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