Seriously, when I set out to build my own home about 10 years ago, I discovered much to my dismay that the small, energy efficient home I had in mind, quite comparable in size to the one my parents first owned while raising three children, was illegal to build. The minimum home size for new builds was twice as large.

This was probably due to the incentives generated by the people crafting zoning and building codes getting their budgets from property taxes, and thus having a strong reason to desire that people build as expensive homes as possible.

Stop mandating that starter homes be so large, and people won’t have to go so far into debt to buy their first home.

A bit more freedom to use non-standard building techniques would be helpful, too: There’s no good reason that factory build homes, “mobile” homes, should be restricted to special ghettos.

I think it may have to be phased in over a long period of time (e.g., in 2009 the equity subsidy is 5% of the total “tax break” available, and 95% is for the debt), but if government had the fortitude to credibly commit to it it would be a lot better than the current incentives to go into debt to buy a bigger house.

I disagree with Mark, however, that we need to have Fannie in whatever mode to create a stable home lending market. Britain’s home mortgage market is roughly comperable to the U.S. market, as are their levels of homeownership and they don’t have the equivalent of Fannie or Freddie standing behind the market. At the end of the day, I don’t see that Fannie is doing anything that a private bank cannot do, and a private bank is less likely to become involved in politically motivated lending the way that Fannie did. Given the experience of the Asian financial crisis, I find it very strange that one has to make the case that political control of the financial sector is a bad idea. Many of our over leveraged financial institutions were sadly vulnerable to the drop in asset prices when the bubble burst in housing. On the other hand, we also know from the experience of banks in Indonesia, Thailand, Korea, and even Japan that when the financial sector is strongly responsive to political pressures that it is likely to load up on politically desirable but questionable loans. Another way of putting this is that political control of the financial sector in Asia loaded up its banks with “toxic assets” that made the banks very vulnerable when there was a bit contraction in the supply of capital, which in the Asian case was caused by the flight of “hot money.”

Finally, as to whether a subsidy for equity would have a disproportionate benefit to the wealthy it would depend on how one structured the subsidy, it seems to me. One could certain create progressive elements. I certainly don’t think that an across the board subsidy of home equity makes much sense. I do think, however, if we want to encourage homeownership we ought to do so through a clear, clean subsidy of equity rather than through the wholesale subsidization of debt.

As far as “dishonesty of high finance,” I think the discipline of finance is getting an undeserved bad rap during this crisis. We have to distinguish finance from financiers. At its core, this crisis is about the housing bubble. If home values had tapered off from 2006 levels and had remained there, we would not have this crisis (or at least to this levels). During a stock market bubble (say internet bubble), the bubble popped resulting in 50% decline in stock valuations in Nasdaq and probably 30-40% in NYSE. No one would say that the concept of the public common stock is inherently bad. Likewise, securitization is a beneficial financial tool that has inherent value. Essentially, it expands the pool of capital for an underlying activity, and funds that activity at a cheaper cost of capital. I think there is a legitimate argument on whether there should be so much capital that funds consumerism, but the concept of efficient use of capital is sound.

As far as the various derivative products, keep in mind that a derivative transaction is a zero sum transaction. The values “derived” from the residential mortgage back securities, and the derivatives simply allocated the risks among various counterparties. This is not to suggest that there is not a huge problem created by these instruments, particularly OTC derivatives. If the diminuation of RMBS values created the primary problem in this crisis (blowing out the balance sheets of financial institutions), then the derivatives caused a secondary effect of seizing up the credit markets by enhancing the counterparty risk in subsequent transactions (insurance is only good so long as the insurer can meet its obligation).

The real problem here is that systemic risk was created by systemic greed along the entire chain of commerce. Securitization is an innovation of value. As far as OTC derivatives, there is a strong argument to be made that there should be less of them, or at least they become more standardized in such a way that the systemic risk to the financial system can be better assessed.

Interesting post. I agree that subsidies should be made express, but I disagree that Fannie and Freddie should be re-privatized. Fannie was created as a public agency, and it functioned superbly in that capacity for 30 years. Freddie was created only after Fannie was mostly-privatized, to provide competititon to offset the advantages Freddie took into the market through its GSE status. I think Freddie should be closed down, and Fannie should be tranformed into a fully public agency.

There are several advantages of making Fannie fully public. First, it would continue to encourage home-ownership by mainting a stable secondary mortgage market, with its attendant positive externalities, but it would do it in a direct and fully accountable way, rather than through the yawn-inducing tax regulations and convoluted GSE status you rightly lament.

Second, Fannie could (and once did) enforce quality in mortgages by purchasing only those that met it’s quality standards (20% down, generally fixed-rate, 31% debt-to-income ratio, etc.). Admittedly, that’s the big hand of government setting the boundaries for a market — but we do that all the time. The choice is not between free market and government control. It’s between ad hoc government bailouts and a functioning market system. I’d take the latter.

Third, Fannie can actually be a money-maker for the government, by re-packaging and selling mortgage-backed securities, where the mortgages backing the securities meet clear quality standards. In other words, it need not be a vehicle for government subsidy.

Usually, if an agency can turn a profit, that’s a very good argument that its function should be privatized. I think this industry is different. Home ownership has more than neighborhood-based positive externalities. It is the basis of stability for most participants in the economic system as a whole. Governments responsible to stakeholders can be motivated in their decisions to protect that function; private actors responsible to shareholders cannot. But that function is so important that when private markets falter, as they are faltering now, governments inevitably intervene in a triage fashion. I think that explains our schizophrenic relationship with housing finance entities (which we have nationalized, de-nationalized, re-nationalized, de-nationalized, etc. etc.).

A government function that can, without subsidy, make homeownership — and thus provide the basis of stability for particpiation in the economic system as a whole for many people — more available, based on quality standards enforced in the market, is a very worthy one. But more importantly: government particpation is inevitable. History has shown that again and again. The only question is whether we want it to occur in emergency, ad hoc fashion, or a more planned and stable way.

Thanks for an interesting post.