Tag: housing market

A Double Dip for Housing?

Washington is fretting this week over news that mortgage applications fell dramatically in November. Coupled with earlier indications of renewed softening in the housing market, there is growing fear that housing is headed for a “double-dip downturn” that could further damage the economy. As a result, Federal Reserve policymakers are considering additional stimulus, while the National Association of Realtors is suggesting an(other) extension of the “temporary” homebuyer tax credit.

Remarkably, neither policymakers nor the media are asking the obvious question: Given all of the emergency interventions in housing that government has undertaken, and the fact that the housing market continues to erode, do such interventions do much good?

Since the bursting of the bubble in 2006, the great unknown has been whether housing prices will revert to their historical trend (and possibly to below trend for a short period), or stabilize at some permanently higher level because a portion of the bubble (aided perhaps by public policy) would prove enduring. There is good reason to expect reversion to trend, but the economy can surprise us.

Let’s use an example to understand this better. The graph below depicts the course of house prices for my hometown of Hagerstown, MD, an area within commuting range of suburban DC that was hit particularly hard by the bubble and its deflation. The black line is a house price index computed by the Federal Housing Finance Agency for 1989–2009. The red line is an extended linear trendline drawn using index data from the period 1989–2002. (You can do the same analysis for your area using these FHFA data.) The question, then, is whether house prices will fall all the way back to the trendline or will stabilize at a level above the trendline. 

Figure

The sharp downward slope at the end of the price line and  the latest housing news suggest that Hagerstown is destined to revert to trend (perhaps after a period below trend). I’ve drawn similar figures for several other locations and they show similar patterns. It looks like the nation’s housing markets, for the most part, are reverting to trend.

When this crisis first began in 2007, Bush administration officials vowed to “stabilize house prices at the highest possible level.” However, despite their efforts and those of the Obama administration, Congress, and the Fed,  reversion to trend appears inevitable. At best, those efforts may have slowed the reversion — in which case, I suppose the Bush goal has been met.

It can be argued that a gentler reversion to trend may be more tolerable than a sharp return. On the other hand, there are fears that a lengthy softening of the housing market will lead to more defaults, less worker mobility, continued weak consumption, and a long period of high unemployment and stagnant wages for those who are working. Perhaps a sharp return would be the quickest way to shed the ill effects of the bubble.

This leaves us with a final question that policymakers, the media, and the public should be grappling with: If all of these emergency housing interventions only result in a slower reversion to trend, then is that benefit worth the cost?

Perpetuating Bad Housing Policy

Perhaps the worst feature of the bailouts and the stimulus has been that, whatever their merits as short terms fixes, they have done nothing to improve economic policy over the long haul; indeed, they compound past mistakes.

Here is a good example:

For months, troubled homeowners seeking to lower their mortgage payments under a federal plan have complained about bureaucratic bungling, ceaseless frustration and confusion. On Thursday, the Obama administration declared that the $75 billion program is finally providing broad relief after it pressured mortgage companies to move faster to modify more loans.

Five hundred thousand troubled homeowners have had their loan payments lowered on a trial basis under the Making Home Affordable Program.

The crucial words in the story are “$75 billion” and “pressured.”

No one should object if a lender, without subsidy and without pressure, renegotiates a mortgage loan. That can make sense for both lender and borrower because the foreclosure process is costly.

But Treasury’s attempt to subsidize and coerce loan modifications is fundamentally misguided. It means many homeowners will stay in homes, for now, that they cannot really afford, merely postponing the day of reckoning.

Treasury’s policy is also misguided because it presumes that everyone who owned a house before the meltdown should remain a homeowner. Likewise, Treasury’s view assumes that all the housing construction over the past decade made good economic sense.

Both presumptions are wrong. U.S. policy exerted enormous pressure for increased mortgage lending in the years leading up to the crisis, thereby generating too much housing construction, too much home ownership and inflated housing prices.

The right policy for the U.S. economy is to stop preventing foreclosures, to stop subsidizing mortgages, and to let the housing market adjust on its own. Otherwise, we will soon see a repeat of the fall of 2008.

Republicans Just as Guilty of Flawed Keynesian Thinking

The core of Keynesian economic policy is that the government must come in and replace reductions in private sector demand with public sector demand, therefore bringing overall demand back to its previous level.  One of the many flaws in this thinking is in assuming that the previous level of demand was “correct” and getting us back to that level is the appropriate policy response.

Take the example of the housing market and the government response.  The primary response of Republicans in Washington has been to offer tax credits and other incentives to replace the drop in demand for housing.  Witness Senator Johnny Isakson’s  recent comments on why we need to extend the $8,000 homebuyer tax credit: “If you take that kind of business out of what’s already a very weak housing market, you do nothing but protract and extend the recession.”

This analysis could not be more wrong.  The tax credit largely acts to keep housing prices from falling further.  However, that is how markets are supposed to clear in an environment of excess supply.  If there’s too much housing, the way to address that is to allow housing prices to fall, which attracts buyers back into the market.

We should also recognize that the tax credit does not help the buyer, it helps the seller, by allowing the seller to charge that much more for the price of the home.

Perhaps the worst impact of the policy is that it encourages the continued building of homes, only adding to the over-supply, which itself will “protract and extend the recession.”  Witness the recent news that housing starts in the US just hit a nine month high.  While these levels are still low in historic terms, and housing inventories are declining, we still have an excess of housing.  The damage done by creating a false floor to housing prices is that builders don’t respond to inventory, they respond to prices, and as long as there is a positive gap between prices and construction costs, builders will build.  The tax credit only serves to widen that gap between prices and construction costs.

Back to Keynes: the central flaw in the thinking behind the tax credit proposal is its assumption that we need to re-inflate the housing bubble.  The previous level of housing demand, from say 2003 to 2006, was not driven by fundamentals; we had a bubble.  There will be a correction in the housing market.  Our choices are to either take that correction quickly and move on, or to prolong that correction, maybe even make it worse, by trying to create a false floor to the market.

Does the Left Know We Had a Housing Bubble?

Over the last week, speaking at a variety of events, I heard three different representatives of the Left; first a Democrat US Senator, then a senior member of the Obama Administration, and finally a “consumer” advocate, all repeat the same narrative:  all was fine in the housing market until predatory lenders forced hard-working honest families into foreclosure, which reduced house prices, bringing the economy to a crash.  That’s correct, apparently the Left believes we all would still be seeing double-digit home price appreciation if it wasn’t for those evil lenders.

Undoubtedly foreclosures, especially those that result in houses that remain vacant for a considerable amount of time, have an adverse impact on surrounding property values.  Many constitute a serious eye-sore and provide a haven for criminal activity.  But did foreclosures really drive down prices, or were foreclosures first driven by price declines resulting from a bursting housing bubble?  While causality is always difficult to establish with certainty, we do know that the rate of house price appreciation peaked and started declining about 18 months before the dramatic up-turn in mortgage delinquencies.  If one prefers a more rigorous test, economists at the Boston Fed have directly tested if prices first drove foreclosures or whether foreclosures drove prices.  Their results conclude that its was declining prices that matter, and that the price effect of foreclosures is minimal.

Why does any of this ultimately matter?  Because if we craft policies to avoid the adverse impacts of the next property bubble based upon a narrative of “consumer protection” – as is being pushed by the Obama Administration, we will do little to avoid the creation of the next housing bubble and its damaging aftermath.  Instead we should be focusing attention on those policies that contributed to the creation of the housing bubble: expansionary monetary policy and the Federal government’s blind pursuit of ever-expanding home-ownership rates at any cost.

Senators Want to Delay Housing Recovery

As discussed in a recent Bloomberg piece, several U.S. senators from both parties are pushing to almost double the recently enacted $8,000 tax credit for first-time homebuyers to $15,000. The same senators are also pushing to remove the current income restrictions — $75,000 for individuals and $150,000 for couples — while also removing the first-time buyer requirement.

The intent of the increase, and the original credit, is to increase the demand for housing and to create a “bottom” to the housing market. The flaw of this approach is that it creates a false bottom, one characterized by government-inflated prices and not fundamentals. It was excessive government subsidies into housing that helped create the housing bubble, additional subsidies to re-inflate the bubble will only prolong the actual market adjustment.

If it were only a matter of prolonging the adjustment, then the huge cost of the tax credit might be easier to justify. Yet by encouraging increased housing production, the tax credit will increase supply when we already have a huge glut of housing. Despite housing starts being near 50-year lows, there is still too much construction going on. The way to spur demand in housing is the same way you spur demand in any market: you cut prices.

Removing the income limits makes clear the real intention of the tax credit, to help the wealthiest households. About three-fourths of existing families already fall under the income cap of $75,000. As we move up the income latter, home equity makes up a smaller percentage of one’s total wealth. The richest families can make do with a decline in their housing wealth and continue spending; they have other substantial sources of wealth. If we have learned anything from the housing boom and bust, it should be that continued government efforts to rearrange the housing market have been costly failures.