Wednesday, June 15, 2011

Comment On Mortgage Interest Deduction In NY Times Economix Blog

My comment to Economix in The New York Times, "The Misunderstood Mortgage Interest Deduction" by Casey B. Mulligan:
Actually, the consumer mortgage interest deduction is irrelevant because mortgage interest rates will adjust (rise) to account for the government tax deduction subsidy. The subsidy will increase the demand for mortgages, but not necessarily increase the overall demand for homes. A homebuyer has a fixed monthly cash flow to divide among taxes, home-related payments (including mortgage interest), other spending and savings. Lowering tax payments through a mortgage deduction will free up cash for home-related payments, which will increase the demand for larger mortgages. The availability of cash for a higher mortgage amount will allow consumers to increase their mortgage to home value ratio or to purchase a more expensive home. Either way, mortgage interest rates will rise due to increased demand for purchase mortgage funds for a larger principal amount and due to the increased risk of homeowner default due to the higher amount of debt and leverage, absent a government guarantee against homeowner default.

The mortgage interest rate will rise until taxes and mortgage payments are in equilibrium again, such that the combined money on taxes and house payments remains the same with or without a mortgage deduction. The government mortgage guarantee (direct and implicit), GNMA, FNMA, etc., prevents more debt and more leverage, i.e. a higher mortgage amount for the same house price, from coming into play. The government guarantee prevents the mortgage interest rate from risk adjusting for the increased risk of homeowner default from the higher mortgage to home value ratio and for the increased amount of household debt. Interest rates will increase solely due to increased demand for mortgage funds due to the tax subsidy created by the interest deduction. Mortgage interest rates will not rise due to increase homeowner default risk, until payment from the government mortgage guarantee agencies, (GSEs), is itself in doubt.

The interest deduction increases demand for mortgage funds, acts as a subsidy, which raises interest rates. A new equilibrium point will be set to meet the demand for more funds, which should be the same as without the interest deduction because the increase in mortgage interest rates will lower demand for mortgage funds until the total of tax payments and house payments are where they were without the mortgage interest deduction. The interest deduction should have no effect on overall demand for housing. Demand for housing is generally affected by other economic factors, such as a region's economic growth, employment opportunities, availability of homes, population mobility, etc. Additionally, the GSEs guarantees will allow homeowners to take on higher mortgage amounts in excess of their risk levels.

128 comments :

  1. loved reading your blog....
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  5. It is rightly said that the consumer mortgage interest deduction is irrelevant because mortgage interest rates will adjust (rise) to account for the government tax deduction subsidy.So I think consumer should not relax for such little comfort .

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