Sheila Bair: The Home Mortgage Interest Deduction Inflates House Prices

Count Sheila Bair among the critics of generous U.S. housing subsidies.

Irvine Home Address … 12 SANTA RIDA Irvine, CA 92606

Resale Home Price …… $959,000

I want to break free

I want to break free

I want to break free from your lies

You're so self-satisfied I don't need you

I got to to break free

God knows, God knows I want to break free

Queen — I Want to Break Free

FDIC's Bair questions housing tax breaks

Count Sheila Bair among the critics of generous U.S. housing subsidies.

Bair, the chairman of the Federal Deposit Insurance Corp., said in a speech Monday that Congress should consider paring back federal tax deductions for homeowners. She said these subsidies helped inflate house prices, harming the very consumers that many of the programs aimed to help.

Bair took aim at federal tax deductions for mortgage interest, local property taxes, and capital gains on house sales (in certain circumstances). She said these taxpayer subsidies for homeowners, taken together, "are about three times the size of all rental subsidies and tax incentives combined."

Even that probably understates the case. Consider the hundreds of billions of dollars the feds are spending to support Fannie Mae (FNM) and Freddie Mac (FRE) in the name of making mortgages available, and the limited-time-only tax credits that have helped to prop up house prices over the past year.

Whatever the tab, though, Bair said the problem is the same: Government subsidies for property owners push up the price of houses, undermining so-called affordable housing programs run by the likes of Fannie and Freddie.

Bair rejected the notion that laws like the Community Reinvestment Act, the 1977 law that encourages lending in low-income areas, fed the housing crisis.

Risky loans "were made in large volumes because for a time they were highly profitable and because Wall Street would buy them and securitize them," she said. "It's as simple as that."

But she said policymakers have a duty to better educate consumers and to reform securitization, the process that Wall Street uses to turn loans into bonds salable to pension funds and other risk-averse institutional investors.

Along the same lines, she said, the government should reconsider popular tax deductions that helped the U.S. homeownership rate hit an all-time high of 69% during the bubble in 2005. That number stayed in the mid-60s throughout the 1980s and 90s. It was recently 67%, the Census Bureau said.

"Sustainable homeownership is a worthy national goal," Bair said. "But it should not be pursued to excess when there are other, equally worthy solutions that help meet the needs of people for whom homeownership may NOT be the right answer."

Letting the bank deal with it

The owners of today's featured property now have a Newport Coast address. Since they couldn't sell this one and get their money back, they have decided to let the bank deal with the problem.

The property was purchased on 6/1/2004 for $978,000. The owners used a $782,400 first mortgage, a $100,000 second mortgage and a $95,600 down payment.

On 9/30/2005 they obtained a $176,100 HELOC which allowed them to extract most of their down payment. They quit paying in early 2009.

Foreclosure Record

Recording Date: 03/23/2010

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 06/24/2009

Document Type: Notice of Default

Irvine Home Address … 12 SANTA RIDA Irvine, CA 92606

Resale Home Price … $959,000

Home Purchase Price … $978,000

Home Purchase Date …. 6/1/2004

Net Gain (Loss) ………. $(76,540)

Percent Change ………. -7.8%

Annual Appreciation … -0.3%

Cost of Ownership


$959,000 ………. Asking Price

$191,800 ………. 20% Down Conventional

4.80% …………… Mortgage Interest Rate

$767,200 ………. 30-Year Mortgage

$194,074 ………. Income Requirement

$4,025 ………. Monthly Mortgage Payment

$831 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$80 ………. Homeowners Insurance

$50 ………. Homeowners Association Fees


$4,986 ………. Monthly Cash Outlays

-$975 ………. Tax Savings (% of Interest and Property Tax)

-$956 ………. Equity Hidden in Payment

$352 ………. Lost Income to Down Payment (net of taxes)

$120 ………. Maintenance and Replacement Reserves


$3,526 ………. Monthly Cost of Ownership

Cash Acquisition Demands


$9,590 ………. Furnishing and Move In @1%

$9,590 ………. Closing Costs @1%

$7,672 ………… Interest Points @1% of Loan

$191,800 ………. Down Payment


$218,652 ………. Total Cash Costs

$54,000 ………… Emergency Cash Reserves


$272,652 ………. Total Savings Needed

Property Details for 12 SANTA RIDA Irvine, CA 92606


Beds: 4

Baths: 3 baths

Home size: 2,535 sq ft

($378 / sq ft)

Lot Size: 5,504 sq ft

Year Built: 1997

Days on Market: 43

Listing Updated: 40308

MLS Number: S616538

Property Type: Single Family, Residential

Community: Westpark

Tract: Othr


According to the listing agent, this listing may be a pre-foreclosure or short sale.

This property is in backup or contingent offer status.

Corner lot in newer area of Westpark. Highly upgraded home, with downstairs bed & bath, gourmet kitchen, laminate wood floors, granite countertops, cathedral ceilings, custom paint, mirrored wardrobes, and a spacious loft – library/office/media/play room. 3-car garage w/ built-ins for extra storage. Large, professionally landscaped yard is great for entertaining. Excellent full community amenities & close to to shops, dining, schools, and toll roads.

34 thoughts on “Sheila Bair: The Home Mortgage Interest Deduction Inflates House Prices

  1. Freetrader

    The home mortgage interest deduction artificially increases housing prices? Who knew? Well, duh, of course it does. It artificially increases the level of debt in society and mis-allocates capital from productive uses to real estate by artificially lowering the cost of RE debt. And, of course, it is fiscally retarded since many US homeowners pay little if any federal income tax thanks to the HMID. The result is actually higher tax rates, since so little income actually gets to down to the TI line on the 1040.

    Getting rid of the HMID wouldn’t eliminate RE bubbles (Australia, without the HMID, still has one) but the bubbles that do inevitably happen would inflate less and be a litle less likely to take down the economy when they bust.

    In conclusion it is fiscally and economically obvious that the HMID needs to go – so yes, absolutely, let’s kill the HMID. I just wish we had elected officials brave and sensible enough to do it – or even to suggest it.

    1. winstongator

      Businesses get to deduct their interest expense too, so if you’re going to go after hmid, you should go after that also. In general, the tax code favors debt over equity investments, which makes for a less stable system.

      I read somewhere that Harvard Business School students researched the proper way to raise capital, and they came up with always using debt…

      1. scottinnj

        The solution to this is either to allow deductibility of dividend payments to shareholders or alternatively have dividend payments tax-exempt to the individual investor (to the extent that the dividend was paid out of income that the corporate had been taxed). The current tax code definitely favors debt over equity and that has really worked out well for us.

      2. Freetrader2

        Well, I think a moment’s reflection should make it clear that a ‘business’ as contrasted with an individual, needs to get a tax deduction for financing costs — otherwise a bank, for example, would be taxed on all of its gross income and would soon go bankrupt due to all the phantom income created by the interest expense. So, unless we want tax rates above 100%, interest needs to remain deductible for a business.

        In order to more fairly balance debt costs with equity,

        I wouldn’t put a whole lot of credence in the HBS study. The cost of debt, even excluding the interest deduction, is ALWAYS less than the cost of equity. So a modeling exercises will lead you to 99% debt financing, with ME holding the 1% equity, every time (since the equtiy return then skyrockets for the equity holder). That’s one reason debt is so popular. The trouble is, models don’t reflect reality, and if the business goes South, the result is bankruptcy – just as in the Subprime loan market. That’s how we got here.

        1. Freetrader2

          I forgot to finish my second paragraph…

          In order to more fairly balance debt with equity, dividends paid should be deductible (or not taxable to the recipient) instead of being double taxed, as they are currently.

      3. Chuck Ponzi


        I’d be surprised if it was always debt… unless they’ve got some math that transcends the basics of discounted cash flows (I guess nothing would surprise me at this point).

        But seriously, in nearly every MBA finance course, they teach the basics of debt vs equity financing which relies heavily on estimations of dividends and dividend growth rates.

        Not surprisingly, when a company doesn’t pay dividends, it’s almost always cheaper to do equity financing than debt. (no financing costs to speak of).


  2. winstongator

    Also, renters can benefit from a similar deduction the same way homeowners do. If the owner of the rental property has debt on it, they deduct that interest from their income. Keeping a target income level, that reduces rents.

    The better solution is moving to eliminate the ability of any taxpayer to deduct interest, and it should be a phased response.

    1. scottinnj

      Gutting the HMID makes so much sense it will never happen. Though one thing I think you could do which might be politically feasible as a 1st step is to limit the deduction to interest on the 30 year fully amortizing purchase money loan. So you can argue this helps you buy a home but really why should cash-out refi and/or HELOC be deductible. We let people deduct HELOC interest (to a point) but not car loans or credit card interest. So it isn’t a big surprise people borrowed alot more against their homes – that really worked out well didn’t it?

      1. winstongator

        I would have a hard time arguing the fairness of allowing a deduction for a purchase but not a non-cash-out refi. The massive cash-out refi was really confined to the areas that saw the most appreciation. Most recent refi in other places was to take advantage of lower rates.

        For CA, the bigger bang would be resetting assessed values for tax purposes at the point of a refi. Maybe the total loan amount or something, but when someone cashes-out, they are taking advantage of the higher property values, so the prop-whatever has no fair standing in that instance.

    2. Freetrader2

      So, if a business has mostly interest expense as a cost, then you would deny that deduction? You mean a bank should be taxed at 38% on its gross income before deductions? Well, that’s one way to solve the debt crisis — to have no debt at all. Of course, we’d end up back in the stone age. Better try again.

      1. winstongator

        This is not as absurd an idea as you’d think:
        “A straightforward fix for excessive leverage
        can be achieved through the tax system. Companies
        borrow, in part, because they believe that debt
        capital is cheaper than equity capital. That is certainly the case under the U.S. corporate tax system because interest is a deductible business expense in calculating income subject to tax whereas dividends are not deductible.”

        William Poole is a senior fellow at the Cato Institute, Washington, DC, and
        distinguished scholar in residence at the University of Delaware, Newark.
        Note: This article is based on a speech that the author gave at the CFA Institute
        Annual Conference in April 2009. He was president and CEO of the Federal
        Reserve Bank of St. Louis from March 1998 to March 2008.

        1. Freetrader

          I am familiar with that quote, which is based on a fundamental misunderstanding of both the cost of capital and the necessity of giving an interest expense deduction for any business. The only way to fix the ‘problem’ is to allow for a tax deduction for dividends or for a full dividend exclusion by the recipient. However, debt will still almost always be preferred to equity capital, because equity capital costs more — so the capital holders are motivated to leverage up.

  3. newbie

    Commerical RE at 30 cents on the dollar. Is this a sign of more to come or a fluke?

    As for the removal of the tax income deduction for interest, it fair because business can deduct the expense. Removal will be the third rail of congress. They will only do it if they are promised a powerful position upon a yes vote. The only other way is to have a long phase out of the deduction, so the voters will not remember who voted for the phase out.

  4. Chris M

    “Bair took aim at federal tax deductions for mortgage interest, local property taxes, and capital gains on house sales (in certain circumstances)”

    I can see eliminating the mortgage interest deduction, but property taxes? WTF is she thinking?

    1. Marc

      Expenses are tax deductible if they are made with the intent of generating taxable income. This is the case with investments by businesses. Why should a person be able to deduct any expenses for the house he/she is living it? Would be like getting a tax deduction for writing off my private car. The personal residence is a personal luxury that should not be tax deductible in any way, the same is the case for property taxes. They should be deductible if you are renting the house to generate rental income. This is how it is handled in many countries around the world and it makes the most sense.

      1. N4

        Finally, an astute observer who recognizes that the question isn’t whether interest should be deductable; it’s whether interest on consumer mortgages should be deductable. The answer is obviously no. The only justification for the HMID is to encourage homeownership, a goal which this blog has forcefully argued is not a worthy end for governments to pursue, and there is no evidence that the HMID even advances that goal anyway.

        The HMID is distortive and regressive and should be elimintated. And surely Congress will do so right after it kills farm subsidies, fixes social security and retires the national debt.

        1. Freetrader

          I am not sure either how the issue of the ridiculous consumer mortgage interest subsidy was somehow leveraged into a discussion of disallowing interest expense for businesses, which makes little sense.

  5. awgee

    Re: the accurate perception that no politician will ever touch the MID.

    Any vote for a Democrat or a Republican is a wasted vote.

  6. awgee

    IR – May I have your permission to copy that photo of the “How to Live” golfers and the accompanying dialogue on the CHB?

  7. Kelja

    Oh, so silly.

    The ability to tax is the root of government’s power over the people. Until the system collapses, the system will remain pretty much the same. Tweaks here and there, but the basic premise of taxing the productive to non-productivity and awarding special interests through tax breaks and incentives will remain.

    A productive individual in today’s world is a milk cow to the government.

  8. ERPguy

    I believe that inflation will erode into the 1 million dollar/100K limit long before the HMID is repealed.

  9. newbie

    “Risky loans “were made in large volumes because for a time they were highly profitable and because Wall Street would buy them and securitize them,” she said. “It’s as simple as that.”

    She’s partially right for once.
    Lack of personal liability for making and selling bad loans was a large factor. The banksters are avoiding cprporate liability by modifications and refinancing to correct the defects in the loans — AA to AAA plus rating, real appraisal and some convoluted note of risk — there’s little chance of getting the money back from the borrower.

    Fairly nice looking house. The guy might still be on the hook for the HELOC as a second, but likely will only lose pennies on the dollar for the loss.

  10. RealisticOptimist

    I’m a little torn on this one…it’s been in place for so long (post depression correct?) and EVERY homeowner qualifies for it, I don’t think we can attribute a bubble to this. Yes, it inflates prices a bit, but it becomes relative, because, again, every homeowner gets it. It inflated home prices when it initially came out (70+ years ago), but now it’s just it’s just built into the price. It would be like if that 8k tax credit became permanent. All it would do is increase prices by 8k. It may be more of a hidden subsidy for the banks, because banks are the one’s that benefit the most from people having to finance a larger amount.

    It may be pointless, but it’s not creating a bubble.

    I have a bigger problem with 30 year mortgages given that the average person stays in a house for 8 years. That costs you TONS in interest.
    Say you buy a 375k house – 75k down, 300k financed. After 8 years, on a 300k mortgage at 5%, the payment for 1st month in Year 9 will have 1050 in interest and 565 in principle. So even after 8 years, the interest is still about 2/3 of your payment. The total balance of the loan is still 250k, despite making 154k in payments. 154k spent to have 50k of it in equity. That’s a lot of interest.

    If the 30 year mortgage didn’t exist, prices wouldn’t be as high because people can only afford X amount per month. So to have the same payment in the example above on a 15 year mortgage, the house would have to be around 265k. With a 15 year mortgage, after only 14 months, your payment flips to be more principle than interest.. With a 30 year mortgage that doesn’t happen until the 16th YEAR! Yes, YEAR!!!!!! Thats 14 months vs 192 months. After 8 years in the 15 yr mtg example, you’ve still made 154k in payments, but you have 94k in equity. Big difference.

    Again – that would mean significantly less interest for the banks though, so it seems the banks are the real benefactor of the longer mortgages. Hmmm…seems to be a recurring theme.

    1. E

      That’s the whole “scam” of it. Isn’t it too bad that so many sheeple think only about the “monthly payment” and don’t really realize how badly they’re getting shafted. And to think that you have to compete with “stupid” money.


    2. D

      The $8K home buyer tax credit increased prices by a lot more than $8K. By increasing the pool of buyers significantly, prices went up more like $50K.

  11. Freetrader

    Actually, we can make a good argument that this is alredy happening. As long as we don’t ‘fix’ the Alternative Minimum Tax, inflation will subject practically everyone taking a mortgage interest deduction to it, eventually. I think that would be a good way to ‘back into’ the end of the HMID. The middle class will find their tax rate capped at 26%. We could reduce the regular tax rates in line and market it as a tax rate reduction. Hopefully budget pressure will allow to this happen.

    1. newbie

      The middle class tax rate was 0% at the start of income tax. Now it about 10% fed plus 5% in CA or 25% and 10% marginal rates, respectively. Also add in SSI.

      It’s the camel in the tent.

  12. RealitySings

    This might be a good argument for never having instituted it or for cooling off an overly hot real estate market by eliminating some of the incentive to buy homes, but at this point it would be a catastrophic policy change. People are already underwater just with the popping of the bubble, and that is with their getting the mortgage interest deduction. Interest rates are already incredibly low, yet people can’t qualify for the homes with their income even with the interest deduction assumed in the qualification calculations, so the homes go into foreclosure. This then deflates property values even further, putting still more property owners underwater. Unless the government is going to pay the banks the difference between what they house was financed for and what it is now worth without a mortgage interest deduction, there is no way we can handle the depressionary blow of temporarily making homes even more unaffordable, since people will qualify for even less in monthly payments if the calculations can’t assume the interest deductions. Everyone for this insane plan is imagining that 1) such severe price contractions at this fragile point in US economic history won’t destroy our economy and many lives; and 2) banks will still qualify people for the same monthly payments even when they know the people won’t be getting the interest and property taxes credited back. That is a ludicrous assumption!

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