In December, the New York Times published a 5,100-word article charging that the Bush administration’s housing policies had “stoked” the foreclosure crisis—and thus the financial meltdown. By pushing for lax lending standards, encouraging government enterprises to make mortgages more available, and leaning on private lenders to come up with innovative ways to lend to ever more Americans—using “the mighty muscle of the federal government,” as the president himself put it—Bush had lured millions of people into bad mortgages that they ultimately couldn’t afford, the Times said.
Yet almost everything that the Times accused the Bush administration of doing has been pursued many times by earlier administrations, both Democratic and Republican—and often with calamitous results. The Times’s analysis exemplified our collective amnesia about Washington’s repeated attempts to expand homeownership and the disasters they’ve caused. The ideal of homeownership has become so sacrosanct, it seems, that we never learn from these disasters. Instead, we clean them up and then—as if under some strange compulsion—set in motion the mechanisms of the next housing catastrophe.
And that’s exactly what we’re doing once again. As Washington grapples with the current mortgage crisis, advocates from both parties are already warning the feds not to relax their commitment to expanding homeownership—even if that means reviving the very kinds of programs and institutions that got us into trouble. Not even the worst financial crisis since the Great Depression can cure us of our obsessive housing disorder.
We’ve largely forgotten that Herbert Hoover, as secretary of commerce, initiated the first major Washington campaign to boost homeownership. His motivation was the 1920 census, which had revealed a small dip in ownership rates since 1910—from 45.9 percent to 45.6 percent of all households. The downturn was likely the result of a temporary diversion of resources away from housing during World War I. For Hoover, though, the apocalypse seemed nigh. “Nothing is worse than increased tenancy and landlordism,” he warned—though surely many things were worse. With little justification, he predicted that in just a few decades, three-quarters of all Americans would be renters. The press echoed the urgency. “The nation’s stability [is] being undermined,” the New York Times editorialized. “The masses [are] losing their struggle for a better life.”
Without waiting to see if postwar prosperity might solve the problem, in 1922 Hoover launched the Own Your Own Home campaign, hailed at the time as unique in the nation’s history. “The home owner has a constructive aim in life,” Hoover said, exhorting Americans to buy property. “He works harder outside his home, he spends his leisure hours more profitably, and he and his family live a finer life and enjoy more of the comforts and cultivating influences of our modern civilization.” Hoover urged “the great lending institutions, the construction industry, the great real estate men . . . to counteract the growing menace” of tenancy. He pressed builders to turn to residential construction and employers to support the cause. Some, like United States Steel and General Motors, agreed to provide parks and other amenities for the new housing developments that proliferated in response to Hoover’s call.
Hoover also called for new rules that would let nationally chartered banks devote a greater share of lending to residential properties. Congress responded in 1927, and the freed-up banks dived into the market, despite signs that it was overheating. The great national effort seemed to pay off. From mid-1927 to mid-1929, national banks’ mortgage lending increased 45 percent. The New York Times applauded the “wave of homebuilding” that “swept over” America; the country was becoming “a nation of home owners.” The 1930 census would later reveal a significant elevation in ownership rates, to 47.8 percent of all households.
But beneath the surface were disquieting signs. For as homeownership grew, so did the rate of foreclosures. From just 2 percent of commercial bank mortgages in 1922, they rose to 9 percent in 1926 and to 11 percent in 1927. This happened, of course, just as the stock-market bubble of the late twenties was inflating dangerously, making the federal housing initiative all the more hazardous. Soon after the October 1929 Wall Street crash, the housing market began to collapse, just as in today’s crisis, though the reasons were slightly different: panicked depositors withdrew money from their accounts, prompting bank runs; the banks ran out of capital and stopped making loans; and the mortgage market seized up. Homeowners, who in that era typically had short-term mortgages that required several refinancings before being paid off, suddenly couldn’t find new loans. Defaults exploded—by 1933, some 1,000 homes were foreclosing every day.
The Own Your Own Home campaign had trapped many Americans in mortgages far beyond their reach. New homeowners who had heard throughout the initiative that “the measurement of a man’s patriotism and worth as a citizen” was owning a home, wrote housing policy expert Dorothy Rosenman in 1945, had been “swept up by the same wave of optimism that swept the rest of the nation.” Financial institutions were exposed as well. Their mortgage loans outstanding had more than doubled between the early twenties and 1930—from $9.2 billion to $22.6 billion—one reason that about 750 financial institutions failed in 1930 alone. Construction firms, too, were ensnared, since they had heeded the government’s call and shifted to residential building. Housing starts jumped from about 250,000 new homes a year in the early 1920s to nearly 600,000 after the housing campaign—before slumping more than 80 percent after the crash. Construction jobs fell 70 percent from 1929 to 1933.
You might think that the Own Your Own Home campaign would have taught Washington the danger of trying to force homeownership up. Instead, the feds responded to the crisis with the Home Owners’ Loan Corporation (HOLC), a New Deal bailout program that made government an even bigger player in the housing market. Congress designed the HOLC to buy up troubled mortgages from lenders and then let homeowners refinance the loans with the government on more affordable terms. In theory, this would both aid strapped homeowners and clear bad loans from banks’ books, allowing them to resume mortgage lending.
The HOLC was a massive new federal agency, employing at its height some 20,000 people—appraisers, loan officers, auditors. By 1936, the agency’s total payroll was $26.2 million, the equivalent of $388 million today. The HOLC eventually received 1.9 million applications for mortgages and approved 1 million. Despite the more favorable terms that the HOLC offered, however, about one-fifth of the new mortgages defaulted, a failure rate that would sink a private-sector bank. Many who failed to pay might have been able to, but chose not to work out any arrangement with the government and essentially challenged the feds to kick them out—which officials were reluctant to do in the face of public opposition. HOLC loan officers classified about 65 percent of the defaults as resulting either from borrowers’ “noncooperation” or “obstinate refusal,” according to an analysis by Columbia University economist C. Lowell Harriss. “This type of noncooperation could sometimes be attributed to a desire to obtain free housing . . . an object that, in view of HOLC’s nature, was not difficult to realize,” Harriss wrote.
Ultimately, the HOLC did file more than 200,000 foreclosure actions. And its purchase of bad loans never revived mortgage lending, which stayed flat for the rest of the decade. The nation’s economic fundamentals were so lousy that little demand existed for new home loans.
The Depression-era federal government created many other institutions to fix flaws in the mortgage market: the Federal Home Loan Bank system to provide a stable source of funds for banks; the Federal Housing Administration (FHA) to insure mortgages; the Federal National Mortgage Association (later known as Fannie Mae) to purchase those insured mortgages; and the Federal Savings and Loan Insurance Corporation to prevent future bank runs. These were valuable initiatives, but they meant that by the end of the Great Depression, the U.S. government had become the dominant force in the mortgage market.
Politicians could now use that regulated market to advance their own policy agendas—or their careers. Many housing experts of the time warned against this politicization, anticipating what was to come. Liberal housing advocate Charles Abrams, for example, publicly worried that as the Depression lifted, yet more new government plans to encourage homeownership would lure unsuspecting and unqualified lower-income families into the housing market. In a May 1946 McCall’s article, “Your Dream Home Foreclosed,” Abrams told American housewives that their “dream house will be loaded with booby traps.” The foundation of a stable economic system, Abrams argued, wasn’t a large percentage of homeowning families, as Hoover contended; it was “how sound the ownership is.”
Initially, Abrams’s fear might have seemed without basis. Intent on a postwar project of boosting homeownership, the federal government had passed the GI Bill in 1944, extending a range of benefits to returning veterans—including government-subsidized mortgages. With the feds footing a big part of the bill, the nation’s long-moribund mortgage market came alive, more than doubling in volume between 1945 and 1950. By 1949, more than half of American households owned homes, and 40 percent of the new mortgages were government-subsidized. And with the Housing Act of 1949, Washington made permanent the powerful role in the mortgage market that it had assumed during the Depression.
But as homeownership grew, political pressure to allow riskier loans increased, too—exactly what Abrams had cautioned against. Rising home prices, a result of a booming national economy, soon began to drive some homes out of reach for ordinary Americans, among them veterans returning from peacekeeping duties in Europe and later from fighting in Korea. Under pressure to keep meeting housing demand, the government began loosening its mortgage-lending standards—cutting the size of required down payments, approving loans with higher ratios of payments to income, and extending the terms of mortgages.
By attracting riskier home buyers, these moves provoked a surge in foreclosures on government-backed mortgages. The failure rate on FHA-insured loans spiked fivefold from 1950 to 1960, according to a 1970 National Bureau of Economic Research study, while the failure rate on mortgages made through the Veterans Administration nearly doubled over the same period. By contrast, the foreclosure rate of conventional mortgages barely increased, since many traditional lenders had maintained stricter underwriting standards, which had proved a good predictor of loan quality over the years.
Ignoring these problems, the government embarked on yet another failed attempt to increase homeownership: the FHA’s urban-loan debacle of the 1960s and early seventies, its most ruinous lending mistake yet. This time, the object was to solve America’s urban discontent. Riots had ripped apart Cleveland, Detroit, Los Angeles, Newark, and other cities during the mid-sixties. Politicians in both parties argued that extending the American dream of homeownership to poor blacks (especially those who’d migrated from the rural South to northeastern cities) and to immigrants (especially Puerto Ricans) would stabilize urban communities and prevent further violence. “Past experience has shown that families offered decent homes at prices they can afford have demonstrated a new dignity, a new attitude toward their jobs,” said Democratic congressman Wright Patman. Or as Republican senator Charles Percy bluntly put it: “People won’t burn down houses they own.”
So in 1968, the federal government passed a law giving poor families FHA-insured loans that required down payments of as little as $250. Not urban uplift but urban nightmare followed. Seedy speculators began snapping up homes in transitional urban areas where crime and unemployment were rising. They would make lowball, all-cash offers to fearful residents, eager to sell and get out of the neighborhood. Once they had the properties, the speculators then turned around and used the new FHA-insured mortgages to sell the homes to low-income minority families for double or triple the price.
Many of these mortgages—approved by bribed FHA inspectors—were way beyond the buyers’ means. And many buyers simply weren’t prepared for becoming homeowners. Some didn’t realize that they were buying properties for two to three times the going rate in their neighborhoods, or even that they’d be responsible for paying for utilities, property taxes, and maintenance. In some markets, like Philadelphia and Detroit, more than 20 percent of the mortgages went to single mothers on welfare. And why not, the government reasoned—they enjoyed a steady stream of government income, didn’t they? This naive view ignored the growing evidence that such households suffered from family breakdown and social disorder, which made them less than ideal borrowers. Journalists also found numerous buyers who couldn’t read English and had no idea what their sales contracts said.
Foreclosures spread like a horrible virus, infecting at least 20 cities. About 4,000 FHA-insured home mortgages in Philadelphia defaulted in just the three years from 1969 to 1971—more than the total number that the city had seen over the previous 33 years of FHA loans. Foreclosures made the FHA Detroit’s biggest homeowner, at a cost of roughly $200 million in losses. In New York, a 500-count federal indictment estimated that some 7,500 FHA-backed homes in East New York, Brownsville, Bushwick, and other troubled neighborhoods had gone bust, costing upward of $300 million. In the end, the government absorbed an estimated $1.4 billion in losses nationwide.
The failed program had more than a financial cost. Neighborhoods like Bushwick—a once-stable blue-collar community in Brooklyn—fell into ruin as scores of low-income buyers simply walked away from their properties, and arsonists, an urban plague at the time, torched the vacant homes. Residents who lived near abandoned houses began sleeping on their porches with guns in their laps to ward off the arsonists. Whole blocks remained burned-out for years (see “The Death and Life of Bushwick,” Spring 2008).
Sure, speculators and corrupt inspectors had duped the FHA. But the meltdown couldn’t have happened without Washington’s unexamined assumption that homeownership would transform the lives of low-income buyers in positive ways. “The program could not work because it tried to solve a problem of wealth creation through debt creation,” Harvard historian Louis Hyman recently observed, aptly comparing the FHA scandals with today’s subprime crisis.
The national FHA scandal should have awoken Washington to the dangers of its homeownership-promotion efforts. Instead, the government simply changed its sights. Just as it had pushed the FHA to insure loans in poor neighborhoods, it now began pushing private banks to lend more in those neighborhoods. The new campaign lasted 30 years, but the outcome was—yet again—foreclosures on a massive scale. The main difference, as we know all too well, was that the foreclosures helped usher in a global financial crisis.
This time, the government’s spur to action was claims by housing and civil rights activists that banks were “redlining”—intentionally not lending in minority neighborhoods. In April 1975, a new group of activists, the National People’s Action on Housing, brought the concept to a national audience at a Chicago conference. Over the next few years, a series of studies by advocacy groups and local newspapers purported to prove that redlining was real. Black neighborhoods, the studies showed, received far fewer mortgages than mostly white areas did, and black applicants had their loans shot down more often than whites with similar incomes. Banks and academic experts responded that the studies didn’t include information about the creditworthiness of borrowers in black neighborhoods, a more important factor than income. Nevertheless, the media worked themselves into a frenzy, pillorying government officials who dared object to the studies’ conclusions.
Congress passed a bill in 1975 requiring banks to provide the government with information on their lending activities in poor urban areas. Two years later, it passed the Community Reinvestment Act (CRA), which gave regulators the power to deny banks the right to expand if they didn’t lend sufficiently in those neighborhoods. In 1979, the Federal Deposit Insurance Corporation (FDIC) rocked the banking industry when it used the CRA to turn down an application by the Greater New York Savings Bank to open a branch on the Upper East Side of Manhattan. The government contended that the bank didn’t lend enough in Brooklyn, its home market.
Bankers recognized that a fundamental shift in regulation was taking place. Previously, the government had simply made sure that banks’ practices were safe and that depositors’ funds were protected. Now, it would use its power over banks to shape their lending strategies. Soon after the Greater New York ruling, for instance, the Federal Home Loan Bank Board told a Toledo, Ohio, bank that it had to eliminate its practice of lending only to its current customers during times when funds were tight; the maneuver might be discriminatory. The FHLBB also cast a dubious eye on other bank actions to tighten credit in a downturn, such as raising the minimum down payment on mortgages.
Other actions by federal regulators sent similar messages. In 1980, the FDIC told a Maryland bank that it couldn’t expand unless it started lending in the District of Columbia, even though the bank had no branches there. Soon, the government was instructing wholesale banks—institutions that have no branches and typically don’t lend to consumers at all—that they, too, had to pursue inner-city lending programs.
The next stop on the road to 2008 was a fateful campaign to lower lending criteria, which, the housing advocates argued, were racist and had to change. The campaign began in 1986, when the Association of Community Organizations for Reform Now (Acorn) threatened to oppose an acquisition by a southern bank, Louisiana Bancshares, until it agreed to new “flexible credit and underwriting standards” for minority borrowers—for example, counting public assistance and food stamps as income. The next year, Acorn led a coalition of advocacy groups calling for industry-wide changes in lending standards. Among the demanded reforms were the easing of minimum down-payment requirements and of the requirement that borrowers have enough cash at a closing to cover two to three months of mortgage payments (research had shown that lack of money in hand was a big reason some mortgages failed quickly).
The advocates also attacked Fannie Mae, the giant quasi-government agency that bought loans from banks in order to allow them to make new loans. Its underwriters were “strictly by-the-book interpreters” of lending standards and turned down purchases of unconventional loans, charged Acorn. The pressure eventually paid off. In 1992, Congress passed legislation requiring Fannie Mae and the similar Freddie Mac to devote 30 percent of their loan purchases to mortgages for low- and moderate-income borrowers.
The campaign gained further traction with the election of Bill Clinton, whose housing secretary, Henry Cisneros, declared that he would expand homeownership among lower- and lower-middle-income renters. His strategy: pushing for no-down-payment loans; expanding the size of mortgages that the government would insure against losses; and using the CRA and other lending laws to direct more private money into low-income programs. Shortly after Cisneros announced his plan, Fannie Mae and Freddie Mac agreed to begin buying loans under new, looser guidelines. Freddie Mac, for instance, started approving low-income buyers with bad credit histories or none at all, so long as they were current on rent and utilities payments. Freddie Mac also said that it would begin counting income from seasonal jobs and public assistance toward its income minimum, despite the FHA disaster of the sixties.
To meet their goals, the two mortgage giants enlisted large lenders—including nonbanks, which weren’t covered by the CRA—into the effort. Freddie Mac began an “alternative qualifying” program with the Sears Mortgage Corporation that let a borrower qualify for a loan with a monthly payment as high as 50 percent of his income, at a time when most private mortgage companies wouldn’t exceed 33 percent. The program also allowed borrowers with bad credit to get mortgages if they took credit-counseling classes administered by Acorn and other nonprofits. Subsequent research would show that such classes have little impact on default rates.
Pressuring nonbank lenders to make more loans to poor minorities didn’t stop with Sears. If it didn’t happen, Clinton officials warned, they’d seek to extend CRA regulations to all mortgage makers. In Congress, Representative Maxine Waters called financial firms not covered by the CRA “among the most egregious redliners.” To rebuff the criticism, the Mortgage Bankers Association (MBA) shocked the financial world by signing a 1994 agreement with the Department of Housing and Urban Development (HUD), pledging to increase lending to minorities and join in new efforts to rewrite lending standards. The first MBA member to sign up: Countrywide Financial, the mortgage firm that would be at the core of the subprime meltdown.
As the volume of lending to low-income borrowers increased, the loans became big business. And slowly, the industry began pitching the loans with the same language that the government and activists had long used, and promoting the same debased lending standards. A 1998 sales pitch by a Bear Stearns managing director advised banks to begin packaging their loans to low-income borrowers into securities that the firm could sell, according to Stan Liebowitz, a professor of economics at the University of Texas who unearthed the pitch. Forget traditional underwriting standards when considering these loans, the director advised. For a low-income borrower, he continued in all-too-familiar terms, owning a home was “a near-sacred obligation. A family will do almost anything to meet that monthly mortgage payment.” Bunk, says Liebowitz: “The claim that lower-income homeowners are somehow different in their devotion to their home is a purely emotional claim with no evidence to support it.”
By the late 1990s, lenders, keen to find new markets to tap, had jumped completely on board the low-income-mortgage bandwagon. In 1997, homeownership had reached a then-high of 66 percent of households. By definition, that meant that many, even most, creditworthy households had already made the plunge. The biggest opportunities for new business thus seemed to be lower-income borrowers. “We believe that low-income borrowers are going to be our leading customers going into the 21st century,” an executive for Norwest Mortgage, a Maryland lender, told the trade press in 1998. With Fannie Mae and Freddie Mac footing some of the bill, “banks are buying these loans from us as fast as we can originate them.”
Any concern that regulators should tighten standards as the loan volume expanded was quickly dismissed. When in early 2000 the FDIC proposed increasing capital requirements for lenders making “subprime” loans—loans to people with questionable credit, that is—Democratic representative Carolyn Maloney of New York told a congressional hearing that she feared that the step would dry up CRA loans. Her fellow New York Democrat John J. LaFalce urged regulators “not to be premature” in imposing new regulations.
And even with lenders now chasing this market enthusiastically, the Clinton administration kept pushing for higher government-mandated goals. In July 1999, HUD proposed new levels for Fannie Mae’s and Freddie Mac’s low-income lending; in September, Fannie Mae agreed to begin purchasing loans made to “borrowers with slightly impaired credit”—that is, with credit standards even lower than the government had been pushing for a generation.
Congress later took up where Clinton left off. Not content that nearly seven in ten American households owned their own homes, legislators in 2004 pressed new affordable-housing goals on the two mortgage giants, which through 2007 purchased some $1 trillion in loans to lower- and moderate-income buyers. The buying spree helped spark a massive increase in securitization of mortgages to people with dubious credit. To carry out this mission, Fannie Mae turned to old friends, like Angelo Mozilo of Countrywide, which became the biggest supplier of mortgages to low-income buyers for Fannie Mae to purchase.
Executives at these firms won hosannas. Harvard University’s Joint Center for Housing Studies invited Mozilo to give its prestigious 2003 Dunlop Lecture. Subject: “The American Dream of Homeownership: From Cliché to Mission.” La Opinión, a Spanish-language newspaper, dubbed Countrywide its Corporation of the Year. Meantime, in Congress, Waters praised the “outstanding leadership” of Fannie Mae chairman Franklin Raines.
There was never any shortage of evidence that the new loans were much riskier than conventional mortgages. In October 1994, Fannie Mae head James Johnson had reminded a banking convention that mortgages with small down payments had a much higher risk of defaulting. (A Duff & Phelps study found that they were nearly three times more likely to default than conventional mortgages.) Yet the very next month, Fannie Mae said that it expected to back loans to low-income home buyers with a 97 percent loan-to-value ratio—that is, loans in which the buyer puts down just 3 percent—as part of a commitment, made earlier that year to Congress, to purchase $1 trillion in affordable-housing mortgages by the end of the nineties. According to Edward Pinto, who served as the company’s chief credit officer, the program was the result of political pressure on Fannie Mae trumping lending standards.
An Atlanta-area minority loan program, crafted hastily after a newspaper redlining exposé, provided further evidence. The program lent more than half of its mortgages to single women with children, including women on public assistance, some of whom took on payments of up to 50 percent of their monthly income. Within a year, 10 percent of the loans had gone delinquent and the homeowners were sinking deeper into other kinds of debt. Yet the program’s woes received little publicity. Community groups argued that the difficulties were all the fault of the banks, which should have offered the loans with lower interest rates.
What made it easier to dismiss such ominous failures was that some of the nation’s most prestigious financial regulators and researchers, including the Federal Reserve Bank of Boston, got behind the movement to loosen lending standards. In 1992, the Boston Fed produced an extraordinary 29-page document that codified the new lending wisdom. Conventional mortgage criteria, the report argued, might be “unintentionally biased” because they didn’t take into account “the economic culture of urban, lower-income and nontraditional customers.” Lenders should thus consider junking the industry’s traditional income-to-payments ratio and stop viewing an applicant’s “lack of credit history” as a “negative factor.” Further, if applicants had bad credit, banks should “consider extenuating circumstances”—even though a study by mortgage insurance companies would soon show, not surprisingly, that borrowers with no credit rating or a bad one were far more likely to default. If applicants didn’t have enough savings for a down payment, the Boston Fed urged, banks should allow loans from nonprofits or government assistance agencies to count toward one. A later study of Freddie Mac mortgages would find that a borrower who made a down payment with third-party funds was four times more likely to default, a reminder that traditional underwriting standards weren’t arbitrary but based on historical lending patterns.
Another reason government kept up the pressure was that no matter how high ownership rates climbed, there was always a group below the norm that needed help. The country’s substantial immigration rates in the 1990s and early 2000s, for instance, produced a whole new cadre of potential Latino borrowers. To serve them, the Congressional Hispanic Caucus launched Hogar, an initiative that pushed for easing lending standards for immigrants, including touting so-called seller-financed mortgages in which a builder provided down-payment aid to buyers via contributions to nonprofit groups. As a result, mortgage lending to Hispanics soared. And today, in districts where Hispanics make up at least 25 percent of the population, foreclosure rates are now nearly 50 percent higher than the national average, according to a Wall Street Journal analysis.
Washington’s, indeed America’s, housing obsession—decades of government and advocacy-group efforts to water down underwriting standards, private mortgage makers’ desire to find new pools of customers as homeownership rates rose, and the rapid growth of securitization of risky loans—carried a steep cost. When the Federal Reserve added low interest rates and plenty of financial liquidity to the mix, the housing boom became a bubble. And then, as everyone knows, the bubble burst in 2008, leading to economic disaster.
Last year, lenders began foreclosure proceedings on some 2.3 million homes, and some experts have predicted that when the current financial crisis has ended, some 8 million homes will have wound up in foreclosure. Though lenders made risky loans to borrowers across the income spectrum, many of the failing mortgages today are in lower- and lower-middle-income neighborhoods. A Federal Reserve Bank of New York study of foreclosures in New Jersey, the state in its region hit hardest by the mortgage collapse, reveals that zip codes with the worst rates are mostly in areas where household income was “concentrated at the lower end of the household income range.”
Yet before we’ve even worked our way through this crisis, elected officials and policymakers are busy readying the next. Barney Frank, the Massachusetts congressman who serves as chair of the House Financial Services Committee, has balked at proposals to privatize Fannie Mae and Freddie Mac, which would eliminate their risk to taxpayers and their susceptibility to political machinations. Why? Simple: the government uses them to subsidize the affordable-housing programs that Frank supports. California congressman Joe Baca, head of the Congressional Hispanic Caucus, also opposes reining in affordable housing lending. “We need to keep credit easily accessible to our minority communities,” he asserts. Republicans and Democrats, meanwhile, have scrambled to reignite the housing market through ill-conceived tax credits and renewed federal subsidies for mortgages, including the Obama administration’s mortgage bailout plan, which recalls the New Deal’s HOLC. As Harvard economist and City Journal contributing editor Edward Glaeser has observed, mortgage lenders have finally “recovered their sanity”—only to have government dangling subsidized low interest rates and tax credits in front of them and their potential customers all over again. Behind these efforts is a fundamental misconception among politicians that housing drives the American economy and therefore demands subsidy at virtually any cost.
Changing notions of fairness and equity also cloud policymakers’ minds. Our praiseworthy initial efforts—to eliminate housing discrimination and provide all Americans an equal opportunity to buy a home—were eventually turned on their heads by advocates and politicians, who instead tried to ensure equality of outcomes. And so, for instance, when elected officials learned that under 50 percent of Hispanic households in America owned homes, Latino politicians sponsored a campaign to raise ownership. Yet the lower rate was perfectly understandable, given the lower educational levels, lower household incomes, and shorter tenure in the country of Latinos, compared with the average American household.
What principles, then, should govern federal policy toward homeownership and the housing construction market? First, our experience since the Great Depression teaches us that a rising economy is the best and safest way to boost homeownership. By some estimates, the “natural” rate of homeownership in America, without dicey government-enabled mortgages, would still be nearly 65 percent—among the highest rates in the world. Government’s most important role in the market should be to ensure a sturdy economy and a reliable judicial system that protects the interests of buyers and sellers in what is the largest transaction that most will ever undertake.
At the same time, government should do no harm, especially when it comes to the cost of housing. One reason politicians and policymakers continue to feel that they must subsidize mortgage rates and launch ownership campaigns is that since the 1970s, local housing and zoning regulations have raised the price of home construction—sometimes by hundreds of thousands of dollars, as economist Randall O’Toole has shown—and thereby reduced the supply of affordable housing. Half a century ago, America’s cities boasted a rich stock of affordable housing, even as their populations grew. Today, even shrinking cities often complain of a lack of it. One solution is for the federal government to tie aid to states to local regulatory reforms that reduce the cost of construction and encourage additional building.
The federal government should also consider eliminating or capping the home-mortgage tax deduction, which drives up the price of housing in ways particularly damaging to lower- and moderate-income buyers. Enshrined in our tax code since 1913, the deduction provides more disposable income to homeowners who itemize their taxes—mostly upper- and upper-middle-income buyers—who can use that money on bigger mortgages, increasing the price of housing. But many moderate-income households don’t itemize and thus don’t benefit from the tax break, and they’re left with fewer housing options as the cost of homes rises around them. In their study Rethinking Federal Housing Policy, Harvard’s Glaeser and Joseph Gyourko of the Wharton School of Business suggest capping the deduction at $300,000 of mortgage debt. That way, it would still benefit those moderate-income families that do itemize, while ending the exemption for others.
Ultimately, the goal should be to end subsidies that amount to a government project to direct homeownership to places where Washington believes it should be taking place. That kind of political meddling in this vast marketplace has wreaked havoc time and again, and will continue to do so—if we keep letting it.