Mass. Exodus
Massachusetts is one of the richest states in the country — because it’s pricing out its own middle class. Why did the state stop building enough to house them?
Big government, not the free market, is the reason the suburban single-family home has become the symbol of the American lifestyle.
Across the United States, it is functionally illegal to build housing like what you find on Elfreth’s Alley, Philadelphia, one of the most photographed residential areas in the country, famous for its gorgeous row houses in the middle of the city. At the same time, the federal government subsidizes the construction of McMansions in greenfield locations miles from the nearest town center.
Thanks to incentives to take out large long-term mortgages, for many buyers the key consideration in buying a house is how well it can store and generate financial value — overriding considerations like location, amenities, and beauty.
Here’s how the system, the American system, works: First, the state or city defines the standard product, through zoning and other rules. The product is a single-family house on a lot large enough that it can only be sited in the suburbs or exurbs. Then, the federal government subsidizes the product. It gives buyers a special government-backed loan to buy it and tax breaks for owning it, and then helps pay for the highway needed to reach it.
This system is a deliberate creation of the government, going back many decades. It is not a product simply of demand meeting supply at agreed-upon prices. Ostensibly, it is meant to promote homeownership. But in reality, it does not. Instead, it encourages mass financial speculation on housing, urban sprawl, and widespread resistance to new construction.
Elizabeth James was just 22 when she was convinced to buy a house in Jacksonville, Florida.
James, whose name has been changed to protect her privacy, had absorbed the message communicated by the federal government, and by a close friend who happened to be a mortgage broker, that homeownership is the way to build wealth.
Although she was not yet settled in her career, she took a major financial risk and took out a mortgage to buy a home in a neighborhood far from where she’d been renting. For her, it marked the first step toward prosperity and into adulthood.
Soon, though, James felt regret. She didn’t fit in with her neighbors and didn’t feel as safe as she did in her old neighborhood. In time, she realized that she was having to drive whenever she wanted to socialize with her friends or go to a bar — major downsides for a single person, as she was then.
She has since moved away and lived in several cities in the United States and in Europe, and has come to understand the importance of the real estate saying “location, location, location.”
Now, in her forties, she lives closer to the core of a big city and isn’t looking to buy if the conditions aren’t right — for instance, if she has to drive an hour outside the city to find a house she would qualify to buy. She wants to be around people who share her interests, and to be able to walk to a grocery store or a pharmacy.
“I think I’ve also realized that a home is not necessarily always an investment as well, and I think that I originally thought that was the case,” she said in a phone call. “I think it’s a place that you live.”
The idea that filtered down to young Elizabeth James — that homebuying is the path to wealth — did not spring up organically. It was promulgated by the federal government over the course of a century, starting with Herbert Hoover.
Hoover, as commerce secretary under President Warren Harding, outlined his vision in a 1922 speech for a housing exhibition, titled “The Home as an Investment.” In pursuit of that scheme, Hoover sought uniform building codes and zoning rules across the country. In 1924, when relatively few localities had zoning, his agency published a model zoning law that, by 1930, thirty-five states had adopted.
What happened in those years was critical to defining the American system of housing. Advised by powerful private industry groups, such as the National Association of Real Estate Boards, the Hoover Commerce Department firmly rejected, as socialist, the model of building public housing that had gained steam in France and the United Kingdom. Instead, it backed a system in which housing was built by private interests — soon, with aid from the government.
At the same time, the agency promoted standardization to ease operations for large businesses. The idea that diverse local codes could allow for differing wall thicknesses or floor loads, for instance, presented an obstacle to construction firms working at a massive scale throughout the country.
In other words, the Hoover Commerce Department began the tradition of the federal government promoting a model in which housing was a standardized consumer and industrial product, one that could be manufactured at scale just as easily in the arid heat of Arizona as in the rolling Green Mountains of Vermont, and financed by an investor in New York City just as well as by a small local bank.
It is true that the United States had a pre-existing pro-suburbs movement in the 1800s, led by thinkers such as Catharine Beecher and Frederick Law Olmsted, that promoted an ideal of the detached home with a yard as combining the best of urban living and rural tranquility. What the Hoover Commerce Department launched, though, was instead a project to transform housing into an investment product that could be quantified, regularized, and generally made legible in a way conducive to the workings of big business, creating the conditions for the sprawl that would later take over America.
Presidents of recent decades would go further. Bill Clinton in 1995 laid out a National Homeownership Strategy, describing a house as an “asset that can grow in value and … generate financial security.” His Department of Housing and Urban Development backed the idea of homeownership as a “forced savings plan.” Both Clinton and George W. Bush, with his vision of the “ownership society,” would seek to boost homeownership rates by letting low-income families take on greater mortgage debt, to disastrous effect in the financial crisis of 2008.
In fairness to politicians, when they tout homeownership, they are simply recognizing the financial reality that homes account for more than a quarter of total household wealth. Two-thirds of U.S. families own their homes, with a median value of $323,000, according to Federal Reserve data. In comparison, the median value of total household assets is only slightly higher, $332,000.
And homeownership is thought to confer benefits not just for families but for their neighborhoods and the broader civil society. Homeowners are more likely to maintain gardens and to engage in church groups. They are also more likely to be engaged in local government.
To conservatives, the “ownership society” rhetoric is appealing because homeowners have more “skin in the game” with respect to taxation. To progressives, homeownership is a worthy goal because it shields lower-income families from inflation and gentrification.
But politicians of both parties have failed to understand the unintended consequences of policies meant to boost homeownership. Most consequentially, those policies do not in fact increase homeownership rates. Instead, they increase housing debt and housing size, thereby encouraging families to overinvest in housing. This is known thanks to a large and growing body of economic literature, and to comparisons with other countries that do not subsidize housing in the same way.
To understand why existing federal policies increase debt and home size — and thereby sprawl — it is best first to take stock of what the main policies are.
One consideration that played an overriding role in Elizabeth James’s decision to buy the Jacksonville home was the fact that she could deduct interest payments on the mortgage from her taxes.
Although the mortgage interest deduction is now fiercely defended by the housing industry, it did not begin as a pro-housing measure. The original Revenue Act of 1913 allowed for the deduction of all sorts of interest payments, effectively treating households like businesses, for whom interest payments are ordinary deductible business costs.
Ronald Reagan’s landmark 1986 tax reform did away with individuals’ ability to deduct other forms of interest paid, such as for credit cards. But it maintained the mortgage interest deduction. Reagan told the National Association of Realtors before the bill’s enactment that “we will preserve that part of the American dream which the home mortgage interest deduction symbolizes.”
The value of the deduction was temporarily limited by the 2017 tax overhaul, commonly known as the Trump tax cuts. In 2025, the deduction will account for almost $26 billion in forgone tax revenue, the Joint Committee on Taxation estimates. If the Trump tax cuts expire as scheduled at the end of this year, that amount would jump to $94 billion next year. As a point of reference, that is a tax expenditure — that is, essentially spending through the tax code — about ten times larger than the Environmental Protection Agency’s annual budget.
Yet the mortgage interest deduction is just one of several major federal tax breaks for housing. Homeowners can also deduct property taxes paid to state and local governments. As with the mortgage interest deduction, this tax break was effectively grandfathered into the code and reflects America’s unique federal–state system of governance. No other country has such a tax break.
In 2022, $107 billion was claimed in deductions for state and local property taxes paid, translating to a tax expenditure of somewhere in the ballpark of $7 billion. This expenditure too, though, will be far larger if the Trump overhaul expires, on the order of $50 billion.
The other major explicit tax break for housing is that homeowners who sell their house are not taxed on their gains, up to a limit of $500,000 for married couples. This measure, which will lose the federal government about $46 billion this year, was added to the tax code in the 1950s, a period of rapid industrialization, to make it easier for families to sell their homes and move if necessary for work.
There is one more housing-related tax break of significance, one that is a bit difficult for most Americans to wrap their heads around. It is that homeowners do not have to pay income tax on what is called “imputed rent.” To understand this tax break, consider two hypothetical people, Arnold and Bob, who each have $500,000 in cash. Arnold buys a house and rents it out to a tenant, who pays $3,000 a month. Arnold has to pay income taxes on that $3,000 in rental income. Bob, meanwhile, buys a house that is the same as Arnold’s for all possible uses, but he moves into it himself. Bob doesn’t have to pay any taxes on the $3,000 “rent” that he effectively pays to himself.
This is not merely a theoretical tax situation. In Switzerland, for example, homeowners must pay taxes on Eigenmietwert, or imputed rental income.
A year after Reagan’s tax overhaul, in 1987, the Danish government, as part of a raft of reforms meant to end years of inflation, enacted a tax overhaul that cut back significantly on interest deductions, including those for mortgages. The reform affected households differently based on their income, creating a sort of natural experiment.
In 2017, a group of economists led by M.I.T.’s Jonathan Gruber concluded, using data based on a census of the Danish population, and looking at reactions to the reform by income, that the change did not affect homeownership at all. Instead, it led to smaller home sizes and lower prices.
Maxence Valentin, an economist at ETH Zurich, is the author of a recent survey of the econometric evidence regarding tax breaks for housing. “It’s still quite a big amount of money that is spent by the federal government that just keeps prices high,” he told me in a phone call.
Such results are not a surprise to economists. It is to be expected that tax advantages get capitalized into the price of a house. Consider a homebuyer with a housing budget of $3,000 a month. At today’s rates and with a 20-percent down payment, that would allow him to buy a house in the ballpark of $500,000. If he gets a tax break for mortgage interest payments, though, he could afford a house of perhaps $550,000 on that same budget. In a market where supply is constrained — which is most housing markets these days — prices just get bid up, and most of the extra $50,000 is pocketed by the person selling the home.
Over time, any policy meant to attach a benefit to owning a home is going to disadvantage homebuyers, making it a wash for homeownership rates.
“We end up with a fundamental contradiction in our housing policy,” said Alan Durning, the executive director of the Sightline Institute, a nonprofit organization in Washington state, in a video call. “We want affordable housing for everybody. We also say we want housing to be an elevator to the middle class, as a form of wealth building. And it cannot be both those things.”
Who gains from the tax breaks? Only those who benefit from high housing prices. That would include the real estate agents, homebuilders, and mortgage brokers, whose pay is tied to prices and loan volumes, Durning said. The National Association of Realtors in 2017 strongly opposed the Trump tax overhaul’s provisions limiting the value of housing tax breaks. They said that it would “deliver a crippling blow to middle class homeowners.”
In fact, the law did not hurt homeowners or homeownership. The key reform included in the law was the effective doubling of the standard deduction, which reduced to just 10 percent the share of people who itemize, or claim specific deductions, such as the mortgage interest deduction.
On top of that, for those who do itemize, the law limited the mortgage interest deduction to the first $750,000 of principal, down from $1 million. And it capped the deduction for state and local taxes paid to $10,000.
Those changes, all else equal, led to lower house prices, according to Valentin’s review. A separate analysis by the economist Dena Lomonosov that looked at granular data in New Jersey found that being shunted into the standard deduction led homebuyers to purchase smaller, less expensive homes and to take on less mortgage debt.
In other words, the temporary 2017 tax reforms led to less housing indebtedness, but not lower homeownership. The post-overhaul experience is evidence that the existing federal subsidies for housing do not promote homeownership, but rather encourage speculation on housing, generally in the form of pricier, bigger homes — which also encourages sprawl, as we will explore.
In addition to tax breaks, the American system is also built on hidden subsidies for mortgages that nudge families into overinvesting in housing.
Today, the homebuying process often begins with a web search: “How much house can I afford?” From there, it’s easy to follow the links to get approved for a mortgage online. What few people realize is how many federal government policies operate on the back end to make such a question conceivable. A whole ecosystem of rules, regulations, and implicit subsidies makes it possible — and easy — for a middle-class family to have access to a 30-year fixed-rate loan.
Meanwhile, an investor in New York — or even in London or Munich — can easily get a cut of the profits on a loan given to a retail employee in Nebraska.
What made this system of financialization possible, as Adam Levitin and Susan Wachter write in The Great American Housing Bubble, was the rise of securitization through the government-sponsored enterprises Fannie Mae and Freddie Mac.
The government’s role in securitization of housing began with President Hoover, who signed legislation to create the Federal Home Loan Banks, which provide liquidity to mortgage lenders. “In the long view we need at all times to encourage homeownership and for such encouragement it must be possible for homeowners to obtain long-term loans payable in installments,” Hoover said at the time.
But government involvement in housing finance took off following World War II, after the 1944 GI Bill authorized the Department of Veterans Affairs to guarantee home loans for the millions of servicemembers returning from the war. To make the loans affordable, they were to be amortized — that is, paid in installments — over a period of up to 20 years, later extended by Congress to 30 years. Prior to the war and the Great Depression, the home loans on offer from banks were generally much shorter “bullet” loans, where one would pay only the interest in intervals and the principal at the end of the term.
Meanwhile, the convention of a 30-year term for mortgages set by the VA was in time adopted by the other federal housing finance agencies that were set up during the New Deal in an effort to effectively bail out the mortgage market. One is the Federal Housing Administration, which is meant to encourage mortgage lending by providing insurance on mortgages originated by banks and other lenders. The other is the Federal National Mortgage Association, or Fannie Mae, which was created to buy insured mortgages from lenders, creating a secondary market for home loans.
With those policies developing in the years after the war, the basic government infrastructure was in place for the mass securitization of home loans. Family decisions about where to live were increasingly shaped by the availability of standardized long-term mortgages.
Around the same time, another policy tilted the scale in favor of homebuying, which was the wartime imposition of rent controls on about 80 percent of the stock. Sales prices were not capped, creating a massive distortion against rentals — such as apartment buildings — and in favor of housing for sale, such as detached homes.
Securitization would become more prevalent as the suburbanization of the country proceeded. Fannie Mae, and its later counterpart Freddie Mac, evolved over the years, eventually becoming private enterprises that package mortgages into securities to sell to investors with guarantees that they’ll be made whole if the loans go bad. This guarantee was and is effectively a government policy. Fannie Mae and Freddie Mac were always thought to have the backing of the government, and indeed they were taken into the federal government’s custody in 2008, during the financial crisis.
Today, Fannie Mae and Freddie Mac, under the direction of the Federal Housing Finance Agency, together with the Federal Housing Administration and the VA, buy two-thirds of all the home loans that are originated by mortgage lenders.
The government guarantee for mortgage-backed securities means that investors who buy them don’t need to worry about the safety of the underlying home loans. To investors, the mortgage-backed securities guaranteed by the government are like U.S. treasuries — ultra-safe bonds that can be bought on a massive scale. The Federal Reserve alone holds $2 trillion in such securities. International buyers are some of the biggest financial entities in the world. In that way, the most local decision of all, of where to live, is transmuted into the most global financial asset.
The dominant role of these government-sponsored enterprises in the housing finance market is assured by the fact that investors know that they would be bailed out (again) if they failed. As a result, Fannie Mae and Freddie Mac are able to borrow to fund their own operations more cheaply than other financial institutions are. Ultimately, some of those savings are passed on to the mortgage borrowers.
The scale of those savings is a matter of debate. One plausible estimate is based on comparing borrowers just above and below the ceiling for mortgages that Fannie Mae and Freddie Mac are allowed to purchase, which is a little over $800,000, or $1.2 million for high-cost areas. The economists Bowen Shi and Yunhui Zhao found that the government-sponsored enterprises subsidize borrowers to the tune of about 0.25 percentage points of their mortgage rate, increasing the average loan amount by more than $15,000. In aggregate, the subsidy adds up to about $11 billion a year, according to the Congressional Budget Office.
But the effects are even more profound than that. It is the backing of the government that allowed the 30-year, fixed-rate mortgage to become and remain the norm in the United States, making housing a favorable investment for most families. Homebuyers can get a bank to lend them hundreds of thousands of dollars to invest in housing, with only 20 percent down, but they generally are barred from investing in other assets, like stocks, on similar terms.
For Americans, that feels like a fact of life. But the United States is actually a global outlier in offering borrowers 30-year mortgages with fixed rates and no prepayment penalties — meaning they can refinance at any point if interest rates fall, making it more attractive to take on such debt.
Taking into account all the government support for housing, including both credit subsidies and tax breaks, the United States is second only to Singapore in terms of government intervention in housing finance, the International Monetary Fund has found. Yet even with this level of government intervention, the United States is middle-of-the-road in terms of homeownership rates.
The Seattle-based Sightline Institute, Alan Durning explains, works to trim back the thicket of local zoning and land-use rules that make it difficult to build housing in the Northwest. In researching how such rules differ between the United States and other countries, Durning came to realize the unique role the U.S. federal government plays in contributing to sprawl via subsidies for home borrowing. “The net effect of the policy,” he said, “is to encourage outward sprawl in most metro areas, and price escalation for fancy condos in the few dense cities that we have,” such as New York City and San Francisco.
A key factor is that city centers cannot easily accommodate new houses. Only areas of sprawl can fulfill the demand for houses that are investment vehicles. “When you give incentives to spend in housing, people will tend to buy bigger houses,” Maxence Valentin said. “That has an impact then on how much land is used by those houses and where you’re going to build.” And where you are generally allowed to build big houses is outside of the city, in greenfield locations.
In addition to subsidizing your loan for a house out there, the federal government will help pay for your highway commute. In the postwar period, following President Dwight D. Eisenhower’s signing of the Federal-Aid Highway Act in 1956, drivers did not fully pay for the highways they drive on. Today, highways are only half paid for by users through tolls or other fees.
It’s hard to imagine, decades later, that it was not always this way. Indeed, in earlier versions of the suburbs, it was the other way around: developers owned and operated streetcars to bring people to new neighborhoods.
In other words, the interaction of federal subsidies with state and local building restrictions effectively codifies the model of “drive ‘til you qualify” — the real estate lingo that represents the reality of homebuying.
True, cities have always grown in size, as successive technologies — the railroad, the electric streetcar, and then the car — have made it possible to live farther out and still maintain a job in the city. But by artificially lowering the marginal cost of long commutes, the government exacerbates sprawl, explained William Emmons, a Washington University professor, who worked on mortgage finance and banking supervision at the Federal Reserve Bank of St. Louis for nearly three decades.
“These are a whole bunch of complex interrelated factors, and they’re affected by multiple levels of government,” he said in a phone conversation. “Anybody who gets interested in reform pretty quickly recognizes that this is a jungle, it’s a tangle of policies.”
When your house is your nest egg and your wealth is tied up in the value of your house, you are more likely to be cautious about any changes to your neighborhood that could lower housing values. Such risk aversion, the housing economist William Fischel has theorized, is the reason for the existence of “NIMBYs” — people who say “Not In My Back Yard” to new construction.
Now, development can also increase home values. Homeowners whose suburbs became as dense as Midtown Manhattan would become unfathomably rich. But when your family’s financial security could be ruined by one bad construction project in your neighborhood, you are much more likely to be extra cautious about what’s allowed.
“Because it’s encouraging everybody to treat ownership as an investment decision, it manifests itself politically as a stronger NIMBY impulse in America than we otherwise would have,” Durning said.
Financially paranoid homeowners are one of the main reasons that localities across the country maintain strict rules on new construction. By effectively turning housing into the most important asset for most families, the federal government created a countrywide militia of NIMBYs.
Of course, federal housing policies are not the only reason people resist change in their neighborhoods. At root, most people are skeptical of massive change because they like their neighborhoods the way they are. But economists think about effects at the margin. And at the margin, federal subsidies have helped entrench NIMBYism.
It’s possible to imagine a built environment much different from the one shaped by the American system of housing finance. The tower-dense cities of East Asia or the gentle urbanism of parts of Europe are proof of alternatives. Americans might choose to build towns and cities like Hong Kong or Vienna, if they were not steered by an activist central government.
“The federal policy,” said Durning, “should be neutral between homeownership and renting, and should provide no particular incentives to invest in your own home compared to stocks and bonds, or your education or your children’s education, or starting and operating your own business — or any other thing. The question of homeownership should really not be an investment decision. It should be a decision that’s about what’s the best lifestyle for you.”