The mortgage interest deduction (MID) from income tax liability is one of the most popular elements of our otherwise despised tax code.  It was created for the most altruistic of reasons: to increase home ownership among Americans.  Owning property has long been both a source of pride and a mark of success in life.  When our country was founded some states only extended voting rights to those who owned property.

I’ve long proclaimed that the government’s social engineering exercise with the mortgage interest deduction was actually quite harmful to our country.  It encourages people to take on increasingly large amounts of debt rather than save.  Well, now the push to expand home ownership is taking a toll on many Americans, but our elected leaders are not going to right their own blunder.  During the recent housing boom many people obtained mortgages that were beyond their means to repay and now defaults are occurring in staggering numbers.  In suburban Cleveland officials are trying to cope with a rash of foreclosed homes.  Politicians are heaping blame on lenders.

The root of the problem is that people who would not be able to purchase a home without the mortgage interest deduction are people who probably don’t have experience in entering complicated financial contracts, as many mortgages can be.  These people may not understand the full extent of the risks they are taking or even the terms of the loan.  The result is regrettably predictable.

The MID has also made it possible for lenders to create products that should only be used by the savviest of purchasers such as interest only loans.  Without the MID they would have a hard time selling those loans, but the MID lures eager, unsuspecting people.  I don’t blame the companies for offering the loans; they’re only meeting the demands of the market.  I will not, however, defend companies that engage in deceptive practices to distribute their product.

When free market idealists such as myself defend seemingly indefensible practices, such as payday lending, one of the reasons is that some of us are able to make informed decisions and we don’t want the government telling us we can’t do something just because there are morons out there who make bad decisions.  Senator Chris Dodd made a great example of this:

Specifically, he [Dodd] wondered why the Federal Reserve did not issue a rule forcing lenders to ensure that borrowers could afford a spike in interest rates under an ARM.

“It seems to be common sense that you want to determine whether people will be able to pay at the fully indexed rate … why didn’t you do that?” Dodd asked the director of banking supervision and regulation of the Federal Reserve, Roger T. Cole.

Dodd thinks the government should require lenders to prove that a borrower can make the payments on a loan if the interest rate increases at a future, defined date.  A good example of this might be a 5 year ARM.  Pretend you are a talented young professional, maybe a doctor, and you want to purchase a house.  You’ve carefully planned out your next few years of work and you have a good idea how your income is going to increase.  Family demands require that you purchase a larger home now and you decide to get an ARM so that you can buy a large house and take advantage of low payments, confident that you’ll be able to make the increased payments at a later date.  Chris Dodd thinks you shouldn’t be able to buy the house.  Another good example would be purchasing a house that you know you will live in for less than 5 years (maybe you’re in the military).  You might want to use an ARM to buy more than you could afford at the increased rate because you know that you’ll sell the house before the rate increases.  Chris Dodd tells you no as well.

The perverse encouragement of debt is one of the reasons I think we should scrap the income tax and adopt the FairTax.  It eliminates a social engineering tool that politicians have used for decades with little thought to long term consequences.

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This entry was posted by Brian on Friday, March 23rd, 2007 at 8:34 pm and is filed under Government, Taxes. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site. Please note the copyright policy.