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Is a Financial Market Meltdown a Negative Externality from Housing Subsidies?

2 min readBy: Gerald Prante

We’ve all heard for the longest time from advocates of the massive amount of subsidies that housing receives from government (both through spending and taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policies) that such subsidies are good policy. But when you move beyond the rhetoric of the “American dream” or “ownership society” and get to the core of the issue, you’ll find that in order to justify such massive subsidies, one must show a positive externalityAn externality, in economics terms, is a side effect or consequence of an activity that is not reflected in the cost of that activity, and not primarily borne by those directly involved in said activity. Externalities can be caused by either production or consumption of a good or service and can be positive or negative. from housing (as well as a sufficient elasticity for the subsidy) in order for it to improve societal well-being.

But given the situation we are in now and the fact that the housing market run-up was largely a bubble, we also have to ask the question of whether or not a bubble (that is fueled largely by irrational behavior) is made worse by massive government subsidies that could possibly fool people into systematically purchasing too much housing? Most would probably agree that this problem exist, but to what extent?

The total net social benefit from housing equals the private benefits less the private costs plus the external benefits less external costs. Ignoring the external costs for a second, the efficacy of $1 in subsidies depends upon the elasticities of demand and supply in the housing sector. But what about the external costs? One such possible external costs is the possibility that we end up in the situation we are in right now. If the subsidy does indeed fuel a bubble in an asset like housing and thereby has a marginal effect of contributing to a greater expected harm of economic catastrophe, we now have an empirical question of whether a subsidy is on average beneficial or harmful to society. (We are holding constant regulatory policy that could be imposed to counter the possible harm done by a subsidy.)

(Note: Some may argue that redistributive housing policies may improve societal well-being, but we have to ask ourselves whether or not it would be better to merely redistribute cash as opposed to in-kind housing benefits.)