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Touching the Third Rail of Housing Policy

Ed Glaeser posted in Economix yesterday about the lessons that the housing crash imparts for housing policy--including the seemingly untouchable mortgage interest deduction. Now that home prices seem to be moderating, the piece provides a vivid reminder of how steep the price curve was, before and after the crash. In successive three-year periods (2003 to 2006, and 2006 to 2009), Glaeser details that home prices in the 20 metro areas tracked by the Case-Shiller Index rose 55 percent, and then dropped by 33 percent.

As we saw from some recent analysis, things look even more volatile in the overheated markets that suddenly went very cold. Inflation-adjusted prices in much of Florida and California’s Central Valley, for instance, fell between 20 and 30 percent over the course of just one year, from March 2008 to March 2009. (Note that these figures are from a separate federal government index that may tend to understate the rate of decline relative to Case-Shiller.) As Glaeser notes, even in regions where there are few if any constraints on building, bubbles can happen when mortgage debt is too cheap and creative.

The policy upshot, though, is even more interesting. Glaeser concludes that as a nation, we have overinvested in encouraging homeownership, and he calls out one popular policy lever in particular:

Yet I think that we have not yet fully faced the fact that our tax code encourages people to finance their homes with as much debt as possible, and that our financial regulations abet irresponsible lending.

Now that we have backed away from the abyss, we can consider making much-needed reforms, like reducing the upper cap on the home mortgage interest deduction, that could depress housing prices in the short run, but make future housing bubbles and crashes less likely.

Earlier this year, the Obama administration proposed such a cap on itemized deductions, including those for mortgage interest, to help finance expanded health insurance coverage. The proposal was basically DOA on the Hill, thanks in part to some misguided charges that it would greatly curtail charitable giving among the wealthy.

Last week, however, the Wall Street Journal reported that the idea of capping itemized deductions was back on the table among Senate Democrats, now that a bipartisan compromise on health care reform seems further out of reach. The endgame here, including how expansions in coverage are financed, is anyone’s guess; perhaps the president’s speech tomorrow night will offer some clues. Meanwhile, though, Glaeser reminds us that there’s a clear economic argument for capping the mortgage interest deduction, and there’s more live discussion around this move (outside the academy) than there has been for years.  

However, the context for the current discussion raises a difficult question: Should a housing policy subsidy be redirected toward health care subsidies, when affordable housing needs--especially for renters--remain so pressing? (Among others, “future HUD Secretary” Barney Frank may have some thoughts on this.) On the one hand, you could argue that subsidizing health insurance coverage for lower-income families would indirectly help many more afford decent housing. Yet the federal tax debate next year, prompted by the expiration of the 2001 Bush tax cuts, should also occasion a fundamental re-assessment of how the national government helps meet the housing needs of families and communities. Perhaps these aren’t mutually exclusive. 

But let’s not allow the political trade-offs in financing health care reform obscure larger questions around how to rebalance federal housing policy. In fact, maybe we’d all end up a little healthier anyway if tax reforms helped us avoid nausea-inducing, roller-coaster housing prices.