-- Posted by Neil H. Buchanan
Earlier this week, I posted some thoughts on the ongoing mortgage crisis, describing various reasons why federal intervention is necessary and appropriate given the depth of the current problem and the circumstances under which mortgage loans are arranged. No matter how one feels, however, about the best way for policy makers to respond -- or, for that matter, whether they should respond at all -- this crisis raises a much more fundamental question: Why do so many people take out mortgages in the first place?
With so many people facing financial ruin over mortgage deals that they can no longer afford (if they ever could), why are we not asking whether widespread home ownership itself is at the root of the problem? Now that the recent housing bubble has burst, it seems obvious that too many people who shouldn't have tried to buy houses were approved to take out mortgage loans. One take on the problem, therefore, is that these people were simply not yet ready for the ultimate prize of owning their own home.
The current problem is thus another one of those crazy interludes that occasionally infects financial markets (and that will take years to clean up). Although the bubble years were indeed crazy, however, the problem goes deeper than that. In fact, it is fairly clear that widespread home ownership really doesn't make sense even when there is no crisis.
For some people, the numbers add up, but for others they really do not. (This is not, by the way, a matter of income levels. Even for many middle income and high income people, renting makes more sense than buying.) See, for example, a web calculator from the New York Times that was posted last year under the headline, "Is It Better to Buy or Rent?" It is fun (in its nerdy way) to plug in various plausible interest rates, resale prices, etc., to see how long one would have to own a home before buying would become financially superior to renting, if ever.
Having owned five homes in my life (none for more than four years) before returning to rentals a few years ago, I have played with these numbers quite a bit. It is truly surprising how difficult it is to find a situation in which owning beats renting in anything less than 8 or 10 years. Given that the average American homeowner moves after 6 years, this says something pretty important about the choices we are making about the biggest purchases of our lives.
What is especially important to notice about these calculations is that The Times's calculator takes into account the tax advantages of home ownership versus renting, the accumulation of equity in the home, etc. It is truly an apples-to-apples financial comparison, including the “opportunity cost” of putting money for the down payment and a portion of each month's loan payment into home equity instead of interest- or dividend-bearing financial investments.
In other words, the standard claims that "paying rent every month is just throwing money away" (as if interest paid on a mortgage is somehow saved), that "the mortgage interest deduction is the great middle-class tax break," and that "home ownership is the surest way to build up financial security" do not withstand scrutiny. The housing market has generally incorporated the tax advantages into prices, and the only financial advantage to home ownership comes from imperfections in the market -- which are legion but which can also cut in the other direction.
If all of this is true, why do people view home ownership as part of the American Dream? (Actually, this mythology apparently extends beyond the borders of the U.S. I was driving through Ontario earlier this summer and saw a sign for a suburban housing development on which a home building company reminded us that it has been helping people "achieve the Canadian Dream for over 30 years.") A big part of the story is direct government policy. The mortgage interest deduction, the deduction for state and local taxes, support for Fannie Mae and Freddie Mac, direct subsidies for loans and first-home purchases, etc., are all based on the idea that home ownership is the ultimate goal of adulthood.
That this system creates huge economic problems, including the tying of people to pieces of property even when there are better and more productive job opportunities available to those who could move elsewhere, is left out of the celebration of white picket fences and apple pie. This is also a particularly good example of how preferences are largely a social creation, not something that people come upon merely through private cost-benefit analyses. Everyone wants to buy a house because everyone else says that they should.
Without such an array of social and policy signals, the hassles and perils of home ownership would surely be a lot clearer. By this point, the cult of home ownership is so ingrained into the nation's psyche and policies that it should only be unraveled with a great deal of attention to the dislocations that would come from a mass movement away from individual home ownership. Given that just the current crisis alone is going to cost us -- privately and publicly -- trillions of dollars and millions of ruined lives, though, it is important to get started.