Property bubbles have been part of American life for centuries. But as Edward Glaeser explains, property bubbles haven’t always led to financial crises, as they have in the recent past. Part of what has happened is that the federal government has been actively encouraging overleveraging for decades. Overleveraging makes household balance sheets far more vulnerable to economic shocks, and a damaged household balance sheet can take years to repair. And now that home prices are recovering, Glaeser argues that we have an opportunity to reset housing policy:
Land and housing prices typically go down after they go up. Banks that are heavily invested in real estate during a boom can threaten the system during a bust. Regulators can counter this risk by pegging real estate values not to current market prices but to longer-term average values. This would essentially increase thecapital requirements during booms for real-estate-heavy institutions.
Finally, the government should stop offering borrowers an underpriced default option through subsidized mortgage insurers such as Fannie Mae, Freddie Mac and the FHA. We don’t need to shut down Fannie and Freddie, but they should be required to demand high premiums for mortgage insurance.
One problem, however, is that it’s not obvious that there is a strong constituency for reform. There is no “avert-disaster” lobby, but there is a real estate lobby. In an ideal world, conservatives — heeding Paul Ryan’s advice about the importance of prudence — would serve as the “avert-disaster” lobby.
But it is politically crucial that reformers try to build constituencies that would be hard-wired to support reform. One could make the case that transforming the mortgage interest deduction into a credit would be a reasonably politically attractive way to discourage the worst excesses of the housing market, particularly in credit-constrained regions. Unfortunately, loss-aversion is a powerful fact of life, i.e., the high-income homeowners in high-cost, capacity-constrained jurisdictions who would lose from such a measure will likely be far more vocal than the less affluent non-filers who would gain from it. So what I’d most like to hear — from Glaeser and others — is how we might address this underlying political economy challenge. Glaeser has thought deeply about this question, but he obviously can’t do it alone.