Mortgaging Household and Global Financial Stability: To What End?

Debt-financed housing was central to the recent financial crisis and subsequent Great Recession. Millions of leveraged homeowners lost trillions of dollars of wealth and the global financial system nearly collapsed. Our system of highly leveraged homeownership therefore deserves critical scrutiny. At the household level, three key features are involved: 1) A widespread preference and policy support for ownership over renting; 2) External financing exclusively in terms of debt (rather than equity); and 3) A relatively high amount of leverage, especially among ex ante financially vulnerable families. The collapse of the housing market proved to be profoundly damaging for many of these families. At the macro level, boom-bust housing cycles have been at least partially inflated by government policies of three types: 1) Tax preferences for owner occupation and debt financing among other policies; 2) An asymmetric monetary policy reaction known as the “Fed put,” which supported a private-sector debt buildup; and 3) Financial liberalization, which contributed to large housing bubbles and financial instability by increasing typical loan-to-value ratios. Despite clear links between highly leveraged homeownership and severe financial crises, little serious discussion of changing our housing-finance system has taken place. As a first step, we discuss modifications to the tax code that could support alternatives to leveraged homeownership.