How We Turned the American Dream Into a Nightmare

Government made greater homeownership a national goal. Now taxpayers are cleaning up the mess.

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Just as I was getting my noodle around the idea—suggested by some economists and Wall Street guys—that the government should flat out buy $500 billion in mortgage-backed securities from banks to end the credit crisis, economist Nouriel Roubini goes and ups the ante.

Roubini, the Official Doomsayer of the 21st-Century Housing Crisis, thinks Uncle Sam is going to de facto nationalize U.S. housing via a $1 trillion housing-mortgage bailout. That would be in addition to, I would guess, a complete takeover of Fannie Mae and Freddie Mac. (If he's right, the government had better be careful, or there won't be enough dough left over to bail out GM and Ford, as well as pay for Al Gore's $5 trillion energy plan.)

See, this is why I begin to worry when cognoscenti say the government should promote This Objective or That Goal. It has been government policy for decades to promote homeownership through a variety of mechanisms such as Fannie and Freddie (the semiprivatization of which, we now find out, was an LBJ idea to get some government debt off the government books, Enron style), the mortgage-interest deduction, the property-tax deduction, the capital-gains exclusion, and, more recently, a very loose Federal Reserve. All that stuff, one way or another, distorted markets and helped create a huge asset bubble that is now imploding.

But there are other reasons that this government housing push is a bad idea, many of which were outlined by President Bush's tax reform panel. Among them (and I lightly paraphrase from the 2005 report):

1) It lowers our standard of living. The economywide tax rate on housing investment is close to zero vs. a tax rate of approximately 22 percent on business investment. This may result in too little business investment, meaning businesses purchase less new equipment and fewer new technologies than they otherwise might. Too little investment means lower worker productivity and, ultimately, lower real wages and living standards.

2) It encourages people to buy more house than they need. All these tax subsidies for housing exceed what is necessary to encourage homeownership or help more Americans buy their first home. For example, the $1 million mortgage limit may encourage taxpayers to purchase luxury residences and vacation homes. In addition, the deduction for home equity loan interest may encourage taxpayers to use their houses as a source of tax-preferred financing for consumer spending.

3) It disproportionately benefits those who don't need it. The benefits of current tax incentives mostly go to the minority of taxpayers, typically higher-income folks, who itemize deductions. More than 55 percent of the estimated tax expenditure for home mortgage interest deductions went to the 12 percent of taxpayers who had cash income of $100,000 or more in 2004.

4) It is unnecessary for high levels of homeownership. There are more than 123 million homes in America, with a homeownership rate of 69 percent. There are many countries that do not allow any home-mortgage-interest deductions for tax purposes, including the United Kingdom, Canada, and Australia. The rate of homeownership in the United States is higher than that in some countries (approximately 66 percent in Canada), lower than that in others (approximately 70 percent in Australia), and comparable to that in still others (the United Kingdom). Thus, it appears that the level of subsidies provided in the United States may not be necessary to ensure high rates of homeownership.

Bottom line: And it continues. President Bush is now apparently dropping his opposition to the Democratic-sponsored housing bill (as this blog predicted). Among other housing goodies, the bill contains some $15 billion in homeowner tax breaks (including a $7,500 tax credit for first-time buyers), new government mortgages for hundreds of thousands of struggling homeowners, and authority to bail out Fannie and Freddie.