Some Politics of Housing

At a few points recently I've heard people argue that housing policy is either not politically salient, or has little to do with the sorts of macro outcomes that led to the housing crisis. So I was interested to receive an e-mail from my senator, Kay Hagan, pointing me to this Politico op-ed she co-wrote with Sen. Isakson and Sen. Landrieu:

Families are working hard to rebuild savings while the housing market remains unstable. Recent news from the Commerce Department shows that U.S. home builders continue to struggle despite signs of recovery in other segments of the economy. According to real estate data released this week, home prices in the first quarter of 2011 suffered their worst decline since 2008.

Yet banking regulators are dangerously close to issuing a rule that would put homes out of reach for many Americans and further cripple the fragile housing recovery. ...

But federal banking regulators last month proposed a 20 percent down payment requirement on QRMs. Regulators went for rigidity, rather than a balanced, flexible approach.

In contrast to our express intent — and despite repeated warnings from other members of Congress, consumer groups and bankers — regulators crafted a narrow definition that could unnecessarily slow the housing market recovery, increase costs to otherwise qualified homebuyers and dampen incentives for sound underwriting.

The 20 percent down payment requirement leaves millions of qualified potential homeowners with two grim alternatives: pay higher rates upfront for a mortgage that falls outside the regulators’ proposed QRM standard or delay homeownership for a decade or more to save for an onerous down payment.

Here we have three senators, two Democrats and one Republican, arguing against tougher regulation that would lead to higher lending standards. They obviously think this issue is salient enough to write an op-ed about it, at a time when most political attention is being paid to budget reform and other issues. And this is the first e-mail of this sort that I recall having received from Hagan's office. In fact, I'm not even sure how I got on their mailing list.

This is merely the most recent in a series of policy choices that incentivize home ownership in the U.S. The most notable of these is probably the mortgage interest deduction, which not only encourages home ownership, but also encourages the building and purchasing of larger homes. And the mortgage interest deduction is pretty firmly embedded in the U.S. political economy. In Showdown at Gucci Gulch, journalists Alan Murray and Jeffery Birnbaum describe how the proposal to end the mortgage interest deduction was almost immediately removed from early versions of the 1986 Tax Reform Act, because it was a political non-starter. Indeed, Congress was better able to reduce and eliminate subsidies to some of the interest groups usually considered to be among the most powerful -- finance and energy -- than subsidies for home ownership.

The 1986 Tax Reform Act did eliminate some loopholes in the tax code that incentivized tax sheltering through real estate investment, but these did not affect primary residences. And TRA1986 also eliminated tax deductions from other types of interest, such as on credit cards and other personal loans. But not mortgage interest on primary homes. Nor was TRA1986 able to reduce or eliminate the exemption of capital gains on home investment, so long as it was a primary residence and the capital gains were under $500,000 (for a married couple filing jointly). Some estimations have claimed that these subsidies increase home values by 15%. Considering that roughly 65% of the country are homeowners, and it is not uncommon for a majority of peoples' equity to be in their homes, it's no surprise that this is a politically salient issue.

This despite the fact that there is a broad consensus among economists, environmentalists, and urbanists that this policy skews behavior away from the social optimum. An inflated market incentivizes speculation and over-purchasing. It leads to too much investment. It also leads to suburbanization, and increased energy usage from heating/cooling/commuting. Consider as well that it benefits the middle-class and wealthy at the expense of the poor, particular those poor that live in urban areas. To make up for it, the government extends loans to lower-income (or otherwise less creditworthy) borrowers through Fannie Mae, Freddie Mac, and the Federal Home Loans Banks. These organizations fund or guarantee over $6tn in mortgages, or over 40% of U.S. GDP, representing nearly half of the country's real estate market. The GSEs are well-known to have a lot of political clout, and have resisted repeated calls for reform during every presidential administration since Reagan, at least. And, of course, they were the biggest originators of subprime (and Alt-A and interest-only) loans, the securitization of which was rewarded by the pre-crisis regulatory structure. (Note that current research indicates that the bulk of GSE losses were Alt-A, which are prime loans, if untraditional.) The GSEs held approximately 45-50% of all mortgages in the country throughout the 2000s. Fannie and Freddie were also the largest purchaser of AAA-rated MBS, which created a market for other mortgage lenders to lend subprime and securitize the loan, which fulfilled their requirements to support affordable housing, particularly for low-income borrowers*.

Other aspects of public policy incentivized home ownership (or real estate speculation) in less obvious ways. The large, persistent current account deficit did not lead to a currency crash as many had predicted, but it did lead to an increase in demand for non-tradable goods. Like housing. This current account deficit is not attributable to any single factor, but persistent budget deficits in the private and public sectors certainly played a major role. The large demand for AAA-rated financial instruments in which to invest a "global savings glut" also led to a demand for securitized home loans. Finance was happy to oblige. There were major geopolitical dynamics at play as well.

All to say that housing policy is an important political issue. It's important for citizens in the United States, and therefore for politicians. It's important for numerous interest groups, in the U.S. and abroad. The housing bubble wasn't engineered entirely by Wall Street, although they certainly worked hard to accommodate it. There was demand from many corners.

*I'm not trying to argue here, as many have, that the financial crisis was caused by the GSEs. It wasn't. I'm merely trying to demonstrate that public policy is oriented towards promoting home ownership in many ways that take many forms. The GSEs are part of that. The have a public mandate to extend loans to less-qualified borrowers, but that is not all of their business or even the largest part.