Last time in this series, I wrote about Policies for Plenty of Housing via Preventing Displacement. Here I outline the hidden reality of US housing policy: It's about real estate appreciation, not housing. And I explain how they polarize wealth, exacerbate racial inequality, decrease productivity and job creation, accelerate climate change, and exaggerate the ups and downs of the business cycle. Next time, I'll come back to the series’s explicit focus on political strategy and how we could put together an unusual left-right coalition to change national politics.
For generations, the major players in federal housing policy in the United States – the largest households, the rules that shape the country's housing most deeply – have operated from agencies whose names do not include the word "housing." The Internal Revenue Service, for example, is the main source of housing benefit. Mortgage and securities regulators from various agencies have a similarly oversized influence. The US Department of Housing and Urban Development (HUD), on the other hand, is only a small player.
Tax laws and mortgage rules indirectly give homeowners hundreds of billions of dollars a year, many multiples of the HUD's $ 48 billion budget.
Tax laws and mortgage rules indirectly give homeowners hundreds of billions of dollars a year, many multiples of the HUD's $ 48 billion budget. And despite all of the US government's debates on home expansion and the provision of affordable housing, the real impact of these federal policies has not included an increase in home ownership or more affordable housing.
Instead, U.S. tax and mortgage regulations are increasing speculation about residential real estate and exacerbating the damage caused by overly restrictive local zoning. Sightlines green urbanism and the abundant housing team are regularly trying to reverse it. These federal policies polarize prosperity, exacerbate racial inequality, reduce productivity and job creation, accelerate climate change, and exaggerate both the ups and downs of the business cycle. It's about the appreciation of real estate, not living space.
U.S. tax and mortgage regulations are fueling speculation about residential turbochargers and exacerbating the damage caused by overly restrictive local zoning.
Fortunately, the incentives these rules create for real estate speculation peaked a decade ago and have declined slightly since then. In 2017, Republican Congress took a surprising step in the right direction by reducing the mortgage interest deduction and related tax benefits. Further progress in the coming years may be within our grasp.
Feed the horses to feed the sparrows
The main players in housing construction – tax breaks and mortgage finance policies – operate on what John Kenneth Galbraith calls the horse and sparrow economy: "If you feed the horse enough oats, some will take to the streets for the sparrows."
The horses, in this analogy to dung-pecking, are the collection of powerful industries that are involved in building, selling, and financing houses. The oats are tax breaks and federal pledges of bailouts should the mortgage industry overstretch. And the sparrows that get the digested oats? They would be ordinary American households.
Horse economy can be good politics: unlike sparrows, horses are big, powerful and are well represented by lobbyists and political action committees. The bipartisan practice in Washington, DC, therefore, has long been to give generously to the mortgage and real estate industries in the hope that the result will be home purchases by millions of sparrows. Apart from the mast of the horses, however, this approach has largely failed.
From lend-and-hold to shadow banking
The US government's intervention in the mortgage business began modestly. During the Great Depression, the government invented the 30-year mortgage and created Fannie Mae to guarantee low-interest mortgages and stimulate the economy. The mortgage was elegant: a way to pay for homes with future earnings. The system was advanced, but only if you were a white working class person. Lending practices were racially excluded from the start, the development of redlining.
The mortgage business evolved over time from a boring but reliable lending business for local banks, credit unions, and savings and credit associations to an ever-accelerating boom, culminating in secured bonds, mortgage-backed securities, and other bundled and securitized easy money loans that collapsed in 2008, sparking the year's devastating financial crisis. The entire decade-long stroll was streamlined when someone took care of expanding the options and housing to more families: horses and sparrows.
The federal role has rarely been to provide public funding in advance. Instead, the U.S. government slightly regulates mortgage lending, allowing the mortgage industry to take enormous risks that can trigger recessions while implicitly guaranteeing their solvency. The mortgage industry not only includes quasi-public institutions like Fannie Mae and Freddie Mac, but also its private shadow banking counterparts such as hedge funds, insurers and the rest of the menagerie that is too big to fail.
Government mortgage policy works much like a rich relative signing a young person's loan. If all goes well, the relative never pays; If not, the cost to the relative can be high. However, in the case of government mortgage policy, the guarantee does not apply to individual mortgages. It's for the entire industry.
It didn't all go well. In the Savings & Loan (S&L) crisis of the 1980s, a third of US savings went broke, and the US Treasury Department bailed out its depositors with a cost of $ 130 billion. The effects contributed to the recession in the early 1990s. But the S&L crisis was nothing compared to the 2008 housing bubble and the great recession that went with it. These disasters cost the United States many times more than direct government bailouts for financial institutions. And they cost the world literally trillions of dollars in lost wealth and collapsing economies, not to mention human misery and ruined lives.
Financialization
Brink Lindsey, of the center-right Niskanen Center in Washington, DC, and Steven Teles, a left-wing political science professor at Johns Hopkins University in Baltimore, document the saga of the U.S. mortgage industry in their 2017 book The Captured Economy. They summarize:
The track record of US regulatory subsidies for mortgage lending is therefore downright miserable. Rather than offering transparent, near-household tax transfers, policymakers decided to encourage home ownership by channeling subsidies through financial institutions, first with the savings and credit industry, then with securitization and shadow banking. Both models of mortgage financing, designed and sustained by public policy, ended in collapse. Aside from the ruinous cost of financial crises, regulatory subsidies have chronically misallocated resources, forcing financial institutions to focus resources on household consumption (rather than productive corporate investment).
Indeed, the mortgage industry, once a cautious niche industry that generated modest profits and stable housing, has become a leading force in financializing the US economy. Securitized home mortgages – thousands of mortgages that are bundled, sliced, and recombined – make up a large part of the Wall Street capital pools that make up the shadow banking sector. The financial industry and its implied short-term nature are on the rise in the economy, shifting investment capital into real estate and other existing assets and away from companies whose innovations in products and services are the engines of prosperity. Write to Lindsey and Teles:
the large and destabilizing subsidies the government gives to debt financing and mortgage lending. . . are a major cause of both the excessive growth of the financial sector and its recurring instability. They are the source of massive rents for financial firms and a catalyst for the excessive risk-taking that misdirects capital and regularly shakes the larger economy.
A decline in the mortgage industry – through tighter regulation and the revocation of the implicit state guarantee on bailouts – would be a healthy step towards a more balanced economy. This would make it a little harder to get mortgage loans, a little smaller, and a little more expensive in terms of fees and interest rates. None of this would like home buyers, but it would drastically reduce the risk of financial crisis and improve the returns on property purchases.
Tax breaks for home speculation
Mortgage policy is only half of the US federal housing policy problem. Four pieces of U.S. tax law also encourage property speculation. These tax regulations grossed homeowners perhaps $ 150 billion in 2020. The flyers are not structured in such a way that they promote property as such or promote stable living space, but rather reward home ownership as an investment strategy. As the benefits grow with income and house prices, they work the other way around like Robin Hood.
American families who earn more than $ 200,000 a year receive, on average, about four times as much housing benefit as American families who earn less than $ 20,000 a year.
The four parts:
- The Mortgage Interest Deduction This option allows you to deduct interest on your home loan (or loan if you have two houses) from your income before calculating your US personal income taxes. The more interest you pay, the greater the tax break, which makes the policy highly regressive. Reduced by Congress in 2017 (as I'll explain in my next article), it still cost the Treasury Department $ 26 billion in 2020.
- The state and local tax deduction (SALT) This option allows you to remove any non-state taxes you pay from your income before filing your federal taxes, including state and local income, sales, and property taxes. This policy functionally gives homeowners a discount on their property taxes, and like the mortgage interest deduction, the benefit grows with your income and home price. The more property tax you pay – and the higher your income – the greater the discount. Despite congressional cuts to Congress in 2017, SALT's property tax portion cost the Treasury Department $ 6 billion in 2020 (assuming the same real estate to other tax ratio as in previous years).
- The Capital gains exemption, This denies the Treasury about $ 35 billion a year and allows home sellers to avoid paying income tax on the first $ 250,000 of profit made from the sale of their homes (or $ 500,000 for married couples). Home parking your savings is a huge incentive: Neither stocks nor other forms of equity investments grow tax-free unless they're included in retirement or college savings plans.
- The imputed rent exemption is a curious animal. It waives the taxation that homeowners receive from using their homes. You may be thinking, "Huh ?! Paying taxes to live in my own house? This is crazy! ”However, as far as economists and tax advisors are concerned, this makes sense. If you rent your home to someone else, the rent you get from your tenant is taxed. If you live in the house yourself, you should consider the monthly value of the Taxes on animal shelters. Like much of the accounting, it is not intuitive, but logical. The imputed rent exemption is likely to deny the Treasury more than 80 billion US dollars a year. In contrast, Switzerland levies taxes on imputed rents. This makes it one of the few Countries where taxpayers have no monetary benefit from owning their homes and not renting them, the Swiss choose to buy or rent for non-financial reasons, and fewer than 40 percent of households buy, compared to 67 percent in the US.
The effects
Two recent summaries by prominent housing researchers bring together the results of a generation of scientists on the damage these policies are causing.
In short, tax breaks and hidden loan subsidies encourage speculation about property values. They encourage buyers to put more money into their homes and less into other productivity-enhancing investments. They offer property prices in high-priced markets with restricted zoning and escalate house and property sizes at the higher end of the market in wider, lower-cost markets. For example, US real estate policy is raising multi-million dollar Victorian prices in San Francisco and accelerating the spread of McMansion in Houston. It also exacerbates inequality. Since the tax breaks are much more valuable for households in high tax brackets, they divert the real estate market away from first-time buyers and newcomers who are mostly in lower tax brackets.
Since people of color have long been legally and politically prevented from owning houses, this process of exclusive price escalation intensifies the differences in prosperity based on race and ethnicity.
Tax breaks and easier loans are raising prices across the real estate market, driving up sticker prices and making the slump more difficult. In the run-up to the 2008 financial crisis, increasingly precarious debt financing was widespread and continues to exist. Since people of color have long been legally and politically prevented from owning houses, this process of exclusive price escalation intensifies the differences in prosperity based on race and ethnicity. It concentrated and continues to focus mortgage foreclosures among people of color during the financial crisis.
Easier credit and tax breaks have hurt the economy as a whole and the environment too. The diversion of capital into mortgage credit (a type of consumption) expresses investment in business (manufacturing). The net effect is slower productivity growth and job creation. Larger houses use more energy and materials and are usually spread over more land. This increases the spread and increases the climate-damaging emissions from both homes and driving that their locations require.
Ultimately, the homeowner tax breaks – not the mortgage system in this case – don't even increase home ownership. Because they raise prices, they hurt first-time buyers and keep them out of the market. Homeownership is less common in the US than in countries like Australia, Canada and the UK, which do not have similar tax subsidies.
Peak horse and sparrow
Under-regulation of mortgage financing by the federal government reached its peak before the financial crisis in 2008. Since then, tightening of regulations has somewhat dampened systemic risk to the economy and reduced the chances of further bailouts. However, mortgage loan securitization remains a primary role for Fannie Mae and Freddie Mac. Investors continue to buy these risky instruments, also knowing that the US government will not allow the mortgage industry to collapse. Because of these guidelines, mortgage loans are easier to come by and have a higher risk of default.
The tax loopholes for homeowners peaked before the 2017 tax reform. In 2015, these homeowner tax breaks were arguably more than $ 240 billion, roughly five times the U.S. housing benefit for renters and low-income households that year. Another estimate put the total at 210 billion US dollars. In both cases, the 2017 reform cut the grand total to around $ 150 billion, a big step in the right direction.
Further restrictions on federal policy would ease the flow of money into property value speculation and lower property prices. It would also dampen all of the damage recorded above.
Next time, I'll turn to politics to make this happen. For now, let's take a look at another model.
Another model?
What could a housing industry look like that no longer feeds the horses to feed the sparrows?
It could look something like the housing industry in German-speaking countries in Europe. The German mortgage industry, for example, is cumbersome and tightly regulated. Homeownership is less common in Germany than in North America, but it's still widespread, with much lower home prices and more living space. However, German tenants enjoy a level of security in their homes that North Americans would be unfamiliar with, as an abundance of housing and German law in most cities ensure both a tenant market and strong tenant rights.
In addition, Austria does not grant house buyers any special favors under tax law or banking regulations. Indeed, Austria does not subsidize mortgage loans, but the production of thousands of ordinary urban apartments. The policy offers affordable, abundant housing; stable, long-term rental contracts as in Germany; and a real estate economy that is far less driven by speculation.
In Switzerland, the taxation of imputed rents means that the policy between buying and renting is neutral. Fewer people buy there than almost everywhere in Europe, and housing is among the cheapest in Europe.
In these countries, housing policy is about housing, not real estate. So home ownership is a good way to live, but a bad way to make money. And that's how it should be. Could this also be our future in North America?