Battered housing prices are central in today’s financial crisis, and some economists fear the economy won’t start reviving until home prices stabilize. Subsidizing banks and homeowners to prevent foreclosures and to encourage home buying can be exceedingly costly and might prop up prices in areas due for price corrections from unsustainably high levels.
So what’s a good way to encourage housing demand without breaking the government bank and in a way that makes long-term economic sense? Policymakers need to answer this question wisely and fast.
Step 1 is recognizing how rents and house prices interact. Surprising but true, despite the 15 percent nosedive in the median price of houses sold between December 2007 and December 2008, the Bureau of Labor Statistics “shelter index” - which measures rents or the rental value of an owner-occupied home actually increased in 2008. Rents rose by more than 3 percent and the rental value of owner-occupied dwellings, by 2 percent.
As foreclosures continue and mortgage options narrow, rents may keep climbing even as home prices fall further.
Given these realities, Congress and the Obama administration should consider allowing low-income recipients of rent subsidies to buy homes and use their subsidies to help pay the monthly mortgage, tax and insurance costs.
You might guess that current subsidies - costing the federal government at least $20 billion per year - are far too low to support a home purchase. That’s correct for some cities. But in others, home buying affords a much better deal both for government and for the person qualifying for a subsidy.
Before crunching the numbers, let’s look quickly at how the rent subsidy program works. The U.S. Department of Housing and Urban Development (HUD) establishes a “fair market rent” in each area equal to the 40th percentile of local rents. Say under HUD’s formula the fair market rent is $800 per month. If the family rents a dwelling for that amount and its household income after work expenses, child care and other exemptions is $1,000 per month, then it receives a $500 per month subsidy and pays only $300 in rent.
Why not use the same formula for home purchases? Instead of helping with the rent, the subsidy would apply to the monthly costs of a mortgage, insurance and taxes. To help with repairs, each month homeowners would be required to allocate a small amount toward an insurance pool managed by local housing authorities. Another requirement should be counseling or classes to make sure prospective buyers learn about finances and homeownership.
But would these subsidies really make home buying affordable? You get that answer by comparing the maximum rental allowances to the costs of buying a home. In many large cities, current rent subsidies are enough. In Detroit, for example, houses in the lowest third of the market’s price range topped out at about $72,000 in 2007. That same year, the fair market rent for a two-bedroom apartment was $793 per month. If the current renter borrowed the full $72,000 at 6 percent interest for 30 years, the monthly mortgage payment would be only about $432 per month. That leaves enough left over from the housing subsidy and the new homeowner’s personal resources to pay for taxes, insurance and repairs.
The story is much the same for Cleveland and Dallas, and even rosier for Pittsburgh. That said, this approach is a no-go in such pricey real estate markets as New York and Los Angeles. In such cities, government would think twice about pushing up housing prices anyway.
And even in communities where shifting the housing subsidy makes economic sense in general, not all families will be ready to assume the upkeep and other responsibilities. Yet, the approach would work well in areas of most cities and especially in economically depressed cities.
HUD already allows some local housing authorities to move from rent to homeownership subsidies. But so far, few renters have gained access to this approach - fewer than 2,000 of the nearly 2 million households getting subsidies - perhaps because local authorities want to avoid the administrative effort and prefer the status quo.
Amid today’s foreclosures and economic malaise, many more would-be homeowners might rush through that door if it were opened further - giving themselves and the housing market a leg up at no net cost to government.
Robert I. Lerman is an institute fellow at the Urban Institute in Washington and an economics professor at American University.