By Alan Zibel and Ian Talley
Published April 06, 2011| Dow Jones Newswires
WASHINGTON -(Dow Jones)- The U.S. should consider capping or cutting the popular tax deduction for mortgage interest as it prepares to debate what should replace mortgage giants Fannie Mae (FNMA: 0.39, -0.00, -0.08%) and Freddie Mac (FMCC: 0.39, -0.00, -0.76%), the International Monetary Fund said Wednesday.
The IMF, in an analysis of housing finance systems around the world, said an Obama administration paper released earlier this year makes progress toward needed changes in the U.S. mortgage system. But the report criticized the U.S. for not tackling the popular tax deduction for mortgage interest, which the report termed “expensive and regressive.”
The U.S. government’s support of the housing market “has been pervasive but has not yielded many of the expected benefits to prospective or existing homeowners,” the report said. “It is clear that an overhaul is needed.”
“As a first step, we would very much recommend that the U.S. would at least cap the mortgage interest deductability,” said Ann-Margret Westin, an IMF senior economist and one of the authors of the housing report. She approved of the recommendation by the U.S. fiscal commission to halve the mortgage limit for deductions and to let it apply only to private residences, but the IMF said any such move would have to be undertaken over time.
The report is one chapter of the IMF’s larger annual Global Financial Stability Report that will be published in full next week.
More generally, the IMF confirmed that government participation in housing finance throughout rich countries exacerbated house-price swings and amplified mortgage credit growth during the run-up to the crisis. The warning advises emerging countries as they seek to develop their own economies.
“Countries with more government involvement also experienced deeper house price declines,” the IMF said.
Pointing to the U.S., both the explicit and implicit subsidies offered by authorities fueled a boom in housing debt and helped overinflate prices. The popping of the housing market helped to spark the global credit crisis.
“The faster you grow, the harder you fall,” said Westin.
The U.S. has a long tradition of providing government support for housing through government-controlled mortgage giants Fannie Mae, Freddie Mac, the Federal Housing Administration and other government agencies. Lawmakers on Capitol Hill are starting what promises to be a lengthy debate about whether to reduce federal support, including winding down Fannie Mae and Freddie Mac.
The two mortgage buyers have been under federal control since September 2008, a rescue that has cost taxpayers $134 billion to date. Fannie Mae and Freddie Mac buy up loans and package them into securities with a guarantee against default.
In February, the administration called for eventually phasing out Fannie Mae and Freddie Mac, releasing a “white paper” providing three options for what might take their place, each with varying levels of government involvement.
The IMF report noted that “an overhaul of the housing finance system will take years to complete” but called on U.S. officials to “step up their efforts now to develop and implement an appropriate action plan.” It did not recommend a specific approach for the U.S. other than to say the role of Fannie and Freddie “should be reassessed.”
The report said that there “is a need for better-defined and more transparent government participation in the housing market, with all such policy measures, including strict affordable housing policy goals, transparently shown in the government’s budget.”
A presidential deficit commission proposed late last year to reduce the mortgage-interest deduction, the largest U.S. government subsidy for housing. Congress, however, has repeatedly fended off efforts to pare back the mortgage tax break, arguing it makes homeownership more affordable and the real-estate industry is warning that any policy changes could be disastrous for the fragile housing market.
The deduction is generally disliked by economists, who say it mostly encourages wealthier Americans to take on more debt. The deduction applies only to the roughly one-third of taxpayers who itemize their returns, typically those with higher incomes.
They say industrialized nations such as Canada and the U.K. have achieved comparable rates of homeownership without such incentives. The U.K. gradually reduced its mortgage-interest break over 12 years, scrapping it for good in 2000 without hurting homeownership rates.
The IMF report noted that the U.S. provides a “plethora of tax breaks and subsidies, including mortgage interest deductions at the federal level, as well as state and local property tax deductions and exclusion from capital gains taxation.”
More broadly, as emerging economies take heed from the housing crisis that enveloped the U.S. and other advanced countries, the IMF said best practice should include better risk management and underwriting standards, more careful government involvement and more prudent incentives for lending through the capital markets.