Should Government Intervene in the Housing Market?

(gentle piano music)

Hal Weitzman: 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 percent before the crisis to about 64 percent 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.

Eric Zwick: 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.

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 that the effect of the program was to increase aggregate home sales by somewhere between 7 percent and 14 percent 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.

Hal Weitzman: So does that mean it succeeded on its own terms in what it was trying to achieve?

Eric Zwick: 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.

Hal Weitzman: OK, but in your mind this was a successful policy, right?

Eric Zwick: Sure.

Hal Weitzman: OK, I mean it would be more successful than letting the housing market take whatever turn it may have taken.

Eric Zwick: 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.

Hal Weitzman: OK, excellent. Bob Topel, you’ve obviously read the paper.

Robert H. Topel: I agree with everything in it except perhaps the conclusions. (Panelists laughing) 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, well, 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.

Hal Weitzman: OK, 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?

Richard H. Topel: You mean something like the mortgage subsidy, or that sort of thing?

Hal Weitzman: Yes, those kinds of distortion, government subsidies towards the mortgage market, the housing market.

Richard H. Topel: 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.

Hal Weitzman: OK, 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?

Eric Zwick: I think it’s hard to know the answer to that question, actually. A lot of the effects that 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 percent down payment. So an additional $1,000, $2,000, $3,000 or extending the window, it’s not clear that that would have . . .

Hal Weitzman: Or extending it to different kinds of buyers perhaps?

Eric Zwick: 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 is 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 in 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 that 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’d probably agree with Bob that a lot of intensive margin subsidies in the housing market just cause 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.

Hal Weitzman: Yeah, I mean, is housing, I guess the question is, is housing a reasonable vehicle for stimulating the economy?

Robert H. Topel: 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.

Hal Weitzman: OK.

Eric Zwick: 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 is 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.

Richard H. Topel: 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 that I think the existence of such an externality is probably fairly convincing. The fact that whatever the evidence is for . . . I mean, 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.

Hal Weitzman: OK. What about the mortgage deductions, since we’ve danced about it? Is it just generally positive or negative for the economy, Eric Zwick?

Eric Zwick: Given the size of the program, which I think the tax expenditure’s something like $70 billion—

Hal Weitzman: That, at the beginning, estimated to be between $70 and $150 billion. So large, let’s say.

Eric Zwick: 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.

Robert H. Topel: To abolished.

(Panelists laughing)

Eric Zwick: To replaced with nothing, just to be clear. (laughing) 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 that would 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 are there 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.

Robert H. Topel: 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, the 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 . . .

Hal Weitzman: So the old joke, I wouldn’t start from here.

Robert H. Topel: 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 health care. Americans overconsume health care because of that distortion, but getting rid of it is a much more costly thing because it’s so redistributive.

Hal Weitzman: 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?

Robert H. Topel: 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.

Hal Weitzman: Right, we might say government is inherently distortive of something.

Robert H. Topel: 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.

Hal Weitzman: So to go back to the question, who benefits and who is harmed by that subsidy?

Robert H. Topel: 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 redistributed 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.

Eric Zwick: 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 $1 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, or to increase relative to what they would in the absence of the program.

Robert H. Topel: 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.

Eric Zwick: But also, 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.

Robert H. Topel: And there it’s exactly the same as the health-care distortion, where we have an incentive to overconsume the thing that’s subsidized.

Hal Weitzman: 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? Does that have the same kind of effect as the mortgage interest credit?

Eric Zwick: There’s some argument that, which I don’t know has been demonstrated empirically, that having that support for the mortgage market, say, reduces interest rates or stabilizes them across places in a way that’s somewhat unnatural relative to the underlying risks from originating those things.

I think of that as being less of a concern than the problem with originate-to-distribute as a model for financing any kind of purchase, but one where there’s so much leverage and affects so many people is extremely problematic. So the fact . . . specifically what I mean by that is the GSCs buy mortgages that they’re not themselves the lending officers, they’re not the person talking to the borrower, and there are incentives down that chain, which I think is a more serious problem that should be addressed.

That problem exists in the private market as well, where, you know, private lenders sell loans, and to investors who don’t necessarily meet the borrowers, and the question is whether the private market can sufficiently sort of enforce that. That’s a separate question.

I think that’s the bigger problem for the GSCs.

Hal Weitzman: But those organizations are supposed to help promote homeownership to exactly the low-income groups that you said, or the ex-renters who cannot, are not in a position to buy, so why doesn’t that work? Or does it work?

Eric Zwick: Yeah, I mean I think we don’t really know. I think it probably helps make sure that there is some source of financing available during bad times when credit markets are weaker, although those are exactly the times when affordability or the likelihood or repaying is low.

I think we’re trying to reevaluate, I think, as a society how we should intervene in the housing market. As house prices increase a lot in places where the younger generation wants to buy, so in a lot of cities where also land use regulation is preventing a lot of development, which makes prices even higher and higher, I think we need to think about what role we want the government to have in the housing market because there are just going to be increasing calls from relatively uninformed people for support and help in the housing market in a lot of these places. We need to have good arguments for why we should or should not intervene. I think more research on this is needed.

Robert H. Topel: And the premise of the question though is that—of your question—was that a larger fraction of people, excuse me, should own houses rather than rent them.

Hal Weitzman: Well that was the intent, was that not the intent of the agencies?

Robert H. Topel: That might be the intent, but step back and ask, well is that something . . . is that a public-policy goal? Is there some market failure that’s causing more people to be renting and fewer people to be owning houses than would occur in an efficient world? That’s got to be the rationale for some government intervention, but I don’t know that there is such a distortion, that some people should be renting, some people should be owning, depending on their preferences and their financial constraints.

Whether we want to force at the margin or induce people at the margin to own houses is . . . I don’t know what the rationale for that is.

Hal Weitzman: Well as you say—

Robert H. Topel: And it can create its own problems as we saw in the housing crisis.

Hal Weitzman: Right, but as you say, the rationale is that there’s an assumption, whether it was in my question or in these agencies and the whole structure of government, that Americans should sort of almost have a right to own their own homes.

Robert H. Topel: Well they have a right to own their own homes.

Hal Weitzman: Well I mean, America has a right to let, to help people own homes.

Robert H. Topel: Yeah I have a right to own a red car, but whether I want to have it, or whether that’s what I’m going to do is a different thing.

Eric Zwick: I mean, is the ability of someone who . . . the inability of someone who’s going to have sort of a lifecycle profile such that they’ll have a higher income in the future but don’t have sufficient income presently, sort of like, so they could afford to make the monthly payment, in fact their rent is similar to the monthly payment, nevertheless they can’t borrow, collateralize that income, or they can’t save up the down payment, so there’s essentially like a, they’re off their Euler equation. This is, I think, the closest rationale.

Robert H. Topel: You promised you wouldn’t say that.

(Panelists laughing)

Eric Zwick: I’m sorry.

Hal Weitzman: And now you said that, explain what you mean.

Eric Zwick: Yeah, yeah. They’re essentially at a corner where basically they want to buy something that would make them better off. They can actually afford to buy something. They in the future will have a lot of income. They can afford it if you think about their permanent income or their lifetime income or something like that, but the credit market says, no no no, you need to have sufficient savings to put 20 percent down, or like [Boston University’s] Larry Kotlikoff says, 100 percent down is necessary, or this kind of a thing, and that actually could lead to welfare losses if that credit-market failure is present.

Robert H. Topel: But you’ve assumed a credit market failure.

Eric Zwick: I proposed one.

Robert H. Topel: And a skeptic would say there’s a reason that I want people to have the wherewithal to make those payments and because, remember what Eric said, that they can afford it in some present value of their wealth sense, but the credit market’s not willing to lend to them against that wealth, and there’s a reason why you have more stringent requirements for borrowing than you would have in a subsidized market.

Eric Zwick: I mean it is illegal to borrow against your future earnings because you can’t commit yourself to be a debtor’s prisoner.

Robert H. Topel: Well, no. That’s true. You cannot become a debtor’s prisoner, but you know I can go to the bank and say, I make this amount of money, and things have been going well, want to loan to me? And they can make the loan.

Eric Zwick: But if you don’t have the down payment, there’s a down payment rule essentially.

Hal Weitzman: So in your mind, is that a market failure?

Eric Zwick: It could be, I think. And I’m actually working on research to try and explore that more rigorously I think.

Hal Weitzman: Specifically the down-payment part.

Eric Zwick: This is, in my mind, the strongest case that can be made for promoting homeownership, so we should indulge it and see how tenuous the case is. I think that’s kinda the, that’s like the right Chicago Approach to like, you know, I don’t know at least like indulge it, but really then be skeptical at the same time.

Robert H. Topel: On that we agree.

Hal Weitzman: Are there other kinds of . . . you referred earlier to other kinds of market failures. Where else do you see that this kind of program that we talked about at the beginning, that the stimulus might be able to help in reallocating resources?

Eric Zwick: Yeah, so, well, specifically I think Bob pointed to the foreclosure externalities, and this is related to how appraisals work. This is related to how people in neighborhoods can affect what their neighbors are doing to homes, and when there are homes that are unused, and you know the grass isn’t being mown and stuff, and someone shows up to look at the house, they say, I don’t want to live in this neighborhood, that goes that quickly, and you know, [the late Ronald] Coase would say absent transaction cost, that should be solvable in the private market, sorry, but where they’re going to negotiate and pay themselves, but you know that doesn’t happen, and that’s a market failure that I think of that this program specifically addressing at this point in time. It’s not sufficient, necessarily. You also need to have buyers that would use these assets that can’t get in there as well, which is where I come back to this credit market failure because if they don’t want to buy in a random place in the middle of Florida where there was a development, and no one wants to actually live there, then moving people into those homes isn’t actually creating any welfare.

Hal Weitzman: Right.

Robert H. Topel: You need to make a case even for that externality that intervention to target that is a useful way of spending society’s resources, especially when the marginal . . . I’m going to use the term, the “marginal cost of public funds,” which is how much we take out of private activity in order to get a dollar’s worth of public expenditure, and it’s way bigger than a dollar, so there’s a distortion there and in the way the government targets how it’s going to spend its money.

If I think about this externality you called the foreclosure externality, but it’s true all the time. You drive through any neighborhood, and the guy who doesn’t mow his lawn is creating an externality for the people next door. And we have ways for the government to intervene in those cases, which is we have rules for how neighborhoods have to be kept up and things like that. Whether you want an intervention in markets with an increase in government spending to internalize that particular externality is a leap of faith, I think, at this point.

Hal Weitzman: Right, might be cheaper just to make sure everyone’s mowing their lawn.

Robert H. Topel: Or it might be cheaper and more efficient just to leave it alone and recognize that externalities are everywhere in terms of loud noise and unmown lawns and things like that, and you can’t fix them all.

Hal Weitzman: Sure. Is there something unique though about real estate? So is there another market where you see the similar kind of failure that might be reallocated, Eric Zwick?

Eric Zwick: Well it seems like real estate, I mean, is the . . . it’s a nice market to be thinking about because it is the, since it’s the largest asset class in the country, in the world—land plus the structures on top of it. it’s a market where a lot of debt is used because of the tangibility of those assets. You can really borrow and leverage up against them. We’ve had colleagues here who have studied in great detail the effects of too much debt, or how debt can cause other problems. And so I think it’s a market that’s very interesting for macroeconomics to think about as well, and it’s a service that everyone consumes, whether by owning or renting. It changes the structure of cities, and sort of affects . . . So I think it’s a very, you know, an important market, and the cost of it means that the government gets involved a lot of different ways. There are a lot of interested parties as well, home builders, realtors, the financial institutions who benefit from activity in the real estate market.

Monetary policy is most effective probably in inducing reallocation in overtime or when people buy homes or refinance and this kind of thing, so we can think about a lot of policy as operating through this market. So that was a rambling answer to your question.

Hal Weitzman: Well, but are there other markets where you might imagine a market failure that would justify an intervention?

Eric Zwick: Of this type? I think it’s harder, although it is the case that deep recessions in a lot of countries around the world right now have a significant real estate component. And I’m thinking specifically of Southern Europe, Ireland, China. I think these are all places where there has been dramatic sort of booms in construction, development, real estate. There are potential for these kinds of programs to be used, whether the externalities that we’ve talked about are present in those situations as well I think is a question that needs to be addressed on a case-by-case basis.

Robert H. Topel: The housing market is a capital market, and capital here means physical assets that are built today in anticipation of their use over a long period of time, and that inevitably involves expectations about what the future’s going to be like because you have to decide what value these assets are giving us over time.

So much of the stuff that would motivate interventions in one capital market, were they true, would motivate interventions in other capital markets. So during a boom, if we invest a lot in shopping centers or machine tools or whatever like that, and then the machine tools are sitting idle at the onset of some crisis, is there a case for intervening in the market—I’m putting it as much as I can in the context that you’re in—of saying, hey look, these guys over here should be buying those machine tools, and these guys are just waiting for the price to come up before they want to sell them. So if you believe that, then it seems to me the case would be similar for reallocation, or so-called stimulus, in those markets as they are in the housing market. Except that, you know, the voting weights are probably a lot different in who makes these policies.

Hal WeitzmanL But if you’re worried about sort of mission creep there, is there nothing different for you about real estate for the reasons that Eric mentioned?

Robert H. Topel: No, there are things that are different about real estate. These things are taken out as individual loans, securitized against only the house, and these machine tools or something like that, they’d be securitized against the machine tool. It’s a productive asset that can be used there, and there aren’t as many subsidies in that market, or distortions in that market, I think as there are in housing.

Hal Weitzman: But I’m saying, the reason for those distortions is because there’s something different about housing?

Robert H. Topel: From my perspective, at 30,000 feet, it’s not all that different, housing versus the machine tools.

Eric Zwick: For me it’s just about the size of it, I think. The capacity to affect the macroeconomy potentially, and the historical record of cycles in the housing market leading the business cycle more generally suggest that . . . just because it’s the largest durable-good asset class. But I agree with Bob. I think durable goods are a general class of things that people buy, cars, houses, machines, furniture, suits. I bought this suit a long time ago (chuckling), and so these kinds of decisions can be thought of in this general way, and then the other sort of externalities can be evaluated. Does it make sense? If I let my suit sit in the back of the closet in disrepair, how much harm to society am I doing? Not much, depends on how much they like seeing me in a suit.

Hal Weitzman: OK, well I think we can all agree that we may need to reallocate some of the suits from our closets, but on that note, I’m afraid our time is up. My thanks to our panel, Bob Topel and Eric Zwick.

For more research, analysis, and commentary, visit us online at review.chicagobooth.edu, and join us again next time for another The Big Question.

Goodbye.

(gentle piano music)