[O]ur housing consumption binge is now over and there is more than enough blame and souring loans to spread around. (See my, "We Have Met the Enemy, and He Is Us," published in slightly different form by the Wall Street Journal under their title, "The Clinton Housing Bubble").
This bubble had significant new features. Topping my list: in 1997 President Clinton signed into law the Tax Relief Act (sponsored by Republicans in both houses) with overwhelming bipartisan support. This law allowed all of us to take a tax free capital gain up to a half million dollars on homes sold.
Enter the financial market innovators, who pushed mortgage securitization as a mechanism for generating more liquid national markets for mortgages and helped us all become tax-free half millionaires by selling our homes. Their so-called "agency problem" (as well as that of Fannie Mae and Freddie Mac) is just economic jargon for bad incentives to provide investors with a little packaged truth about real economic risk -- risk that was historically recognized in the sizable down payment requirements.
But in the wave of a tax-free, get rich quick bubble, what is the truth? If builders, buyers, realtors, lenders and mortgage packagers all think their asset prices will be higher tomorrow, then the down side risk is beyond perception, and we have a widespread agency problem with ourselves. The creativity of traditional due-diligence is swept aside.
Politically, correcting this will be even harder than getting rid of the ethanol subsidy for corn. But it's time to phase out Fannie Mae and Freddie Mac -- let them go the way of the S&L. (Of course, this will be difficult because the political process has the biggest "truth in packaging" problem of all.)
Also, if you are going to insist that the consumer-durable good called "housing" enjoy tax-free capital gains status, then please extend this provision to apply to all assets. If you sweeten only one asset then you can expect capital to flood into that asset exactly as we have witnessed! Or, better yet, ignore the distinction between capital gains and income, and allow all saving/investment to be deducted from income for tax purposes.
Read the whole thing.