The true story behind the financial crisis.

[Matthanuf06]

Originally Posted by dangolegators

We are talking about the change in demand. Mortgage deduction played no measurable role in the sudden increase in demand we saw in the mid 2000s. To my knowledge, the rules of the mortgage deduction did not change prior to the bubble. If they had changed to create more incentive for home ownership prior to the bubble, you would have a point. But, and correct me if I am wrong, the rules did not change.

Extremely easy credit, low interest rates, and a speculative ponzi-scheme-like craze were the drivers.

Sure, that's fair and I agree. However these things are dynamic as well. As the market was rising, the deduction became more important to more people as they were buying more expensive homes, and reduced the cost of the home.

[Minister_of_Information]

Originally Posted by dangolegators

This is nonsense. You yourself said 'Lower interest leads to higher purchase price and same net payment.'. With the same net payment, there is little or no change in the incentive to buy a house that the mortgage deduction provides. You are claiming that in times of low interest rates, the mortgage deduction 'accelerates' the market. I'd say the exact opposite. The lower the interest rate, the less the incentive is to take advantage of the mortgage interest deduction.

Yes that's true if people are making the same net payments on traditional mortgages during the period of asset inflation, but in fact they begin speculating on appreciating assets by taking on more leverage either via higher payment, ARMs with teasers, or interest only loans. In that environment the mortgage deduction is subsidizing a cycle of appreciation and speculation by reducing its cost and increasing the palatability of these novel financing instruments. When no cycle of appreciation and speculation exists the effects are as you describe, and novel financing instruments hardly exist.