In a column last week, Paul Krugman questioned whether it makes sense for the government to subsidize home ownership. Krugman wasn't dissecting the mortgage interest deduction in particular. He was asking a more basic question, "Do high homeownership rates on balance make us better off?"
Widespread home ownership obviously has some pluses. Home owners have an incentive to keep up their properties and neighborhoods, and they tend to demand better local government than renters.
Krugman identified some disadvantages, too. Home owners are less mobile than renters, which makes them less flexible during economic downturns. More single-family homes mean larger and more distant suburbs, and thus longer commutes. (He could have added that resources devoted single-family homes are diverted from other productive uses, such as new factories or start-up companies.)
But I think Krugman got this one wrong:
[T]here’s the financial risk. Although it’s rarely put this way, borrowing to buy a home is like buying stocks on margin: if the market value of the house falls, the buyer can easily lose his or her entire stake.
Krugman is implying that we should worry about the financial risk of homeownership out of concern for homeowners. I think we should worry about the financial risk of homeownership out of concern for cities.
Homeowners are intensely risk averse. The reasons are obvious: (1) home owners tend to be highly leveraged; (2) their homes are by far their largest asset; and (3) a home is an illiquid asset. If a homeowner has just 10% equity in his house, a modest 3% swing in the home price causes a 30% swing in the value of his largest asset. And it's an asset that he cannot easily dump if things start looking bad. (I suspect that home owners in "stepping stone" neighborhoods are the most risk averse of all.)
Because home owners are risk averse, they are "change averse." They understandably are allergic to changes they reasonably believe will hurt their home values (such as a landfill or homeless shelter moving next door). But they fight other changes that at first blush one might expect them to welcome. They often fight new development projects nearby even though the projects are likely to enhance home values. "Likely" is not the same thing as "sure thing"; there is a chance the development will deflate rather than inflate home values. (For example, homeowners may worry that a high-quality multi-family project will deteriorate over time to "affordable housing," a euphemism for a lower class of resident.) Because it's hard to predict exactly how any given development will play out, risk-averse home owners tend to oppose chancy neighborhood development.
But this puts homeowners crosswise with optimal city development policy. A big city has a highly diversified portfolio of development sites. A growing city will have many prospective projects scattered around. Sure, some of these projects will be busts, but more likely than not they will enhance value (provided they are subject to "reasonable" constraints). Because a city is hedged against the risk of a single project going bad, it can trust that the odds will even out over time. To maximize community welfare, it ought to take risks with development. It should end up with more good projects than bad and more robust and flexible residential and commercial markets as a result. ,
A high rate of home ownership within the city, however, stacks the deck in favor of homeowners. Not surprisingly, the result is a city government that is less tolerant of risk than it ought to be. High home-ownership rates encourage cities to hold development below the optimal level.
These are not the only instances in which homeowners systematically oppose optimal city policy. Homeowners have an incentive to restrict new housing supply to prop up home prices. Homeowners tend to insist that local development cater to their neighborhood rather than contribute to specialized, regional trading centers.
Put it all together, and high rates of home ownership lead to inefficient land use policies. This may be the most insidious effect of the government's encouragement of home ownership for everyone.
