Yes, Washington did help cause the financial crisis

September 25, 2009

There are, to be sure, lots of villains to blame for America’s financial crisis: regulators, Wall Street executives, credit ratings agencies, Alan Greenspan.

But the one baddie Washington doesn’t want to touch is, well, Washington. Its crime: pushing federal policies that favored ever-increasing home ownership, particularly from the mid-1990s on, and thus helping spawn the housing bubble at the center of the devastating meltdown. (We’ll focus on its legacy of financial bailouts another time.)

The sheer scope of the bipartisan, federal pro-housing undertaking is mind-boggling.

As Jeffrey Miron, a Harvard University economist, noted in testimony this week to the House Financial Services Committee, a list of past and ongoing efforts would include the Federal Housing Administration, Federal Home Loan Banks, Fannie Mae, Freddie Mac, the Community Reinvestment Act, the deductibility of mortgage interest, the tax-favored treatment of capital gains on housing, the HOPE for Homeowners Act and the $8000 homebuyer tax credit.

Then, of course, there are the Federal Reserve’s efforts to bring down mortgage rates.

The federal tax subsidy alone amounts to some $200 billion a year, according to the Tax Policy Center. Put it all together and it’s clear that Uncle Sam created immense incentives for home ownership, from which Wall Street eventually found a way to coin huge profits.

Well, at least for a while. Even former Federal Reserve chairman Paul Volcker conceded this week to the same committee that government housing efforts, in the form of Fannie and Freddie, were a “factor” in the crisis.

But while Washington is creating financial regulations and regulators, going after banker pay and questioning the role of the ratings firms, it seems intent on leaving its pro-housing policy bias intact.

That may be necessary for a while, until the housing market finds it legs. But then it’s time for Uncle Sam to gradually get out of the housing business. Breaking up and privatizing Fannie and Freddie would be a good start to an exit strategy, as would phasing out the mortgage interest deduction.

The risk of maintaining the status quo isn’t so much that we’ll have another housing bubble. Rather, it is the continuing opportunity cost of devoting so much precious capital toward housing.

Finding a better use for $200 billion a year in a country with a crumbling infrastructure, a yawning budget deficit and an uncompetitive tax system shouldn’t be hard.


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Posted by Instapundit » Blog Archive » JAMES PETHOKOUKIS: Yes, Washington Did Help Cause the Financial Crisis…. | Report as abusive

Uh, did you REEEeeely mean to say “phasing out the mortgage interest deduction.” ????I’m with you up to that point, and by all means require credit worthiness of potential home buyers, but what good would getting rid of the mortgage interest deduction do?

Posted by Ed Nutter | Report as abusive

The problem in Washington started in 1992 with a change to the charter of Fannie Mae in which was inserted an affordable housing mandate. Specifically, the Congress asserted that, “the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation have an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families…” As part of the change, the legislation also required that Fannie and other HUD lenders review their underwriting practices ( uscode12/usc_sec_12_00004601—-000-.html) to determine to what degree minor points like down payments of 5% or more and credit histories inhibited the goal.Adding insult to injury, Congress also set quotas on Fannie et al as to the number of mortgages they were required to purchase in the portfolio each year that met the aforementioned mandate. This helps explain to the man-on-the-street the seemingly illogical/irrational/idiotic procedure of granting a mortgage to someone unable to repay it. In 1994, 34% of all Fannie mortgage purchases were “affordable housing” mortgages rising to 50% in 2000.Just another example of social engineering at its finest that has been well hidden by those most responsible.

Posted by Night Ranger | Report as abusive

but what good would getting rid of the mortgage interest deduction do?I’m not in favor of getting rid of it but it does create a tax incentive to take on debt. In the Washington DC sense it also would be a tremendous short term “revenue generator”.

Posted by bandit | Report as abusive

Being able to write off the interest deductions is a subsidy. Apply known subsidy type problems to the home mortgage market and you get: overpriced goods sold at an uneconomical level which causes inflation in the market and builds it up artificially.The net result of that has been an expectation for ever increasing home prices as a part of the cost of the mortgage (interests) can be written off, thus raising the amount of principle that can be expected for a loan. It is an inflator of expectations for home value, and if it was not there you would not expect your home value to rise much over your ownership period. While that is a modest inflator, when it is added in with a push to get those who have no income, no jobs or assets into the market, then things go haywire on a grand scale.

Posted by ajacksonian | Report as abusive

Ed Nutter,Is there some right to deducting mortgage interest that I’m not away of? Sure, as a home owner myself, I’d hate to see it go, but its sole purpose is to encourage home ownership. In the days of 20% down and fully amortizing fixed rate loans, home ownership was a good way to get people to save for the future whether they liked it or not. Without that loan structure, it is unclear that home ownership is the best path towards wealth.It has taken enormous efforts by Washington to push home ownership up just a few percentage points over decades. It seems pretty clear that there is a natural level of ownership that is sustainable. If we try to exceed that, eventually people who should be shackled to a home, end up with a mortgage they can afford, and Boom, see the last 24 months.The interest deduction is just a way to encourage home ownership. I don’t think home ownership for all is a goal we should be pushing for, so removing one of the incentives is reasonable. Politically impossible sure, but reasonable.

Posted by Spencer Ogden | Report as abusive

democrats are expanding the community reinvestment act with HR 1479 modernization act of 2009. The former CRA which contributed to the lowering of lending standards leading to the bubble/meltdown will be expanded to more financial institutions by democrats if it passes, if I understand this bill correctly (its available online). But given what gov has done with supplemental retirement, medicare, va care, postal service (PO is getting a $4 billion break from gov.), fmae, fmac debacle…how can this end well.

Posted by frankg | Report as abusive

There should not be a phase-out of the mortgage interest deduction. It is good for people to own homes.And yet, it is only good for people to own homes they can afford.The problem is not “too much home,” it is “buying a home using too much debt.”Therefore, the correct solution is to make mortgage interest deduction proportional to the amount of equity you have in your house.If you have 5% equity, you only get 5% of your mortgage interest deducted. If you have 70% equity, you get 70% of the deduction you get under the current system.This encourages getting equity into your house as fast as possible, through larger down-payments or paying more than the minimum payment each month.This in turn discourages living in an over-leveraged fashion.Which is the real problem, of course. People need to learn, not to never use debt, but to only use debt wisely, when they can easily afford it.

Posted by R.C. | Report as abusive

Our current financial crisis is the result of government control and management of the mortgage lending industry. Only the government could be so stupid and blind as to lose $2 trillion outright ($2,000 billion) lending money to build houses, the safest and most analyzed type of asset existing.They set standards for the industry to follow, lowered those standards according to socialist ideology, bought the bad loans that resulted, guaranteed repayment to the institutional lenders if anything went wrong, and pressured ratings agencies to stamp AAA on new and poorly understood mortgage securities.We Guarantee It–> rantee-it.htmlAn organization and review of public sources of information about what went wrong.The government is guaranteeing us into poverty. Politicians discovered a loophole in government finances. They could borrow as much as they wanted, off budget and without debate, by granting guarantees.Supposedly private businesses like Fannie Mae and Freddie Mac borrowed as much money as the entire national debt at the time, $5.4 trillion ($5,400 billion). The politicians crying the loudest about free market failure and lack of regulation were the ones who directed this disaster, blocked regulation in place, and refused restraints. The guarantees go on today.

Posted by Andrew_M_Garland | Report as abusive

Getting rid of the mortgage interest rate deduction is unthinkable… but if you thinkable it, it would would make homes much more affordable because prices would fall. Now that would be an affordable housing program!

Posted by John Wake | Report as abusive

As a tax accountant, I see government all the time doing social engineering through the tax code. EIC, child tax credit, child care, home interest, medical insurance are all items that have found their way to the tax code. The purpose of taxes is to raise money for government purposes. Every person should be subject to paying taxes with no special allocations for their social circumstances or personal choices. Why is interest income taxed and interest expense deductible. Ans. Interest is good for the banks, eliminate both and you get more savings and less borrowing.To steal(forcibly take) from only a small section of the population leads to the feeling of unfairness and resentment by those who have to pay. The march on Washington was in large part by those who are paying. It is easy to increase benefits if someone else pays the freight, that is why the poor vote for promises and the payers will always be in the minority. I know it is reactionary and unpopular, but unless you pay the bill you should not be calling the shots.

Posted by Stuart Jones | Report as abusive

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Helping ownership is a worthy goal — but it should be limited. It should also be helping ownership, not speculation/ investment (no difference).Ownership is equity; no equity, no ownership. The mortgage interest deduction should be replaced by a flat rate 30% house payment tax credit, on interest AND principal, up to a lifetime maximum of $500 000 (to increase at 10* prior year’s mean taxpayer income as filed with IRS.)

Posted by Tom Grey | Report as abusive

“Finding a better use for $200 billion a year in a country with a crumbling infrastructure, a yawning budget deficit and an uncompetitive tax system shouldn’t be hard.”But would those who marched on Washington, as described above, go along with that? They may be paying taxes; they are also the recipients of those mortgage interest deductions, and they are the owners of those homes with mortgages backed, at the end of the chain, by Fannie or Freddie or FHLB or some MBS made more profitable tax codes – and they still want their Medicare, too. Take away their deduction, and they’ll teabag for tax cuts – to them, fixing crumbling infrastructure is just code for union jobs and affirmative action contracts.I cannot dispute that executing the goal of home-ownership was counter-productive in some, many cases. That’s a different argument than whether the principle goal is reasonable, proper, just. I’m with those who’d say it is – but then I and my family benefited from a VA backed mortgage – were VA mortgages also a cause of our current problems?Between government policies that promote a nation of renters and landlords, or policies promoting a nation of homeowners and renters aspiring to own a home, I’ll take the latter…

Posted by Dave Raithel | Report as abusive

The stage is already set to get rid of deductability of mortgage interest. The cap is now $1,000,000. Through the coming hyper-inflation/dollar-collapse we will all be living in multi-million dollar houses soon.

Posted by bc | Report as abusive

Apparently there is a difference between owning a home and investing in a property. My reason for home ownership was definitely not based on the “financial windfall” I receive by deducting the mortgage interest.It seems to me that anyone who could be lured into taking on debt by the promise of a tax deduction would find some other hole to shove his money in. A fool and his money, as it were.After 21 years, my payments have shifted toward principal reduction. Not that it matters, for if this deduction is not phased out, BHO will figure out a way to redistribute wealth regardless.

Posted by Nate | Report as abusive

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Posted by Uncle Sam And The Housing Crisis – Housing Doom | Report as abusive

The mortgage interest deduction should be retained. This is the only way to offset the obscene profits that banks make from home loans. The average hard-working American needs at least some relief from the burden of paying over $300,000 for a $100,000 house.

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