Politicians from both parties have spent decades trying to subsidize the “American dream” of home ownership. This always has been a misguided effort, but the Wall Street meltdown illustrates that government intervention sometimes can have truly catastrophic consequences. Policy mistakes caused the bubble, and those mistakes largely were driven by political decisions to boost home ownership (now that the bubble has burst, additional government policy mistakes are making a bad situation worse, but that’s a separate issue).
The fundamental issue, at least from an economic perspective, is whether it is a good idea for government to distort the allocation of labor and capital. This sounds like arcane economic jargon, but it is the key issue because the long‐term prosperity of a nation — and the living standards of its people — depends on whether resources are channeled to their most productive uses. Hong Kong has enjoyed astounding economic success because government rarely interferes in the market, whereas France suffers from economic stagnation because of burdensome levels of taxes, government spending and regulation.
The United States is somewhere between Hong Kong and France. We generally allow markets to operate, which is why disposable income in America is so much higher than it is in France. But our government does intervene in some areas (such as housing), and this hurts our competitiveness and explains why we don’t grow as fast as Hong Kong.
Government intervention in housing is pervasive. Let’s start with the policies that encourage over‐investment in housing and then focus on the policies that contributed to the market meltdown. A number of government policies are designed to steer people toward housing, including:
- The home mortgage interest deduction, which provides a tax preference for middle‐class and upper‐class people to invest in housing.
- The Federal Housing Administration, which subsidizes home ownership for lower‐income buyers.
- Traditional Fannie Mae and Freddie Mac subsidies, which tilt the playing field so that investors put more money in residential real estate.
These policies sound good, which is why politicians put them in place, but they are economically harmful because they encourage people to put money in residential real estate instead of other forms of investment. There is nothing wrong with having lots of nice housing, of course, but when government interference makes housing excessively attractive, this necessarily means less money is available for other purposes — such as providing capital for future economic growth. This is why scholarly research generally has found that housing subsidies hurt long‐run growth.
Other housing subsidies, put in place in more recent years, played a key role in causing the current turmoil. A bipartisan push to increase home ownership resulted in laws and regulation that dramatically expanded the activities of government‐sponsored enterprises (Fannie Mae and Freddie Mac) and put them on a mission of funding loans to people with poor credit. Combined with too much liquidity, thanks to the Federal Reserve’s lax monetary policy, this “perfect storm” of bad policy created a housing bubble. Now the bubble has burst, and we are suffering through the consequences.
As a stereotypical house‐in‐the‐suburbs American, I certainly appreciate the value of home ownership. But sometimes there can be too much of a good thing. Government subsidies have hurt our economy in the long run by reducing business investment, and they have slammed our economy in the short run by causing an unsustainable bubble. Maybe it’s time to replace government mistakes with market forces.