Of the many causes of our economic crisis, few were as damaging as the securitization of home mortgages. But there's another culprit - a tax benefit so popular with Americans that politicians question it at their peril.
First, let's examine the securitization issue. Large investors believed that the American housing market was a solid, low-risk way to invest billions of dollars. Corporate stocks might return more, but with greater risk; bonds might be less risky, but with less return. They thought mortgage-backed securities offered the ideal mix of strong returns with low risk. Millions of mortgages, pooled and sold like stocks, seemed like too good an investment to be true. And in the end, they were: Institutional investors, often highly leveraged, lost trillions as Americans began to default.
Then the finger-pointing began. Anti-government types blamed Fannie Mae and Freddie Mac for facilitating home loans to buyers who could not afford them. Corporate critics singled out greedy lenders for weakening their application criteria to the point where they were issuing so-called NINA loans ("no income, no assets") and creating adjustable loans that were initially affordable but became untenable when rates increased. Financial economists faulted banks and other institutional investors for becoming over-leveraged, and the lax regulatory structure that allowed them to lend huge sums without sufficient capital reserves.
A certain amount of blame was correctly aimed at homeowners who got themselves into mortgages they could, at best, afford only in the short term. Politicians and voters are culpable in another way, however, because the U.S. provides a powerful incentive to buy: the mortgage interest deduction. Yet as you listen to the national debate about the housing crisis, you won't hear a peep about this tax preference - because politicians of all stripes support it.
The mortgage interest deduction subsidizes homeownership. Unlike rent subsidies for the poor or seniors, we tend not to call this form of redistribution "welfare." But in the broadest sense, it is a form of welfare that largely benefits middle- and upper-class Americans, including this columnist.
Obviously, the intent and effect of this tax preference are to increase homeownership. It's working: About two-thirds of Americans own their homes, and homeownership is the single most important asset for tens of millions of citizens.
But the mortgage crisis also reveals the dark underbelly of the mortgage interest deduction. For one thing, it disproportionately benefits high-income earners who buy expensive homes. In 2003, taxpayers with incomes over $75,000 filed 16 percent of all tax returns yet accounted for 54 percent of the deduction's total tax savings; the 52 percent with incomes under $30,000 claimed just 9 percent of the tax savings.
This tax benefit also encourages people to buy a bigger house than they otherwise might afford. Indeed, because the deduction applies regardless of whether the borrower pays a high or low interest rate, makes a big or small down payment, or pays down principal monthly or opts for an interest-only loan, the mortgage deduction has the perverse incentive of rewarding higher-interest, lower-down-payment and interest-only loans - precisely the sorts of loans that got many Americans in trouble in the first place.
Under normal market conditions, the mortgage deduction is an important inducement to homeownership, even if it rewards those in the higher income brackets more. But its unintended consequence was to exacerbate a homeowner frenzy that swept up builders, buyers, lenders and investors.
You will be hard pressed to find a politician of either party in Washington calling for a re-examination of the unintended consequences of this popular tax preference, and none of us is willing to point a finger at ourselves either.
Thomas F. Schaller teaches political science at UMBC. His column appears regularly in The Sun. His e-mail is firstname.lastname@example.org.