Tag: home loans

End, Don’t Cap, the Mortgage Interest Deduction

The housing market is soft, so this is the worst possible time to get rid of the mortgage interest deduction, right? Well, it’s not that simple.

1.) The deduction is not a subsidy to homeowners. It’s a subsidy to people who have mortgages, and then only if they itemize their taxes. Those claiming the standard deduction can’t take advantage. Paying cash for a home won’t qualify you for the deduction, either. Following a great recession fueled by would-be homeowners borrowing more than they could afford, it’s well past time for the feds to get out of the business of subsidizing home debt.

2.) Borrowing to own a home now costs homebuyers less in interest than it has historically, which means that the cash value of the mortgage interest deduction is lower than it will be under higher (future) interest rates. In other words, this particular tax-code goodie is at a historically low value to taxpayers, so why not get rid of it now?

Mitt Romney has nibbled around the edges of this idea. He would cap the mortgage interest deduction. In delivering a bit of a backhanded compliment, Yonah Freemark and Lawrence J. Vale write in the New York Times that “while Mr. Romney’s tax proposal overall may not be fair or sensible—or even mathematically logical—Democrats shouldn’t be so quick to attack any change to the mortgage interest deduction.”

Freemark and Vale would use the boost in federal revenue from ending the deduction to fund new housing programs. However, ending the mortgage interest deduction could also be used to lower overall tax rates. Mark Calabria and I chatted about the mortgage interest deduction this week for the Cato Daily Podcast.

GSE Loan Limits Fell…and Home Sales Went Up

On October first, the Fannie Mae/Freddie Mac maximum loan limit fell (from around $729,000 to $625,000). The Senate later voted to extend that limit until December 2013. Some House members, such as Rep. John Campbell (R-CA) warned that if the loan limits were not raised back to their previous levels, our housing market would “crater.” And of course the special interests in the real estate industry all but implied that if the taxpayer did not remain on the hook, then we’d all be living in caves before too long.

It was easy enough to make such outlandish statements in the absence of data. Now we have some data, and from of all people, the real estate industry. According to the National Association of Realtors (full disclosure: I worked there about 10 years ago):

Total existing-home sales, which are completed transactions that include single-family, townhomes, condominiums and co-ops, rose 1.4 percent to a seasonally adjusted annual rate of 4.97 million in October from a downwardly revised 4.90 million in September, and are 13.5 percent above the 4.38 million unit level in October 2010. [emphasis added]

You read that correctly. The loan limits fell and then home sales actually rose, which is the opposite of crater. I’m not claiming that the decline in loan limits caused home sales to increase, but I am claiming that the housing market did not crater, as was predicted.

FHA Bailout Watch

The Federal Housing Administration has been one of the government’s main instruments for propping up the housing market in the wake of the housing bust. But as has been widely reported, the FHA is in danger of needing a taxpayer bailout because of rising defaults on mortgages it insures.

FHA-insured loans originated in 2007 and 2008 – when Bush administration housing officials were mainly concerned with “winning back our share of the market” – are defaulting at higher rates as this graphic from the Washington Post shows:

FHA officials are optimistic a bailout won’t be needed, but the Post reports that not everyone shares this optimism:

The audit, released in November, found that the cash the FHA set aside to pay for unexpected losses had dipped to historic lows, well below the level required by law. As of Sept. 30, those reserves were estimated at $3.6 billion, down from nearly $13 billion a year earlier. The most recent figure represents 0.53 percent of the value of all FHA single-family-home loans – far lower than the 2 percent required by Congress.

But Ann Schnare, a former Freddie Mac official, said the situation could be even worse. She said the audit underestimates future losses because it does not take into account all loans that are now overdue, only those that the FHA has paid claims on.

To avoid a bailout, the FHA recently proposed more stringent standards, which would include raising the premiums it charges to cover losses. However, even if a bailout isn’t needed and the FHA continues to “make money,” that would only call into question the need for the FHA to begin with. Why can’t the private sector provide all mortgage insurance?

The answer is that the mortgage lending industry likes knowing it can originate mortgages that the government will cover in the event of a default. Heads they win, tails Uncle Sam loses. The president’s new budget makes this clear in addressing concerns about the FHA’s currently low reserves:

However, it is important to note that a low capital ratio does not threaten FHA’s operations, either for its existing portfolio or for new books of business. Unlike private lenders, the guarantee on FHA and other federal loans is backed by the full faith and credit of the Federal Government, and is not dependent on capital reserves — FHA can never “run out” of money.

That’s right – the federal government can simply tax, borrow, or fire up the printing presses.

The government has been propping up the housing market with taxpayer subsidies in the wake of a housing boom and bust it helped create. If policymakers continue to keep the housing market on artificial life support, taxpayer will remain on the hook. If it pulls the plug and the market takes another downward spiral, Washington will probably rush in with more bailouts.  It appears taxpayers can’t win.

See this essay for more on federal housing finance.