• Definition
• Background & Evolution
• Objectives and Main Approaches to Subsidizing Housing Finance
• Key cases to watch
• Related Documents

Definition

Background & Evolution

Of all forms of housing subsidy, housing finance subsidies are among the most prevalent, in both emerging market and advanced economies. They have a long history and are deeply entrenched in the housing finance systems of most countries. Subsidizing finance can be fairly easily achieved at a national level and is therefore often a first policy choice.  

• In the past, the response of many governments to poorly developed housing and housing finance markets was to take over housing production and finance or establish special entities funded by a dedicated tax on labor, often providing high but non-transparent subsidies, i.e. subsidies that do not appear on the country’s budget and of uncertain size. Such subsidy systems often combined supply-side subsidies to state-owned institutions with deep interest subsidies to developers and households in the form of below-market interest rates and low down-payment requirements relative to market risk. Such systems were frequently unstable and inefficient and required regular bail-outs by governments. Moreover, the interest rate subsidy is a regressive instrument and further increased housing inequity in most countries.

• Comparative housing subsidy research conducted during the 1970s and 1980s in the United States [i] and Western Europe emphasized the inefficacies of supply-side subsidies. Several industrial countries moved, at least partially, to direct demand side subsidies (household vouchers) and even some Latin American countries with fairly stable macro-economies and well developed financial markets such as Chile. Such income transfers afford maximum choice to households, are efficient and transparent, and can be targeted to specific segments of the market. Moreover, they do not distort the housing or housing finance system itself and can be applied to rental and owner-occupied housing, and new and used housing.

• In many emerging market economies the application of an income transfer system—-earmarked or conditioned upon increased housing consumption—does not yet work to improve housing conditions, however. The housing sector in many developing and emerging markets was and is still constrained by incomplete housing finance markets and inefficient land markets. Even if finance is available, the regulatory system often makes it unprofitable or unfeasible for private developers to operate in the middle-income market. Housing vouchers are therefore unlikely to improve housing conditions for the lower/middle income groups and often benefit developers rather than consumers. In Chile, for example, the voucher system worked only in that part of the market where lenders were comfortable operating. Even in industrial economies with efficient financial markets, the transfer to demand-side subsidies was never complete. Strong vested interests in the housing industry prevented phasing out of supply and tax subsidies, and there are still “real” side supply constraints that made delivery of low income housing unfeasible (see Gyourko’s supply side page on this portal).

• During increased macroeconomic stability and growth of financial systems preceding the recent crisis, many emerging market economies began reforming their old state-dominated supply side subsidies and initiated new subsidy incentives aimed at improving housing finance markets and creating a more level playing field across state and private lenders. The objective was to serve an increasing part of the middle income segment through the private sector and reduce the overall subsidy level by the use of credit. For example, Korea began a major reform of its state housing finance systems and related subsidies after the Asian crisis, and saw steady growth in its mortgage sector and housing production for middle and lower middle income households. Equally, household subsidies are being reformed in many countries to be more transparent. These reforms are, however, complex and evolve over a considerable period of time.  

• The recent crisis has slowed—but not derailed—this process in many countries. The private sector withdrew from the market; its place was filled, yet again, by subsidized state finance institutions using cheap credit in countries where such lenders are still prominent. In countries as diverse as the United States, Brazil, Mexico and Indonesia, state institutions make or support more than 90 percent of the mortgage loans; in other countries subsidized state guarantees cover an increasing proportion of mortgages. The challenge now is to gradually re-engage the private sector in the middle income market and expand transparent household subsidies where necessary to move further down-market. Since indebtedness of households has become a major issue in many countries (e.g., South Africa, Brazil, the United States), transparent subsidies will increasingly need to be linked to savings.

• For households not qualifying for a mortgage loan, subsidies in developing countries and emerging markets still need to focus on upgrading the physical infrastructure of (informal) neighborhoods and the provision of serviced land and a modest superstructure or high density multi-unit housing. Incentives and support for housing micro-lenders sometimes complements these efforts to allow households to speed up the construction or improvement of their homes (Hoek-Smit, 2009). Where feasible, voucher systems for rental subsidies are introduced (e.g., transition economies).  

• Subsidies to rental housing have been part and parcel of housing policy in post-war industrialized countries, specifically Western Europe. The instruments have changed from subsidized public housing to rental vouchers and various incentives for social or private rental investors. Public rental housing and rent control were, in the past, the prevailing models in emerging markets as well. Public housing has, however, been disregarded in most countries because of its high cost, maintenance and social problems. Rent control is slowly being phased out because it stifles investment and prevents maintenance of the stock. Very few countries have implemented alternative rental housing incentives and subsidies. Some use escalated depreciation for tax purposes and other such stimuli. Gradually, however, more attention is being paid to developing incentives to expand formal sector rental housing. (See Rental Theme page)
  

[i] The Experimental Housing Allowance Project, a large-scale research experiment in the 1970s in the United States tested the relative efficiency of different types of supply- and demand-side subsidies..  

Objectives and Main Approaches to Subsidizing Housing Finance

Three broad goals are usually involved, explicitly or implicitly, in political discussions about subsidy intervention in the housing sector:[i]  

1. Improving public health.
2. Improving justice and fairness in society, i.e. redistributing income through housing.
3. Overcoming inefficiencies or failures in the housing or mortgage market that cannot be solved through regulation.  

The first two of these goals for subsidy intervention relate directly to improve sanitation and housing conditions, and focus on promoting welfare in society through the housing sector. But for which households or market segments? For home-ownership or rental housing? And, if homeownership is to be stimulated, is the focus on first-time home-owners only?

- Two different population groups are often distinguished in designing subsidy programs to fulfill these goals:

• those who with some help can access mortgage finance and formal market-produced housing, and 
• those for whom the housing market will not yet deliver housing and who require direct support to access serviced land/upgrade their living    environment or rental housing.

The third goal focuses on expanding housing opportunities by pricing, and allocating costs and risks in the housing and housing finance sector more optimally. Specific market constraints that prevent mortgage and housing micro-finance lenders and/or developers from serving different segments of the population need to be identified to develop an effective package of regulatory and subsidy measures to address such bottlenecks. Such subsidy incentives to market players should be phased out as soon as the private sector is able to take on the specific risks and costs, and exit clauses need to be part and parcel of program design.  

This division in objectives and approaches brings into focus the very different types of analyses involved in subsidy design (Hoek-Smit, 2009):

• Identifying problems individual households face in improving their housing conditions (e.g., low income, unstable income or employment, savings constraints, poor housing collateral, lack of mortgage finance or home-ownership information) and the type of subsidy incentives that might address them.
• Understanding specific constraints in expanding housing finance systems (e.g., funding constraints, liquidity risk, credit risks, interest rate risk, lack of housing sector and credit information), and the design of subsidy incentives to reduce them.
  

[i] There are various other rationales for the use of housing subsidies, such as influencing economic and political stability (commonly used to support home-ownership), and stimulating economic growth (generally used to support various countercyclical assistance to the construction sector). These goals are featuring prominently in the current subsidy measures to support the housing sector in Brazil and the United States during the current downturn. In developing countries housing markets are often too inefficient to make housing subsidies a wise choice to reach such goals.  

Key cases to watch