Tuesday, September 24, 2013

Homeownership and the Role of Government

A strong rental housing market strengthens us all

This post may be a tough sell and rejected outright by some readers. But if you've made it this far, please stick with it and keep an open mind.

A recent article by Anjli Raval in The Financial Times highlights an increased preference for rental housing over homeownership in the United States and describes the combined effects of a poor economy, heavy student debt load, and underwater mortgages on housing tenure choice ("Should I buy or rent?"). Call me a geek if you want, but tenure choice and government policies that strive to influence that choice have interested me for a long time. In fact I did my master's thesis in economics on the topic in 1986.

But nowhere have I read a clearer, more succinct discussion of these topics than in a 2011 essay by the Federal Reserve Bank of Richmond. I don't usually post large blocks of quoted text, but I see no way to improve upon the essay. So here goes:

"As Congress discusses reforms to U.S. housing finance policy, it is not clear that the United States should devote substantial resources toward subsidizing homeownership. Owning a home may not be beneficial for everyone and current policies to promote homeownership may leave families, financial institutions, and society at large more vulnerable to adverse economic conditions.

"The United States federal government has a century-long history of promoting homeownership through subsidies to housing finance that are both direct (to homeowners) and indirect (through mortgage markets). Following the recent, severe decline in house prices, spike in foreclosures, and related financial crisis, policymakers are discussing how to reform aspects of U.S. housing finance policy to create a more stable housing market. In doing so, there are two main questions that policymakers and the public should consider: Is it desirable to promote homeownership, and, if so, how should policymakers go about it?

"What are the potential costs of homeownership? First, homeownership can be a costly option for households who need or desire mobility. Selling a home entails significant transaction costs. As a result, homeownership makes a household relatively more dependent on the health of the local job market. From a macroeconomic perspective, the inability or unwillingness of some households to sell their homes may act as additional sand in the gears of economic recovery from a recession. One result of the recent housing decline has been a large number of homeowners who are "under water" on their mortgages; they owe more than the home is currently worth ...

"Renters, by contrast, may be somewhat protected from adverse economic conditions. Economic theory suggests that the price of renting housing services will fall in recessions simply because demand for local housing should fall as well. Renters can more easily relocate in search of better job prospects or in response to declining neighborhood conditions, helping themselves and helping the overall labor market to function more efficiently. Lastly, renters often are explicitly protected against the risk of physical damage to their dwelling ...

"For these reasons, the conventional wisdom that equates renting to throwing away one's money is misleading [emphasis added]. Renting buys flexibility, a potentially better-diversified portfolio of assets, and a degree of protection against local economic fluctuations. For some households these advantages will be worth more in the long run than a housing asset, and a larger rental market may reduce the degree to which the economy as a whole is exposed to housing market risks ...

"In the Richmond Fed's view, it is not clear that the United States should continue to devote substantial resources toward subsidizing homeownership."

The mortgage interest deduction is a direct housing subsidy of about $70 billion a year, most of which accrues to affluent households. The indirect subsidies to Fannie Mae and Freddie Mac are estimated to be $120-180 billion annually with more than half flowing to stockholders rather than lowering the cost of mortgages.

The old adage "Don't put all your eggs in one basket" holds true for tenure choice. A diverse basket of household assets is stronger than one where life savings are sunk into one immobile, illiquid housing asset. And our economy is stronger when it's diversified so that one burst bubble doesn't sink us all.