This is the last of three FREE Insight Columns on housing policy. The earlier columns discussed government-mandated “affordable housing,” and, more generally, the effect of state and local land use regulations on housing creation. This column analyzes the appropriate federal role in creating and maintaining a healthy housing market.

Federally subsidized public housing began in 1937, for the benefit of unemployed workers and their families. By the beginning of the 1960s, these original residents found better opportunities, and income ceilings for tenants drove out those remaining residents with decent, steady, jobs, who could have become community leaders. Large public housing projects became home to the underclass, and almost universally are considered failures. Government housing vouchers for low-income families have been somewhat more successful, but limits on funding and continuing social problems make them problematic. My focus here, however, is on federal efforts to promote homeownership.

Over the long term, homeownership has not proven a particularly good investment. The increase in housing prices has been roughly proportional to inflation. Ignoring this basic fact was the principal contributor to the present housing crisis. This does not mean, however, that homeownership is a poor choice for most middle- and upper middle-class individuals.

While homeownership is an indifferent investment, traditionally it provided family privacy and residential stability, and was an excellent vehicle for savings. Young couples would work to assemble a 20 percent down payment, and sometimes received assistance from their families. Over time, these buyers’ mortgage payments went increasingly to repayment of principal. At the end of 30 years, they would enter retirement owning their homes free and clear. They could stay in place, use the funds for medical or other needs, or help fund their children’s down payments, and thus begin the virtuous cycle anew.

Communities, too, would benefit. Homeowners had a real stake in the continued vitality of their neighborhoods and towns. They would try to ensure that surrounding owners kept up their properties, and would willingly pay taxes to ensure the reputation of the school system. They would be interested in civic affairs, since wasteful municipal spending would come from their pockets, and shortsighted behavior by government and others would harm resale values. The role of homeownership in cultivating thrift and responsibility would spill over into state and national politics and government, as well.

The national economy also benefited from housing creation. The financial health of contractors, real estate agents, financial institutions, furniture and appliance makers and retailers, and many others, depended on a vibrant housing market.

For the President and Congress, support for the housing industry followed Mae West’s advice that “too much of a good thing is wonderful.” Aggressive action by government and the private financial sector to expand homeownership to less suitable homebuyers fed the great housing boom of the early 2000s. As prices zoomed up, mortgage brokers urged long-time owners to “unlock the equity” in their houses, and refinance, cashing out their gains to fuel consumption. In hindsight, the great housing bust that began in 2008 was the culmination of this reckless behavior. The Federal Government, the financial and housing industries, and gullible or overreaching buyers were all at fault.

Only a small part of federal assistance for housing went towards subsidies of public housing tenants and moderate-income groups. Significantly, more money went to subsidies for upper- and upper-middle income homeowners. The deductibility of home mortgage interest, what economists refer to as a “tax expenditure,” overwhelmingly benefited wealthier taxpayers, and was an important factor in encouraging them and their imitators in the middle class to buy more housing than they needed. While housing industry groups maintained that mortgage interest deductibility was necessary for healthy markets, Canada has no such deductibility, and a greater percentage of the population owning their residences than the United States.

The ownership of land always has been a mark of status in society. In the past, it denoted those with family stability and wealth leading to inheritance of property. In modern America, homeownership marked those with the discipline and good fortune to accumulate a sizeable down payment, and the expectation of job stability necessary to support long-term mortgage obligations.

In an increasingly egalitarian society, however, some questioned why individuals without savings or demonstrable income should be denied the dignity of being homeowners. Adding to the pressure on government to extend homeownership, many of those excluded were members of racial minorities or ethnic groups with fewer economic resources. However, direct government subsidies for ownership were expensive. The answer was the expansion of nominally private entities, Fannie Mae and Freddie Mac.

The implicit bargain was that these two giant government sponsored entities (GSEs) would make very handsome profits for their private shareholders, but would guarantee to purchase mortgages generated by private mortgage brokers and by banks for the benefit of low-income and low-asset borrowers who otherwise could not obtain home loans. The markets assumed that the GSEs were amply compensated for the extra risk, since their profits were derived largely from their ability to borrow cheaply in international money markets, based on implicit Federal guarantees of their solvency. The federal government couldn’t lose, because nationwide housing prices had never declined. Best of all for housing advocates and Congress, this form of government assistance was off the books, and did not count towards federal deficits. As long as housing prices continued to rise, everyone was a winner.

Some practices corrosive of prudent mortgage borrowing initially were developed by Fannie and Freddie’s private competitors. These included “teaser” loans, with low interest rates for the first year or two, and “liar” loans, requiring no documentation of income. However, the GSEs were quick to enter the game, and their huge size meant that their overall contribution to ensuing problems predominated.

The housing crisis began when borrowers with teaser rates were unable to make the considerably higher monthly mortgage payments required after their loans were reset to market interest. Those with liar loans did not have the resources to weather the now-turbulent economic waters, and could not bail out by refinancing or selling at a profit, since housing prices had stopped climbing.

Banks, too, made huge amounts by buying shaky loans from mortgage brokers and then selling interests in them to investors all over the world. It seems like everyone involved in the process was operating on either hope that housing prices would rise forever, or that greater fools would buy them out.

Five years after the housing market peaked, and three years after the bubble burst, it is unclear how federal housing policy will change. For the moment, the fears of private investors mean that Fannie and Freddie prop up housing more than ever. However, it is untenable that government continues to assume huge risks and to encourage over-investment in housing in the long run.

Private entities must replace the GSEs, and the federal government should stop subsidizing home purchases, and housing of any sort, beyond basic shelter for those with low incomes. From the perspectives of civic virtue and family stability, a return to the prudent 30-year fixed-rate mortgage would be ideal.

Unfortunately, hyper-dynamic financial markets create an unsecure environment for such long-term mortgages. Our collective unwillingness to deal with chronic federal deficits by cutting spending or raising taxes adds to uncertainty. The lack of regulations limiting the use of teaser rates, undocumented loans, imprudently low down payments, and cash-out refinancing (permitting the use of homes as ATMs) contributes to the problem, as well.

Leaving home finance to international money markets always ensures money for home loans, but likely means volatility in interest rates and less prudent loan underwriting. On the other hand, the old system of banks and savings and loan institutions holding the mortgages that they originated led to sound underwriting, but was dependent upon lenders being confident that they could obtain short-term deposits at fairly predictable rates for many years in the future. Also, under the traditional finance system, ample funds were sometimes available for good housing loans, but often funds were insufficient and mortgage rates zoomed.

There are no easy solutions to these problems. However, prudent federal tax, spending, and regulatory policies are a predicate to a flourishing economy, and to sustainable housing investment. This requires that legislators obtain relevant information, face choices squarely, and exercise political will.