RALEIGH – I’m going to do something different today.

Although I tend to focus my “Daily Journal” on state and local matters, as is true for Carolina Journal and JLF as a whole, it sometimes proves impossible to ignore national and international issues when they come to dominate political and policy debate in North Carolina. That’s where we are at this moment in American history, a moment when worldwide economic travails – and widespread economic ignorance – seem on the verge of creating an inflection point in the trend line of freedom.

An inflection downward, in case you’re wondering.

Via phone calls and emails, many readers have responded to my initial column excoriating the Paulson bailout plan with requests for more background and explanation. As it happens, I wrote about housing and mortgage issues extensively in my 2001 book Investor Politics. Rather than trying to figure out some way of rephrasing what I wrote, I’m going to quote myself at some length — at least for the purpose of demonstrating that every decade or so, I get something right:

The next big change in public policy towards physical capital began in the 1930s. The Roosevelt administration sought to prop up employment through a variety of federally funded public works projects. Some of the projects, including roads, utility improvements, and other infrastructure, may well have added significant value to local economies. Others were nothing more than pork-barrel projects. In addition to direct expenditures, which worsened the budget deficit (against which Roosevelt had railed in the 1932 election), the administration decided to use federal credit to leverage private economic activity and increase employment in the (unionized) construction trades.

The Federal Home Loan Bank system created a series of district banks that purchased loans from private lenders in order to encourage mortgage loans and new housing construction. The Home Owners Loan Corporation helped families refinance their mortgages rather than face foreclosure, offering long-term government-backed loans in exchange for short-term private loans. Between 1933 and 1935, it issued $8 billion in loans to a million American families. In 1934, Congress passed a Housing Act that created federal mortgage insurance for small homes. The new Federal Housing Administration (FHA) would pay off lenders in the event of a default. The act also created the Federal Savings and Loan Insurance Corporation to bail out S&Ls overextended in their core mortgage business. In 1937, another Housing Act expanded federal loan guarantees further and established ongoing federal support for state and localities to build and operate public housing projects for the poor. Finally, in a 1938 amendment, Congress created the Federal National Mortgage Association (FNMA, or “Fannie Mae”) to buy and sell mortgage loans on the secondary market.

This alphabet soup of new agencies, spending federal “credit” rather than actual dollars at first to minimize their impact on the budget deficit, had dramatic long-term consequences. By 1940, FHA mortgage insurance covered 40 percent of housing starts. Private lenders emulated the FHA’s 20- to 30-year loan terms, even for more affluent homebuyers ineligible for FHA insurance. Previously, private lenders had typically required a 40 to 50 percent downpayment and offered mortgage loans for 3 to 10 years. With FHA insurance, lenders cut the downpayment amount to 20 percent, and later to 10 percent. It particularly made sense to lengthen terms and minimize downpayments because of the impact of the mortgage insurance deduction discussed earlier. World War II brought the first widespread income tax and gave average Americans a strong incentive to prefer debt over equity in buying a home. It might cost a family more in the long run to pay little down and borrow over 30 years, but much of the additional debt service evaporated in lower taxes.

The Roosevelt administration’s original political constituency for these initiatives was organized labor, as its more candid leaders acknowledged. But later, private-sector interests that initially opposed a federal role in housing — such as associations of Realtors, lumber dealers, homebuilders, and S&Ls — came to champion their protection and expansion. No wonder. From an historical trough of 44 percent in 1940, the homeownership rate shot up to 63 percent by 1965. Millions of Americans took out long-term mortgage loans, deducted the interest, and headed to suburbia on new state and federal highways to buy more spacious and comfortable homes than had ever been seen, thanks to standardization and new homebuilding materials and technologies. Bankers, mortgage lenders, Realtors, and property insurers made a killing. And unlike the pre-war trends, these really were due in large measure to government intervention in the market. By providing generous tax breaks and manipulating credit markets to favor residential construction, Washington had engineered a societal result unlikely to have come from a market process.

Nor has the result been an unqualified plus from the standpoint of Investor Politics. Yes, personal ownership of capital assets — homes — did rise markedly. But so did personal debt. Furthermore, until legislation in the late 1970s and early 1980s shielded IRAs and 401(k)s from tax, the mortgage interest deduction and other breaks led many Americans to treat homes as their sole form of retirement savings. During the 1970s, in particular, as families poured their savings into their homes as a hedge against both inflation and taxes, markets for other personal investment tanked. The average corporate stock lost 23 percent of its value during the 1970s, while the average house appreciated 155 percent. One memorable innovation during the period was the condominium, which was little more than a way of giving apartment dwellers the same tax and credit advantages that single-family homeowners already enjoyed. Author Philip Longman is particularly caustic about the economic consequences of the federal government favoring housing over other forms of investment:

In the short run, all the subsidies pouring into the housing sector did help to stimulate economic growth and forestall recession — providing yet another reason why cutting the subsidies became political impossible, no matter what damage they might be doing to America’s future standard of living. . . [But] capital that could have gone for retooling American industry at a time of mounting foreign competition went instead for financing the sale and resale of houses and condominiums at ever higher prices.

The alphabet soup of housing-credit agencies that Roosevelt created still exists to a large degree, conferring unjustified windfalls to some industries at the expense of others and attracting scarce financial capital into increasingly marginal investments. Fannie Mae and Freddie Mac, for example, have used their special governmental privileges — which include access to federal credit as well as exemption from federal regulations and state income taxes — to grow in size and influence far beyond what even New Dealers might have dreamed. As late as 1980, commercial banks and S&Ls retained up to three-quarters of residential mortgages in their portfolios. But over the past two decades, Fannie Mae and Freddie Mac have significantly increased their participation in the market, now purchasing more than half of all newly originated home mortgages.

Many of these are then pooled as mortgage-backed securities and sold in the secondary market to institutional investors. Still, according to an analysis of Fannie Mae and Freddie Mac by the American Enterprise Institute, the two government-subsidized companies will have assumed risk for nearly half of all residential mortgages in the United States by 2003. The financial exposure to taxpayers should the housing market suffer a downturn could be staggering.

In retrospect, I may have understated the risks.

Hood is president of the John Locke Foundation.