Why we shouldn’t subsidize construction

By Felix Salmon
May 28, 2010
post on subsidizing construction loans, especially from Tom Lindmark, who points out that if you want a short-term jobs boost which doesn't increase US imports very much, then construction is a great area to subsidize. Lindmark cites Mike Mandel in support of his argument, which is always a good sign, but it's worth noting that Mike kicks off his post by noting that he's "never been a big fan of home construction as a driver of economic growth". It's a cheap high, and the hangover is always brutal.

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I’ve received some great feedback on my post on subsidizing construction loans, especially from Tom Lindmark, who points out that if you want a short-term jobs boost which doesn’t increase U.S. imports very much, then construction is a great area to subsidize. Lindmark cites Mike Mandel in support of his argument, which is always a good sign, but it’s worth noting that Mike kicks off his post by noting that he’s “never been a big fan of home construction as a driver of economic growth”. It’s a cheap high, and the hangover is always brutal.

Meanwhile, commenter winstongator points me to this article from today’s Raleigh News Observer. He does so because Brad Miller specifically singled out Raleigh as a city where new construction was needed. The first line says it all:

Hue, the multicolor building that is the largest condo project ever attempted in downtown Raleigh, closed its sales office without ever selling a unit.

Of course, one 208-unit condo is not necessarily representative of the new-construction market more generally. But its fate does help explain why lenders might be reluctant to throw good money after bad when it comes to construction loans.

Miller, too, emailed with some good points:

Subprime lending was not driven by home ownership; home ownership was the political excuse for it…

Only about ten percent of subprime loans were for the purchase of first homes. More than 70 percent, as I recall, were refinances… and the vast majority of homeowners who got subprime mortgages qualified for prime mortgages…

Oversupply undoubtedly was a result of the bubble in many markets. Of course home builders built like crazy when they could sell houses for much more than houses cost to build. But I suspect that an oversupply of houses is less of a factor in the collapse than is widely assumed…

When we come out of this we’re going to have to reinvent our housing market, by the way. Have you thought much about that?

This is all true; the peak level of home ownership in this country predates the subprime bubble, and the bursting of that bubble can’t credibly be blamed on too much construction.

So if home construction wasn’t to blame for the bubble and bust, and if it’s good for employment, then shouldn’t we encourage it, at least in the short term?

No: the fact is that we’re already plowing far too much in the way of government resources into the housing market. Virtually all mortgages these days are funded by some arm of the government, be it FHA or Fannie Mae or Freddie Mac, and the Fed of course is doing its job too by keeping interest rates at zero, just because the financial system might suffer a massive solvency panic all over again if interest and default rates were to rise again. The housing sector is keeping the government hostage, and the government should be withdrawing from it as much as possible, rather than feeding it even more than it’s doing already.

The difference between Germany and Spain, when you get down to it, is that Germans work for companies which provide goods and services that the rest of the world wants. In doing so, they make good money, which they save up. That’s how they became rich. The Spanish, by contrast, have massive unemployment, and most of the country’s GDP growth in recent years has come from the construction industry. Their main export is tourism, if that counts as an export, and the main way that Spaniards have become rich in recent years is by sitting back and watching the value of their real estate grow exponentially.

The U.S., going forwards, needs to be less like Spain and more like Germany. So let’s not subsidize housing. That way lies fiscal disaster.


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Don’t these kind of subsidies *oppose* the government mortgage props by increasing the supply? I thought the whole point of the federal programs on mortgages was to prop up prices by increasing demand (presumably to prevent further collapse).

Subsidizing an increase in supply would seem to produce *downward* pressure on housing prices. Far from subsidizing housing, it would hurt current homeowners. Am I missing something?

Posted by absinthe | Report as abusive

If we look at construction as something generally desirable, the specific reasons this might be true have something to do with constructing things that people want, need, can or are willing to afford. It’s not just about building any old thing and acting surprised when the numerical projections don’t come true. Sometimes residential homes get built that are more than houses, they’re ‘homes’ in the traditional sense of the word. More often, though, the word “home” gets cuisinarted up with all sorts of other garbage, like subprime mortgages in the boiler-rooms of Goldman Sachs et al.

Condo developments aren’t the same as single home owner transactions, but they are often subsidized from all quarters throughout their various stages of fabrication. Suburban tract housing developments are not every homeowner’s ideal habitat, but their builders and financiers are publicly subsidized from the get-go onward, until Nature wreaks havoc on their shoddy construction.

So-called mixed use city developments with allegedly affordable low-income residential rental housing units set aside to greenwash the mall and condo modules of the deal are heavily subsidized. Insanely subsidized are also commercial metropolitan office-building projects and suburban big box discount hangars and (yecch) Wal*Marts, whether they then complete or fail to, or go completely to seed as often happens. The developers get paid like they were the bankers’ in-laws. Imagine how often that’s literally true and you’d still be only half right.

None of these subsidized transactions does anything for typical individual owners in the residential housing market whose role is constantly being cited as though ever had any chance of being as subsidized as the ghost towns of former commerce gone barren, which we (and our banks) have all subsidized like there was no tomorrow.

It would be nice if there were no tomorrow for them, but the (where’d it all go?) subsidy problem as it effects people who will always need an acceptable place to live should not be commingled with the far subsidy-hungrier and generally more failure-prone commercial real estate market which has been catered to, hand and foot, as if TBTF.

Me, I’d give the finance side of the real estate market market an F for entrepreneurial talent and an H-minus for honesty. And the only kind of construction I’d ever subsidize had better be pretty darn good, not having been concupiscent with run-of-the mill ticky tacky developer financing.

Posted by HBC | Report as abusive

should we subsidize the construction of bike lanes?

Posted by q_is_too_short | Report as abusive

I think similar to the energy sector, we need a shift away from the traditional construction jobs to more green type jobs – including retrofits of buildings with energy efficient features, public transport oriented features etc. That would be a good thing to subsidize to provide temporary jobs for idle construction workers as well as giving a boost for that part of the industry. Whatever happened to the ‘cash for caulkers’ idea which was along these very lines!

Also isn’t a temporary subsidy better than unemployment benefits? Both costs money to the government but in the former case you get some return for investment. Here is a slight twist to that saying about education v/s ignorance – “If you think subsidies cost money, wait till you consider unemployment”

Posted by jorobins | Report as abusive

Would it not make sense to either get rid of the mortgage interest deduction, or or least put a cap on it? One could argue that there is some social good in making homes more affordable for low-to-moderate income folks. Even so, it would be possible to structure the deduction so that it is not a boon for high-income folks.

Posted by j7uy5 | Report as abusive

Home construction is not an investment in productive goods. It’s an investment in consumptive goods, as Keynes very aptly noted in his ‘General Theory.’

Subsidies to consumption as a national economic policy are unsustainable. As such your observation regarding Spain and Germany, as different as those countries are in other regards is very fitting. Please follow up with a broader piece examining the emphasis in ‘credit financed consumption’ vs. ‘credit financed investment’ in national economic policies.

Posted by Finster | Report as abusive

Government should not subsidize any part of the economy.
Every dollar spent on one sector, or project, is a dollar taken from another sector, or project, at a price of higher taxes and/or inflation in the future.
Any subsidy is creating inefficiency and distortion.
The higher the subsidy, and the longer in place, the bigger the damage.
Just take a look at the current recession, and you’ll easily trace its roots to the US subsidy for housing.

Posted by yr2009 | Report as abusive

HAS THE AMERICAN DREAM BECOME A NIGHTMARE? For decades, the U.S. government has subsidized homeownership, resulting in real estate speculation and overinvestment and contributing to the global recession. Yet Washington has been adding even more subsidies and deepening the federal commitment to the old housing strategy, making it harder to move to a new one.

1. Mortgage Interest Tax Deductions.

2. Artificially Low Interest Rates and Adjustable Rate Mortgages.

3. Tax Credits for first time home buyers was promoted as free money, and Congress extended the program to repeat buyers. This tax credit was like a drug, and the housing industry became addicted. Extending the credit just worsened the problem.

4. Down Payment Assistance. FHA rules made the down payment issue worse by allowing volume builders to give buyers the required 3% down payment through third-party non-profit corporations such as Nehemiah Corporation in California. Builders gave money to Nehemiah, who then gifted the funds to the buyer for a small fee paid by the builder. It was a way to put more renters into homes and line the pockets of homebuilders.

5. Federal Mortgage Insurance. Banks normally want 20% down but will gladly lend when the government insures loans with just 3% down or less. FHA, VA, Freddie Mac and Fannie Mae now guarantee some 80% of all new mortgages and have insured 96.5% of new mortgages so far this year, putting even more of the burden of risky loans onto taxpayers.

6. Low Down Payments. The USDA now even has a zero-down home loan program, and Texas has begun a down payment assistance program. These were homebuilder initiated proposals that are primarily aimed at generating wealth for builders, realtors, mortgage lenders, and Wall Street. Government officials knew, or should have known, that zero-down loans would put borrowers at risk and taxpayers on the hook. That’s because buyers with little or no skin in the game would be more likely to default on loans and go into foreclosure when inflated home values fall below what is owed, or when property taxes or adjustable interest rates rise, or when employment or medical problems arise.

7. Net Operating Loss Carryback. The extension of this tax provision allowed big builders to refile their tax forms and get over $2.6 billion in rebates from taxpayers, a windfall they’ve been using to buy up land at discounted prices.

Posted by JustLaws | Report as abusive

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