Two Ways to Revamp U.S. Housing Policy

America shouldn't waste the current housing crisis. With prices plummeting, foreclosures soaring and the mortgage market in disarray, the country should rethink a federal housing policy that has failed.

The policies that got us here, like Freddie Mac, Fannie Mae and the home mortgage interest deduction, put too much faith in subsidized borrowing.

Encouraging everyone to make highly leveraged bets on housing was patently a mistake. Housing policies of the past also erred by aiming at amorphous, often contradictory objectives, including higher homeownership rates, more affordable housing units and, most recently, higher prices. Those policies then mistakenly applied the same policy medicine to every housing market, whether housing was abundant and inexpensive or scarce and unaffordable.

When the government lends, taxpayers end up paying for the defaults that follow.

The problems of old-style housing policy are well illustrated by the unwise proposal being considered to provide subsidized loans to home buyers at 4.5 percent interest. The historical, quite modest relationship between interest rates and housing prices suggests that this proposal will increase housing prices by at most 5 percent. A 5 percent price rise will do little to stem foreclosures in markets where prices have already fallen by 30 percent.

Subsidized lending looks cheap, but isn't.

When the government lends, taxpayers end up paying for the defaults that follow. Those people who claim that the plan will be cost-free seem to forget that this spurious argument was made to justify Freddie Mac's and Fannie Mae's credit guarantees. The policy will also encourage more overbuilding in Las Vegas and more over-borrowing in Detroit, neither of which is a good policy objective.

What would be a more sensible approach to housing policy?

In our new book, "Rethinking Federal Housing Policy," published by the American Enterprise Institute (and available for free download here), we argue that federal housing policy should ensure that our poorest citizens are able to live in decent housing, and should address the high housing costs facing many middle-income Americans.

These are two distinct problems that require two different solutions--neither of which involves subsidized lending.

The first problem, the shortage of housing for the poor, is best solved by providing more housing vouchers, not expensive tax programs aimed at stimulating construction of affordable housing. Subsidizing developers to build new housing for the poor makes no more sense that paying auto companies to provide a special line of poor people's cars. Our current system, where the poor generally buy used cars, is a much more efficient way of providing cheap transportation. Section 8 vouchers can enable the disadvantaged to live in existing homes, which is much cheaper than new building.

The Low Income Housing Tax Credit, the primary tool for subsidizing housing supply, makes the mistake of trying to apply the same rules everywhere. It subsidizes new housing in Manhattan, which needs more building, and in Buffalo and Houston, which already have plenty of cheap homes. A better approach would be to scrap the tax credit and make Section 8 vouchers more available and portable across cities.

Section 8 vouchers aren't going to do anything to ease the high housing costs facing middle-income Americans, though. That problem requires policies that reduce the barriers to building.

The current housing price slump shouldn't disguise the fact that homes in San Francisco and New York remain extremely expensive by historical standards. Prices are far above construction costs because robust housing demand, fueled by rising economic productivity, has collided against barriers to supply, like minimum lot sizes and height limits.

Borrowing subsidies, including the home mortgage interest deduction, do little good when housing supply is constrained. In markets with limited supply, credit subsidies push up housing prices, and make housing less, not more, affordable.

Moreover, the benefits of the deduction go disproportionately to richer Americans who itemize on their tax returns and own bigger homes. Rather than a new round of credit subsidies, it makes more sense to gradually reduce the upper limit on the home mortgage interest deduction and shrink the public role in encouraging people to bet big on housing.

The only path towards widespread affordability is to build more, which requires reducing NIMBYist regulations. Localities tend to put their own interests ahead of the nation's interest by restricting building in order to keep prices up and reduce congestion. The federal government should increase its efforts to counter this tendency. After all, stopping building in one area just leads to building and more congestion somewhere else. In other settings, when groups try to increase prices by restricting supply, the government sends in the antitrust police.

In the housing context, this means prodding restrictive, high-cost areas to permit more building. New York and greater San Francisco are the two most productive areas in the country, but people have increasingly moved to lower-wage Sun Belt cities because those areas have low housing prices created by unfettered supply.

It is bad economics to let local barriers drive people to less productive areas, and it is also bad environmentalism. The environmentalists who prevent building in temperate California are actually increasing carbon emissions, by driving people to build in the far more energy-intensive suburbs of Houston and Phoenix.

Expensive localities are never going to give up their growth controls on their own, but the stimulus package provides a natural tool for promoting affordability. If some aid to expensive states is made conditional on permitting more construction, then pricey places will face incentives to permit more units and promote affordability. Those incentives will encourage restrictive cities and towns to look beyond their borders, and to make America more affordable by permitting more construction in the high-price housing markets that are undersupplied and unaffordable even to the middle class.

Edward L. Glaeser and Joseph Gyourko are the authors of Rethinking Federal Housing Policy: How to Make Housing Plentiful and Affordable (AEI Press, 2008).

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About the Author



  • Joseph Gyourko is the Martin Bucksbaum Professor of Real Estate, Finance and Business & Public Policy at The Wharton School of the University of Pennsylvania.  He also serves as Director of the Zell/Lurie Real Estate Center at Wharton and is Chair of the Real Estate Department.  Professor Gyourko received his B.A. from Duke University and a Ph.D. in economics from the University of Chicago.  His research interests include real estate finance and investments, urban economics, and housing markets.  Professor Gyourko is a Research Associate of the National Bureau of Economic Research (NBER) and is Co-Director of the NBER Project on Housing Markets and the Financial Crisis.  A former editor of Real Estate Economics, Professor Gyourko presently serves on various journal editorial boards.  Professor Gyourko is a past Trustee of the Urban Land Institute (ULI) and currently serves on the Board of Directors of the Pension Real Estate Association (PREA).  Finally, he consults and advises real estate various companies and investors.


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