03/18/2010 05:12 am ET Updated May 25, 2011

The Dilemma's Innovator

Friday's New York Times op-ed page contains a necessary, albeit anachronistic, criticism of the tax credit for first-time homebuyers, a "proposal" supported by Senator Chris Dodd. John Carney of ClusterStock and The BusinessInsider argues against extending and expanding the credit. Evidently, he didn't realize that Congress has already done just that: President Obama signed a bill into law last week that delays the program's termination and makes the credit available to all homebuyers.

Still, Carney's worry that the tax credit "enable[s] some of the worst mortgage practices of the recent past" remains valid. The credit is poorly targeted because it now applies to families making up to $225,000 a year who purchase homes worth up to $800,000. But, as Carney suggests, at the lower end of the pricing spectrum (below $228,000), the credit also incentivizes home purchases by buyers who put no money down- buyers who are more likely to foreclose on their homes.

Carney's op-ed brings up an issue vital to the current debate about financial regulation and ensuring that consumers are protected from the abusive mortgage practices that precipitated the foreclosure crisis. One of the primary arguments against a Consumer Financial Protection Agency, which would watch over financial products like mortgages and credit cards and perhaps sanction "vanilla" products, is that it would stifle innovation. As an unintended consequence, the argument goes, low-income consumers who would not qualify for, say, a "normal" mortgage would not be able to obtain a riskier one and, in turn, would be shut out of homeownership.

Yet, data from the recent subprime boom suggests otherwise. A recent paper (via The Stash) demonstrates that financial innovation in fact harmed low-income consumers:

Somewhat surprisingly at first glance, agents born with low income prospects benefit the least from mortgage innovation. The reason for this is that in all likelihood they will remain renters their entire life. The gains are so small, in fact, that in a model where house prices respond to demand for housing, mortgage innovation is likely to have a negative impact on agents who are born poor. Mortgage innovation primarily benefits the agents who are at the margin between renting and owning or need some financial help to buy bigger houses.

This conclusion provides good cause to be suspicious of arguments that regulation of financial products would by nature harm lower-income households who in recent years came to depend on cheap and risky credit to obtain homes. To the extent that Carney is right and the tax credit perpetuates practices similar to those used by subprime loans, the homebuyers' credit not only benefits wealthier households, but also has the potential to harm lower-income ones.

Instead of perpetuating the federal government's over-subsidization of homeowners and under-subsidization of renters -- the feds provide four times the support to the former as the latter -- Congress should work to develop a housing policy that helps, not hurts, low-income households. A Consumer Financial Protection Agency that roots out harmful mortgage products, even at the expense of expanding homeownership, would not be a bad start.