I work in real estate. I definitely don't think RESIDENTIAL real estate interest should be tax deductible. It's totally and utterly arbirtrary and is counter to the federal gov't's drive toward affordable housing, as are the GSEs and FHA. ALL or most consumer interest used to be tax deductible, but that was done away with, leaving basically residential real estate as the last interest tax deduction for non-business-related expenses.
Up until 9 days ago, I worked for one of the GSEs (I've moved on to work at a private bank doing real estate). In the fall of 2008, I made 3 observations to my colleagues:
1) The GSEs and FHA actually serve no purpose. Their purpose is to promote affordable housing by increasing liquidity into the markets. They were successful at increasing liquidity, but because of the huge amount of liquidity created and the absurd leverage requirements (it was 2.5% down, now 3.5%) of FHA loans, home prices nationwide became totally unaffordable for many home buyers, encouraging mass fraud and bubble like activity, inevitably bankrupting many people and making the poor even poorer.
2) Gov't intervention to prevent a housing collapse (including homebuyer tax credits) will work counter to the federal gov't's long-standing mission of accomplishing affordable home ownership in the United States because it will prevent prices from falling to earth. If home prices remain inflated 1) another bubble and collapse is inevitable and 2) Many Americans will continue to be priced out of the market. Anyone who currently follows the real estate market can already see the single-family real estate engine reigniting nationwide. It's actually a sad site to see. NOTHING has been learned and nothing has been accomplished because of this collapse. Interest rates are still low, liquidity for most minimally competent people is still very available, and prices are again swinging higher. Not a goddamn thing accomplished.
3) The interest tax deduction actually inflates home prices. At 6% interest, $4,000 in annual tax savings increases leverage on a home by more than $66,000, which is priced implicitly into the purchase price of homes.
When I asserted this to my colleagues, I was stunned at the reaction--virtual silence. Because they had never heard anyone criticize government's role in creating this mess. They were so convinced that their job (and mine) was honorable that they bought into their own hype and had never so much as challenged the conventional wisdom. I'm wrong half the time, but on this issue, I am so right that it makes me physically ill to see what's going on in the markets.