In his critique of the much-admired new book House of Debt, Jay Weiser warns that government mortgage guarantees have “undermined market discipline, encouraging risky borrowers to load up on artificially low-rate debt.” Might there be another, more constructive approach to helping U.S. households achieve sustainable homeownership? For the sake of argument, let’s leave aside the question of whether it’s appropriate for public policy to favor homeownership over renting.
In 2010, O. Emre Ergungor of the Federal Reserve Bank of Cleveland argued that if our goal is to encourage sustainable homeownership, we ought to favor down-payment assistance over interest-rate subsidies, like the federal mortgage-interest tax deduction. In a similar vein, Joseph Gyourko of the Wharton School has called for replacing the Federal Housing Administration, which guarantees mortgages and which has been a financial failure, thanks in part to high default rates among the borrowers it backs, with a subsidized savings program that would match the savings of qualified households, thus helping them make 10 percent down payments on homes within their economic reach.
Gyourko’s proposal is motivated by a number of concerns:
(1) the FHA has failed to discipline its risk-underwriting process, and he is skeptical that it will ever do so, due in part to political pressures. Starting from scratch makes sense if this is indeed the case.
(2) The FHA is undercapitalized, with a leverage ratio (as of last year) of over $40 in outstanding insurance guarantees to every $1 in what it calls total capital resources to pay off losses, a marked deterioration from the 12 to 1 ratio in fiscal year 2007. The mortgages the FHA insures belong to borrowers who are leveraged at 33 to 1 on average. As soon as housing prices fall, the FHA will find itself quickly overwhelmed and it is a safe bet that taxpayers will be left to pick up the pieces.
(3) A subsidized savings program will address the equity shortfall, it won’t require a large bureaucracy capable of pricing complex mortgage guarantees and managing the foreclosure process, and the success of big mutual-fund companies demonstrates that such a program can be operated with low overhead, thus ensuring that taxpayers resources are directed to achieving the underlying goal of helping households accumulate wealth.
(4) By focusing on borrowers, Gyourko’s proposed subsidized savings program is less likely to have its benefits siphoned off by realtors and homebuilders. Consider the distinction between Pell grants, which go to students from low-income households, and tuition tax credits, which benefit all students, including more affluent students. While Pell grants only increase the purchasing power of a discrete group of students below a certain income cutoff, tuition tax credits that benefit all, or almost all, students shift the entire demand curve. So while we wouldn’t expect Pell grants to contribute to tuition increases, universal aid would do so if supply is not terribly elastic. In a similar vein, the mortgage-interest tax deduction shifts the entire demand curve; in supply-constrained regions like coastal California and the northeastern United States, this shift contributes to higher home prices, as Gyourko and Edward Glaeser observe in Rethinking Federal Housing Policy. A narrowly-targeted subsidized savings program designed to help borrowers save up for a down payment would have a far more modest impact on home prices, even in capacity-constrained regions.
(5) Unlike mortgage guarantees, which are notoriously difficult to price properly, a subsidized savings program would have highly visible costs. This is very much a feature in that it allows policymakers to more carefully weigh its costs and benefits. Yet it is a political liability, for obvious reasons.
(6) The program would increase domestic savings and encourage financial discipline and long-term planning among borrowers. In contrast, the FHA subsidizes risky, highly-leveraged bets on the direction of the housing market that can leave the balance sheets of low- and middle-income households badly damaged when the housing market goes south.
As for the cost of the program, Gyourko suggests that it would be far lower than that of putting the FHA on a sound financial footing. This seems like an excellent proposal for conservatives interested in fostering personal responsibility and who hope to avoid a future taxpayer bailout of the FHA, which looks all but inevitable in the absence of meaningful reform.