if some fool (Uncle Sam and the taxpayer by coercion) is willing to subsidize buying a house and not subsidize renting an apartment, then isn't it rational to buy rather than rent. Particularly since the homeowner will be building equity instead of the landlord.

You used "massive investment" and leveraged in the same sentence. In fact, the current crisis has arise precisely because many mortgagees have no investment in the house--therefore they are willing to walk away. This can be a rational economic decision--if you have 200,000 of debt for an asset worth only 160,000 without having made a substantial downpayment, why not just walk away from the property. If, on the other hand, you had to put down 10% in cash, then walking away means you lose 20k, and the bank is really only out 20k because they have the house and your original 20 k too. Psychologically, people will not walk away from their mortgage if they realize they are losing their substantial down payment.

I agree that the discovery of something wrong in the neighborhood can be an issue--in theory. In theory, an efficient market should take care of this issue. In essence, when you buy into a given area, previous buyers should have been able to detect fundamental flaws in the market and this would force discounting of the home prices.

Over time, I suppose, the gradual erosion of property values could happen because of social issues, e.g., worsening school system, or GM closes the plant, boom goes the house prices or you discover that your housing development is the latest Love Canal.

Labor mobility is an issue only if one must sell immediately, and if one bought his house at a market peak or is selling at a market trough. Otherwise you put your house on the market, discount it enough to sell, and move. My next door neighbor did just that, and in an area allegedly overbuilt and in a bad market, sold his house in less than a month.

Yes, you can get upside down in a house, especially if you move frequently or get fired suddenly. Many large companies assist their upper level employees for company mandated moves.

The real issue is why we in the US are so convinced that houses will appreciate faster than inflation, forever. Many people have learned the hard way that this is not a law of nature.

Cheap labor, not the cost of capital, is the reason why quality jobs are disappearing from the US. Capital is an international commodity, which is why China may own US someday.

The system is rigged towards homeownership, not because it makes economic sense, but because it makes political sense. Public policy is only rarely guided by true economic sense. If it were, we'd probably have a national sales tax, or a flat tax, or some other system of taxation rather than the insane system we have now. But you couldn't "soak the rich" with a flat tax, Congress couldn't slip their political patrons special deals, and you'd increase the unemployment rolls by adding hundreds of thousands of accountants, lawyers and bureaucrats. When Reagan simplified the tax system in the 80's, one of the original proposals was to eliminate the mortgage deduction. That one didn't make the first cut.