How to Encourage New Home Construction--and How Not To

An article in the San Francisco Chronicle today shows that the idea of federal tax credits to pay buyers to purchase new homes still has some traction, even though most experts quoted in the article agree that this would be ineffective.

But no one seems to be looking at a critical reason why indiscriminate tax breaks are a bad idea, or what we should be doing. Instead, there seems to be depressed resignation to the prospect that the new homes market is weak and will stay that way for a long time.

Why are tax breaks a bad idea? The reason construction is in the dumps is that lots of households took on mortgages that they couldn’t afford, and now there is a glut of foreclosures and a dearth of lending.  Encouraging people who are on the cusp of deciding to become homeowners is a big mistake now because some of them may not be able to repay their debts.

Also, the areas where most new construction used to happen—in sprawling suburban  neighborhoods with no transit service—are now the hot spots for foreclosures so hardly anyone wants to build there any more and a tax credit wouldn’t be enough incentive.

But construction is also depressed in attractive transit-rich, compact neighborhoods where lots of good projects are on hold due to lack of demand. We could solve this problem, though, by encouraging banks to take reduced transportation (and energy) costs  into account in mortgage lending, so that, for example, prospective homeowners  wanting to buy in a neighborhood with $300 a month lower transportation costs could qualify for a mortgage with $300 a month higher payments.

This is better than considering new tax credits for several reasons. First, it would solve the real problem facing many households: that the bank is refusing to lend them money for the home they want because it appears to be unaffordable; second, it would cost the government nothing; third, it would increase the security of mortgages; fourth, it would encourage more housing in sustainable locations.

Economic policy-makers need to take off their blinders and look at the big picture of how we got into the mortgage mess and how we could painlessly get out.