Our government forays into the housing market have been a disaster, to say the least.

The mortgage interest deduction goes solely to the wealthy and costs the government nearly $100 billion a year. For some perspective of how out of whack this subsidy is, the residents of Nancy Pelosi’s pricey San Francisco neighborhood get roughly 100 times the benefit, per household, of the denizens of my middle class home town in central Illinois.

Of course, our government-sponsored enterprises are an even more ill-conceived subsidy for home buying. Fannie Mae and Freddie Mac ostensibly increase the amount of capital available to finance home buying by purchasing mortgages from banks and other mortgage originators, packaging them into mortgage-backed securities, and then selling them to pensions, hedge funds, and the like. But it is dubious that their existence meaningfully increases home ownership rates: The Census Bureau announced last month that the U.S. homeownership rate was 62.9 percent, its lowest since 1965 and well below most EU countries, virtually none of which has anything akin to either the mortgage interest deduction or government-sponsored enterprises buying up mortgages.

Not only does the MID and the GSEs fail to boost home ownership but they also can exacerbate broader problems in the housing market, and financial markets in general. The MID encourages people to purchase as much house as they can possibly afford in order to take full advantage of the tax break, which set up many people for disaster when they lost their job in the Great Recession of 2008–2009.

The pressure the federal government put on the GSEs to extend credit to low-income borrowers in order to help boost home ownership amongst the middle and lower-classes ended in tears for millions of Americans as well, as the swings in the housing market destroyed the value in their homes and left them unable to afford to continue living there.

The plunging home prices cratered the portfolio of the GSEs and led the Treasury to use the 2008 Home Equity and Recovery Act, or HERA, to place them into a conservatorship, with the shareholders seeing their share of the company slashed to just 20%, with the government assuming the rest. 

However, the demise of Fannie and Freddie was premature: the reported losses of the GSEs were just temporary, a fact that was clear to many shareholders who held onto their stock or jumped into the company post-crisis. For these people, holding onto the stock post-crisis appeared as if it would work out to be a good bet, especially once real estate prices returned to their previous levels.

Unfortunately for them such a bet failed to account for the vagaries of government action. In 2012 the Treasury imposed an amendment to HERA that effectively nationalized the GSEs and cut out the shareholders from any residual profits. The massive profits generated by Fannie Mae and Freddie Mac–which Treasury officials fully anticipated prior to the takeover–went directly into Treasury’s coffers, helping the Obama Administration claim a victory over the federal budget. The 2012 deficit was “just” $1.1 trillion, or $200 billion less than the previous year, helped by th outsized GSE profits that year.

While the third amendment may have been a short-term political salve, it has created longer-term problems that the next president will have to deal with. The major problem is that because the third amendment “sweeps” the entire net worth of each GSE into Treasury’s coffers each quarter, it means that neither of them have sufficient capital to withstand a sub-par quarter without a draw from Treasury. Should the real-estate market so much as hiccup it’s going to mean a loss for one or both, and a new injection of taxpayer dollars from the government could create a political firestorm and a round of finger-pointing that could lead to another short-term fix that makes a further mess of the lending market for homes.

The plight of the GSEs has not been grist for the masses but it’s time we began some sort of dialogue about our nation’s housing policy going forward nevertheless. Sacrificing $1 trillion of tax revenue and socializing the gains and losses from home mortgage has done nothing to boost home ownership or improve our economy.

Or, to be more precise, worse than nothing: the effective expropriation of the shares of Fannie and Freddie held by the public for short-term political expediency will assuredly have repercussions down the road, as investors become more wary of trusting the government to hold up its side of a deal. The virtual disappearance of any private label mortgage-backed- securities is a side-effect of the capriciousness of the government in mortgage markets in recent years.

The optimal policy solution is simple: we should begin by ending the mortgage-interest deduction, which is by far the most regressive blue-state tax break in existence, and follow that by gutting the government’s footprint in the market for mortgage-backed securities.

Accomplishing the latter is tricky even if it were to become politically possible: the problem is that it is hard to conceive of an entity that is buying, packaging and reselling mortgages operating without there being some sort of implicit government backstop, even if the government swears up and down it would never bail out such an entity. If it were to grow large enough there would inevitably be some sort of systemic risk with the collapse of an entity issuing MBS’s, and once the market perceived that to be true it would be duly exploited by both sides of the transaction.

One solution would be to simply have a number of smaller, competing entities and take steps to prevent one from growing “too” large, a proposal others have already offered. Another step might be to give back the private GSE shareholders their share of the company and for the government to sell its share off as well, and come up with a way for the federal government to capture the value of its effective MBS guarantee in some way.

Or, if we’re being creative, we can try to come up with a way for the Treasury to effectively tie its hands so as to make it impossible for it to intervene in the market, even if it were to collapse. However, I fear that this is as doable as it would be for the federal government to forswear helping people who build in floodplains when their houses inevitably get damaged by flooding, to paraphrase a famous example by the Nobel prize-winning economists Finn Kydland and Ed Prescott.

The current quasi-nationalization of our mortgage markets and billions of dollars of tax breaks for homeowners has not done one whit for home ownership while creating all sorts of potential problems in the housing market.

There’s always a risk in attempting any sort of major reform; what’s unclear is whether we can possibly do worse than the status quo.