Published on Oct 31, 2016

review.chicagobooth.edu | From Fannie Mae and Freddie Mac to the mortgage-interest tax deduction, the US federal government plays an enormous role in the country’s housing market. But what effect is it having—and is there cause for it to be involved at all? Chicago Booth’s Robert H. Topel and Eric Zwick discuss how government intervention affects prices, homeownership, home size, and more.

0:07
– Should the government support the housing market?
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US government agencies play a huge role
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in housing compared to other countries.
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Fannie Mae and Freddie Mac, the government-controlled
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mortgage companies, turn trillions of dollars
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of risky mortgages into risk-free bonds,
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while America’s annual mortgage subsidy
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is estimated to be worth somewhere
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between $70 billion and $150 billion.
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Part of the stimulus package introduced by the US government
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during the financial crisis was a series of
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first-time home buyer credits
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providing interest-free loans and tax credits
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for home purchases.
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But homeownership rates have dropped
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from 69% before the crisis to about 64% now.
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So who did these policies help?
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Welcome to The Big Question,
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the monthly video series from Chicago Booth Review.
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I’m Hal Weitzman, and with me to discuss the issue
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is an expert panel.
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Robert Topel is the Isidore and Gladys Brown
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Distinguished Service Professor of Economics
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at Chicago Booth.
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He’s an expert in labor economics,
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industrial organization and antitrust,
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business strategy, economic growth, public policy,
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and the economics of health, energy, and national security.
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And Eric Zwick is an assistant professor of finance
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at Chicago Booth.
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He studies the interaction between public policy
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and corporate behavior with a focus
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on fiscal stimulus, taxation, and housing policy.
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Panel, welcome to The Big Question.
1:32
Eric Zwick, let me start with you
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because you actually did some research
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on this housing stimulus.
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Tell us how it worked and whether it worked.
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– So joint with David Berger at Northwestern
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and Nick Turner at the US Treasury,
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we looked into a temporary fiscal program
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called The First-Time Home Buyer Tax Credit,
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which was specifically a temporary program
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designed to address distress during the housing market
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in the wake of the Great Recession.
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So in 2009, 2010, inventories in the housing market
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were at all-time highs, a number of sales were distressed
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coming out of either foreclosure
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or off of bank balance sheets,
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and the design was a temporary tax credit,
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$8,000 for first-time home buyers,
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so people who had not bought before,
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to try and induce them to buy during this window
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and sort of shore up the housing market temporarily.
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So we set up a research design
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to try and study this question,
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and I refer viewers to the paper to check that out.
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The findings were that the program was quite effective
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in inducing a large amount of demand into the program.
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We estimate the effect of the program
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was to increase aggregate home sales by somewhere between
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7% and 14% during the policy period,
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so about during 17 months in the throes
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of the crisis really.
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This demand didn’t immediately reverse.
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It was concentrated in the existing-home sales market,
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which implies that the direct GDP effects
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were quite modest and limited actually
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to realtor and origination fees
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and perhaps complementary furniture purchases.
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But when thinking about the distress in the market,
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we see a lot of evidence that the program
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facilitated beneficial reallocation
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of underutilized assets from sort of
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low-value owners of them, such as banks or builders
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who had already built the homes,
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to constrained higher-value buyers,
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people who were induced to buy because of the credit,
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who were unable to buy because of disruptions
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in the credit market or because of down payment constraints,
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but because of the $8,000 were able to buy.
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And we saw that the market stabilized,
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house price growth stopped falling as rapidly,
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at least temporarily, and so when evaluated
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as a stabilizer, the program seems to have been
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more effective than when thought of
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through the traditional demand-management
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fiscal policy view.
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– So does that mean it succeeded on its own terms
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in what it was trying to achieve?
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– I think it means there’s a case for fiscal policy
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and for this kind of program to be used
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during these kinds of periods of extraordinary distress
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when market failures such as these credit market disruptions
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or foreclosure externalities are first-order concerns.
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During normal times, I wouldn’t say, recommend
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this kind of a program necessarily,
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but I think when evaluated as a reallocation device,
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we could say it was successful.
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– Okay but in your mind,
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this was a successful policy, right?
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– Sure.
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– Okay, I mean it would be more successful
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than letting the housing market take whatever turn
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it may have taken.
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– Yeah, I think there’s a lot of evidence
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to suggest that the kinds of problems
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that the housing market was suffering
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would’ve been more severe in the absence of the program.
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– Okay, excellent.
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Bob Topel, you’ve obviously read the paper.
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– I agree with everything in it
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except perhaps the conclusion.
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I thought all of the empirical experiments
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that Eric did were excellent,
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but the question I asked myself at the end was,
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well, if the capital market, here the housing market,
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had been operating efficiently,
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what would I have expected from a program
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that provided $7,500 to $8,000 in subsidy
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to first-time buyers?
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And that had, as they point out, different impacts
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in different markets because there’s more
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potential first-time buyers in different markets,
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and most of the empirical, perhaps even all
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of the empirical findings, I would’ve said,
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yeah that’s sort of what I would’ve expected to happen.
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I was impressed by the fact that
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so much of it was not at the margin of the housing market.
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What I mean is in terms of pure stimulus,
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the effects were to, as Eric points out,
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reallocate the ownership of existing housing
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from one group to another. But whether that’s
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an efficient—whether the failure of that to happen
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in the absence of such a program
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is a market failure or not is another question.
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– Okay, and what about the bigger question
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you referred to earlier, Eric, of whether the government
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should be involved.
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Now you said, you sort of advertised the idea
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that there’s all sorts of distortions, which we talked about
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in the introduction in the housing market.
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If those distortions weren’t there,
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would such a program be more appropriate in your mind?
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– You mean something like the mortgage subsidy,
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or that sort of thing?
6:15
– Yes, those kinds of distortion, government subsidies
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towards the mortgage market, the housing market.
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– I think my answer would probably be the same
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if I was in Canada where there is no mortgage subsidy.
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And the evidence that the housing, the mortgage subsidy,
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improves the operation of the housing market
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would, I think, certainly be judged meager.
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Would they need such a stimulus in Canada
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in the same situation?
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I’m not convinced we needed it here.
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– Okay, Eric Zwick you thought the stimulus
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was a good idea, and it did work to a certain extent.
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Does that mean had we had more of a stimulus
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at that point, we would’ve had more of a beneficial effect?
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– I think it’s hard to know the answer
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to that question actually.
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A lot of the effects we see come through
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is sort of the value of the $8,000 specifically
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in alleviating down payment constraints.
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As it so happens, at the median price
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during the policy period, the down payment
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for people who chose FHA loans was $7,000,
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a 3.5% down payment.
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So an additional $1,000, $2,000, $3,000 extending the window,
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it’s not clear that.
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– That extending it to different kinds of buyers perhaps?
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– Yeah, so we open it up to first-time buyers.
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When you open it up to non-first-time buyers,
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you’re introducing the possibility
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you’re just inducing people to switch
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from their previous home to the other home,
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and I think the case for that is even weaker
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than the case of moving someone
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who is going to buy in two, three, four years
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to buy now.
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I think Bob’s exactly right to ask
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what is the market failure that this program is inducing?
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I’m trained as a public economist,
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and we always think of the role of the government,
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if it’s doing anything, to sort of address
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either market failures or address concerns
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about redistribution embedded in the
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social welfare function.
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I think the redistributive case for this program
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is somewhat weak because home buyers
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tend to be relatively wealthy,
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even first-time home buyers
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and sort of thinking about the income distribution
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are wealthier, so you have to evaluate it
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as addressing some market failure.
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There’s a lot of research to suggest
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during the recession, foreclosure externalities
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were important, the effects on spillover consumption,
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the effects on neighborhoods through crime
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and elevated vacancy were high.
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In other markets,
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I think these kinds of spillovers are much less,
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so I’m thinking about things like business equipment,
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whether China should reallocate unused steel factories,
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this kind of a question like unused battleships,
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I’m not sure such a first- time battleship-buyer program
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would be as good an idea.
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On to whether in peacetime we should have
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mortgage interest subsidies, I’ll talk more about that
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in the future, I think I’ll probably agree with Bob
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that a lot of intensive margin subsidies
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in the housing market just caused people
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to buy larger homes, more square footage,
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and more expensive places.
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I don’t really see the public policy rationale there,
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but we can certainly talk more about that.
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– Yeah, I mean, is housing, I guess the question is,
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is housing a reasonable vehicle
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for stimulating the economy?
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– Can I just interject?
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Because I think when the lay person hears you say stimulus,
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they’ll think of activities by the government
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that increase economic activity
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and increase total output,
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and I think much of what Eric finds is no,
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it didn’t really increase the economic activity
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in the housing market in the sense of creating
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a bigger housing stock, so it didn’t have those things
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that people would traditionally think of
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as a stimulus.
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What it did, on the best interpretation,
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is reallocate housing from some folks
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who were holding housing to other people
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who might’ve had higher value of the housing,
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so it was totally reallocated.
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The stimulus impact in the traditional sense
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was, as I understand it, really de minimis.
10:15
– Okay.
10:16
– Yeah, and I think I mean that’s very specific
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to this point in time when we’re entering
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with, you know, an unused inventory of houses
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in the millions basically, so there’s a stock
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of extra homes that we’re trying to work down,
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and it’s a classic sort of investment boom,
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and the question’s whether it makes sense
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to actually try and speed that process
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of using those assets or not.
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The stimulus effects, yeah, were much smaller
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than the cost of the program, I think.
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We don’t include, say you give someone $8,000,
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and they spend a fraction of that on consumption,
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presumably a lot of that’s going to the down payment,
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which is really a form of savings,
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but there are complementary furniture purchases.
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– Well, the most convincing externality in the paper
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I thought was the, you call it the foreclosure
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or the empty house externality next to mine,
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that affects the value of my property
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because that one’s not being taken care of,
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and I believe that one, whether it’s worthwhile
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having a government intervention in housing markets
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to deal with that in particular situations
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is another question, but that’s one
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where I think the existence of such an externality
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is probably fairly convincing.
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The fact that whatever the evidence is for,
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they made a convincing case that it exists,
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did this affect the magnitude of the externality
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in some measurable way?
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I don’t think you had any evidence on that.
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– Okay, what about the mortgage deductions
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since we danced about it?
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Is it just generally positive or negative
12:00
for the economy, Eric Zwick?
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– Given the size of the program,
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which I think the tax expenditure’s something like
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$70 billion—
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– That, at the beginning, estimated to be
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between $70 and $150 billion, so large, let’s say.
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– —we have very weak evidence of the sort of
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social benefits of this program, I think.
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I think there’s an almost universal agreement
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among economists that this program
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should be modified, ranging from capped to replaced.
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– [Bob] To abolished.
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– To replaced with nothing, just to be clear,
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or abolished, and the question I think to, you know,
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implement this as a program capping or abolishing it,
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that we need to have some answers to is
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what is the effect of such an abolition on house prices?
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They’ll be different in Houston, Texas,
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than it would be in New York City.
12:55
That would be an interesting, actually,
12:56
area of research that we should have some estimates there
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so we can think about that because there are
13:01
some sort of transition costs for getting programs
13:05
like that implemented,
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and the second question is
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are there more efficient ways to,
13:09
if we want to stimulate homeownership at all,
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to promote it. If down payment constraints
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are the primary market failure,
13:17
if there is a market failure in the credit market
13:19
that prevents people from say borrowing
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against their future income, collateralize that borrowing
13:24
against that house, and so they have to wait
13:26
to save up a down payment, and this kind of a program
13:29
that’s like a down payment subsidy can help,
13:32
then maybe we should think about a much more
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cost-efficient program potentially
13:36
which would be replacing it
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with some kind of down payment subsidy.
13:39
– Economists are really good at saying
13:41
that if there’s some subsidy
13:43
that’s creating a large distortion,
13:45
and the mortgage subsidy would be creating
13:47
a large distortion in the way people decide to consume,
13:50
and they would be substituting towards
13:52
consuming more housing services
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and less of other things,
13:56
then it would be a more efficient world
13:57
if we didn’t have such wedges or distortions.
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But getting from A to B is another story
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because if you think of a world
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where you got rid of the housing mortgage deduction,
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well that’s going to affect housing prices,
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and there’s a big redistribution from people
14:13
who now own houses because the value of their houses
14:16
would go down, so achieving this kind of thing.
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– So the old joke I wouldn’t start from here.
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– Yeah, you can’t get there from here.
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You’ll have to start from somewhere else,
14:28
and it’s the same thing with the tax-preferred status
14:32
of employer-provided healthcare.
14:35
Americans overconsume healthcare
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because of that distortion,
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but getting rid of it is a much more costly thing
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because it’s so redistributive.
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– And just to explain, just to go back for one step,
14:47
what exactly are the effects of this subsidy then?
14:52
Who does it help?
14:53
Who does it harm?
14:54
– Well, what it does is it increases the amount of housing
14:58
that people want to consume,
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so we’re all distorted in our consumption decisions
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away from other things, toothpaste, television sets,
15:06
other things that don’t have that tax-preferred status.
15:08
– We might say government is inherently distortive
15:10
of something.
15:12
– Yeah and part of our jobs as economists
15:14
is to point out the places where it is distortive
15:16
and say maybe that’s not a good idea.
15:19
– So to go back to the question,
15:21
who benefits and who is harmed by that subsidy?
15:26
– Well in the long run, we’d probably
15:28
all be slightly better off had we not gone down this path,
15:31
but if we wanted to get off this path,
15:33
it would be redistributive from the people
15:35
who are now owners of houses,
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and that’s part of the cost that would see to it
15:42
that we don’t.
15:43
The political support is unlikely to be there.
15:46
– It also seems to benefit, so it benefits owners
15:49
relative to renters.
15:51
It also benefits high- priced areas relative
15:55
to low-priced areas because of the structure of it.
15:59
It benefits second vacation home buyers
16:01
because you’re allowed to deduct mortgage interest
16:05
on two homes up to a million or something like that
16:08
in the amount of mortgage balance outstanding,
16:11
so relative to other social programs,
16:14
it’s actually quite regressive,
16:16
and its value is increasing in your marginal tax rate,
16:20
so that means that the more income you make,
16:22
the bigger the subsidy is,
16:24
so there’s a very strong incentive,
16:28
specifically for richer people
16:31
in more expensive places to buy as much housing services
16:35
as they can, I mean to increase relative
16:38
to what they would in the absence of the program.
16:41
– So I think of just one margin that Eric referred to
16:43
is buy versus rent.
16:45
It increases homeownership, and I’m sure
16:48
that some politician would say that a function
16:51
of government is to increase homeownership
16:53
in the United States, but why we should have
16:55
a larger proportion of people buying houses
16:58
rather than renting homes escapes me.
17:02
– But also, if homeownership doesn’t even change,
17:06
it changes the number of bedrooms you buy.
17:09
Does a third bedroom really benefit society
17:11
more than a second bedroom?
17:13
I mean, that’s a really hard question to answer.
17:16
– And there it’s exactly the same
17:18
as the healthcare distortion,
17:21
where we have an incentive to overconsume
17:22
the thing that’s subsidized.
17:24
– What about the Fannie Mae and Freddie Mac,
17:27
the government-sponsored agencies that buy up
17:28
large quantities of mortgages
17:30
and turn them into risk-free bonds?