crisis much worse than it would’ve been otherwise—but it is regressive; the primary beneficiaries are wealthy people who buy even bigger homes.
Removing housing subsidies would be good policy in every way. But is has become a “third rail” of American politics for the simple reason that most people own homes and get huge benefits from the breaks; they will be up in arms if they are taken away. While it may be unfair to remove these breaks after people factored them into their decisions, we should gradually eliminate them. This will ultimately lower the value of housing, making renting more affordable as well as buying (for those who would live in a world with home subsidies).
If we want to help lower and middle income people, we can do so directly in much better ways. We could take some of that $230 billion and lower the income tax brackets, raise the standard deduction, increase the Earned-Income Tax Credit, or do a host of other things like increase grants for college education. But it is long past time to get the government out of the housing market.
P.S. Frank Rich nails it on how this week's news should prove a godsend for Obama and the Democrats.
Jason Scorse