Conservatives blame poor government policy for causing the housing bubble, while progressives blame the financial industry. While most arguments on the right focus on the government-sponsored enterprises Fannie Mae and Freddie Mac, its stance actually might not need to rely on them. Data indicates that the government's broader efforts to make housing an attractive investment has funneled money away from business and into the housing sector.
This analysis comes from University of Chicago economist Casey Mulligan, via the New York Times Economix blog. He analyzed the value of housing capital, as a measure of profitability, in the U.S. from 1950 to 2000. He calculates it to be average out to 5.7% over the period. Here's his chart:
It was 6.4% in 2000.
He then did a separate calculation to determine the value of business capital. At 15.3% over the 50-year period, excluding taxes, it was much higher. This implies overinvestment in housing. Mulligan explains:
Business capital has been so profitable to the economy because it is more scarce. It's the law of demand: the less business capital there is, the higher the rate of return that remaining business capital earns because each unit of capital serves more customers. A low profit rate for housing is a symptom of its abundance.
This would seem to imply that prudent investors would be better off investing in business than housing, since business capital is more productive than housing capital. So what happened? The government made housing look like a more attractive investment. Mulligan also calculated profitability with taxes taken into account:
The business-residential profitability gap is almost 10 percent, but our attempts to adjust both profit rates for applicable taxes show that the after-tax profitability gap is zero to five percentage points.
In other words, tax differences sweeten residential real estate investment. They result in it looking nearly as profitable as business investment.