‘Housing prices must fall, yet…housing prices must not fall’
Tyler Cowen sums up the central problem with our economy, asking “Should we let housing prices fall?”
Many smart people say we should. It seems increasingly clear that we must. For how long can the government prop them up? Are we never to have a private market in mortgages again?
Yet what happens if we let them fall? Arguably many banks would once again be "under water." Enthusiasm for another set of bailouts is weak, to say the least. Our government would end up nationalizing these banks and it still would be on the hook for their debts. The blow to confidence would be a major one, especially if along the way we saw a recreation of a Lehman or Bear Stearns or A.I.G. episode.
I increasingly believe there is no easy way out of this dilemma and it is a major reason why the U.S. economy remains stuck. Housing prices must fall, yet…housing prices must not fall.
Here is a very good Dave Leonhardt piece on two different views of housing. It’s where to go, if you are looking for the case for optimism. I am more pessimistic than David because I see the private sector interest in mortgage securities as remaining quite weak, which suggests the market knows which way prices have to move.
I don’t see any other way around this conundrum – housing prices are going to fall. End of story. They were massively inflated during the housing boom, and people simply can’t afford the sticker price – hell, they couldn’t afford the price five years ago, but at least then we were all under the dizzying impression that somehow prices would just keep going up, up, up…
I’d bet we have at least a 25 to 40 percent decrease in home values still ahead of us, depending on how badly inflated various regions became during the boom years. No amount of government policy will change this, though it might soften the landing a little. I think there needs to be more of a coordinated effort on the part of lenders to help people get out from under water. It’s in the best interest of the home buyers, the lenders, and Unlce Sam to make this happen. But there really is no easy solution in a situation where the necessary compromises by necessity lead to someone losing a great deal of money.
Whether now is the time to buy is another question altogether. Interest rates are very low, and buying now – after prices have come down significantly already – might make sense if you plan on keeping a property for a long time. That being said, the very fact that there is so much uncertainty over whether or not to buy a house indicates the likelihood of falling prices in the near future.
Depressing.Report
Anything that can’t go on forever won’t.
If it is to be done, best it be done quickly… and, to be perfectly honest, we should have let this happen years ago.Report
My partner and I bought a home in 2007. We paid about $158,000 for the house and I can assure you that the value of the home has dropped considerably since then.
When we chat about the housing crisis, he usually exclaims that buying a house is a risk. Housing prices are not guaranteed to go up forever, and they just might fall.
I think he’s correct. Buying a house is a risk and the home could very well be devalued. The thing is, that’s the risk we take when we buy a home. The value might go up, but they may also go down.
As for whether the government can do anything, I don’t know. The thing is, we buy things all the time that lose value over time, cars being the primary example. A house is not guaranteed to gain value. We buy houses to live in them and if we make a little money when we sell them, that’s great. But the thing is, they are places to live, not investments.
As it stands, we are “underwater,” owning more than the house is worth. But as Daniel notes, we aren’t really in any danger unless the we decide to sell the house and then we will have to take a big hit. But again, that’s the risks of buying a house.
I think what has to be learned from this whole debacle is that homeownership is a nice thing, but it is not a right of all Americans. It’s a big responsibility and society (including government) need to help people prepare for this responsibility, which includes banning silly products like no-doc or interest-only loans.Report
@Dennis Sanders, Right there with ya Denny, bought a charming condo at 200k and now it’s at 160. We’re not underwater since we put a lot down but certainly the loss of equity stings. Still, since we always intended to live in it for a long time we’re not heavily troubled though sometimes I imagine what we could have gotten had we somehow had the inkling to wait until the market hit bottom (ironically we thought at the time it was at the bottom). An extra bathroom would have been nice.Report
This is the long run problem with government intervention — when the effects hit, it’s difficult to trace the effects back to the original causes because so much time elapses in between, but the causes can be traced back to the beginning of the push for home ownership, or even the Fed manipulating interest rates, or the tax break on mortgages — it eventually got out of hand. As fas as prices, we might have to have deflation in other areas, like lumber, concrete, wiring, plumbing, appliances, labor etc, because what people are willing to spend on a house might be lower than the cost to build it.Report
@M. Farmer, Yes Mike, but you can’t lay the blame for asset bubbles at the feet of government alone. The tulpengekte went down in 1673 long before serious government intervention in the markets was a twinkle in some statists eye.Report
@North,
I can lay the blame for the housing bubble at the government’s feet, even though home-buyers should have resisted the temptation — if the temptations weren’t there, and if the market was working as it naturally works without gvernment intrvention, homebuyers, banks, or anyone else wouldn’t have been able to take advantage.Report
@M. Farmer, The point is Mike that markets throw out bubbles on their own without government intervention and people do buy into them and then get shelacked hard when they burst. I’m not saying this particular one wasn’t strongly related to some government involvements. Just trying to keep things balanced.Report
@North,
But, that’s what I was saying. You aren’t balancing — you are bringing up a separate topic. What you added doesn’t take away from the fact that government intervention in the market such as home-owner promotion has negative consequences, and it doesn’t balance out anything, it just adds another separate issue that has nothing to do with my point. If I had said all bubbles are caused by government, you might have been balancing, or correcting me.Report
@M. Farmer, Well great, then we’re on the same page.Report
@M. Farmer,
As Obama said — it’s time to turn the page.Report
@North,
Plus, sometimes a tulip is more than a tulip
http://mises.org/daily/4341Report
@M. Farmer, Did the government have a role in the problem? Yes. But so did the market. The private sector also had a role in creating a bubble that only made things worse.
Government can mess things up, but so can the market. Neither should be considered god-like.Report
@Dennis Sanders,
No one is considering the market God-like, but the housing bubble wouldn’t have happened in a free market, at least not to the extent of threatening global finances–economics would have prevented it — Jesus, why do I have to be saying the market is perfect when I simply make a point about government intervention? These false equivalencies are maddening.Report
@M. Farmer, So, how can we know that a housing bubble would have never occurred in a free market?Report
@Dennis Sanders,
With sound money policy and un-manipulated interest rates, it’s damn near impossible. But I will concede that just about anything is possible, except the impossible, of course. But, really, this is not the forum — however there are economic realities which prevent such bubbles — Mises explained it well in Austrian economics. And, Doug French’s book, linked above, destroys the Tulip myth.Report
@Dennis Sanders,
Plus, when government is involved up to their necks, you can’t say the market caused anything, because the market is controlled by outside forces. You can only say the market interfered with by the government caused it.Report
If people start thinking of their homes as, well…homes and not investment properties, they’ll be just fine. Buy a house you can afford, do what you want to it and enjoy.Report
@Mike at The Big Stick, this sentiment was expressed by Dennis, also. The problem I have with it (and I mean a problem of conceptualizing, not politics) is it ignores the importance of real estate as a limited and special kind of capital. If real estate inherently loses value like other consumer goods, then ultimately why should anyone own land? It will eventually lose all its value, right?
No, there are two markets entangled in the housing bubble, and it might be worthwhile for someone smarter than I to untangle them. The Real Estate market sells land according to its value to whoever would improve it. The benefits of such exchanges being market-driven is one of the strongest arguments for land property rights of any kind. The Housing market is a subset of land users; namely, house builders and house owners.
During the housing bubble, real estate prices were usually what was put down in the ledger books as increasing, with more modest increases in the values of improvements. The “true value” of the real estate should be reflected in people’s willingness to pay large mortgage payments for the privileges of the property’s location: commute, schools, malls, lack of malls, whatever. The housing bubble did, perhaps incorrectly, layer an additional value of perceived investment value that wasn’t there, and it appeared to do so on the Real Estate side of the ledger, rather than the Housing side. But to say that real estate should not be regarded as an investment at all is to suggest that real estate doesn’t have real value associated with its location that is likely to endure.
To sum up, when I hear people saying that purchasing real estate should not be for investment at all, I hear echoes of opposition to our property ownership system overall, not just to government intervention. How do you prevent real estate speculation without curtailing property rights severely?Report
@Boegiboe, People buy cars every day that will only depreciate in value, but that misses the larger point. I’m not saying homes can’t go up in value. I’m saying that they shouldn’t be viewed as an investment but rather a place to live. Money invested is for personal enjoyment, not profit.Report
@Mike at The Big Stick, I’m with Mike on this one. If people viewed houses as essentially a different form of renting and treated any long term value change in their home as incidental then it’d probably result in a healthier home market.Report
The housing market will recover when the next generation of young people can afford to buy houses. I am already seeing evidence of this in our regional market. People are still succeeding in America and serious young people are being qualified for mortgages. There may be a seasonal price adjustment but the spring of 2011 will bring new life to the housing market. It’s good to remember that new players are continuously taking the field.Report
This is a topic about which I know a lot (no, i will not end sentences with a preposition). Here are a few somewhat connected thoughts:
1. The long-term blame for the political support of the idea of homeownership belongs to all of us (and our parents). This is what we wanted, as voters, and what we got. A big chunk of that policy was set in the extraordinary post WWII boom in suburban housing. But i’m not aware of any issue in politics where legislation and regulation more closely track what the middle class wants.
2. The post 2000 spike in home prices was attributable to a perfect storm of financial innovation, and state-level and federal-level regulatory incompetence and blindness. The Fed, Bill Clinton, GWB, the Republican party and many East Coast Democrats linked into the gusher of money coming out of Wall Street bear the brunt of that blame.
3. The single biggest factor in determining whether a house goes into foreclosure is the drop in price. This makes sense; if you think you might go into the black in five years, you may well hang on to your house. But if its 20 years before you see any equity, just give the bank the keys.
4. So preventing housing prices from falling too far both keeps people in houses and keeps banks (and other public investors in mortgages — like pension funds) from going broke. So that’s a good thing and worth doing.
5. But keeping the market at substantially more than the market-clearing price absent govt intervention has major downsides. No one is building houses. People who have jobs and could be providing a boost to the economy by getting into houses of their own are kept out of the market. Price support is expensive. Workouts which reduce principal are impossible at a large scale. The most recent attempt to allow judges to impose cramdowns on residential mortgage debt in bankruptcy failed, demonstrating the ongoing strength of the banking industry (but not their collective intelligence).
5. Libertarians write the following sentence a lot: People should know better. But they don’t, and they vote, and they call their Congressperson. Given the irrational connection that people have to their houses, the question then becomes what is the most sensible policy.
6. I’ve thought about this a lot, and I’m still not sure. It seems to me that the best idea is to try to get employment back up through overall stimulus and let the chips fall where they may on housing.Report
No small part of the idea of propping up home prices appeared to be the belief that the bubble caused prices to be too low, and that after a couple of years they would mostly bounce back. Call it mistaken, naive, wishful thinking…. The NYTimes column linked by Cowan accepts that housing prices will start to rebound, albeit not for “a few years”. It’s a truism that at some point prices will start to rise – the big question is when and how quickly.
I suspect that Tyler Cowan is correct, and another part of it is concern that further drops in the housing market will harm bank balance sheets. Also, as long as housing prices stay at their current levels, the construction industry is likely to remain depressed. In much of the country it’s pretty easy to find a nice home for sale, right now, for considerably less than it would cost to build the same house.Report
Rather than reducing housing prices, we should inflate other prices.
The way out of this problem is inflation. Krugman has pointed out that inflation is one of the things that got us out of the Depression and laid the foundation for post-war prosperity by wiping out debt.
The Fed should get out of this obsession with avoiding inflation. A little dose would reduce a lot of unpayable debts. It also would bring other prices in line with housing prices.Report
@Steve,
Yes, let’s raise the prices on the stuff poor people buy, so Ken and Buffy aren’t upside down in their McMansion.Report
@Steve, Steve, inflation would also devastate everyone’s savings and pensions. I don’t think it’d be doing anyone a favor to try and inflate housing debt away. Also wages typically rise much slower than prices in inflation scenarios so we’re talking about a serious decrease in the standard of living.Report
@North, Almost everyone’s savings are either explicitly or implicitly index linked, since they’re coupled either to the stock market or to relatively short term interest rates. The losses from an inflationary policy would be absorbed by the banks who own longer term debt than the general public, much of it at fixed rates – that’s why its not gonna happen, at least not on a scale sufficient to bale out the housing market.
However, Scott Sumner (www.themoneyillusion.com) has been arguing since the crisis that the Fed’s policy since mid-2008 has been deflationary in effect, since nominal GDP growth has been about 8% per annum lower than was expected, partly due to lower than expected inflation. He’s been arguing for explicit targetting of NGDP or at least of inflation by the Fed, which would be slightly inflationary at least relative to the current situation.
I’m pretty confident that this is the right thing to do, but I doubt the Fed will ever do it precisely because the banks balance sheets will be hurt by inflation in the short run even if growth would help them in the longer run.Report
Joseph Stiglitz wrote an insteresting article about this subject, and what he thinks needs to be done.Report
As a variant of the “No True Scotsman” theorem, the “No Free Market” theory is anthropologically interesting but that’s about it. There is no purely free market in the universe. Full stop.
The question then becomes “Are the externalities (Yes, those pesky things again) positive enough to justify the government putting its thumbs on the scales of this particular market, and did that have anything at all to do with the mess we’re in?”
The more important question of course is “What can, or should, we do about it?” The answer seems simple but it gets caught up in that knee-jerk response to someone else getting “something for nothing” that you didn’t get. Plus some gnashing of teeth over what will happen to the banks when things are worth what they’re worth and they have to deal with that en mass. Hopefully we’ll get over that before the bottom really falls out.Report
Not quite sure I’d agree. The price to rent ratio indicate that most of the boom has already disappeared (see http://4.bp.blogspot.com/_pMscxxELHEg/SwwLMNmxidI/AAAAAAAAG4U/YExykMMJm5Q/s1600/Q3PriceRent.jpg). Whatever housing prices are now keep in mind these are prices in an economy with 10% unemployment and deflation. Would an economy with 5% unemployment and modest inflation of 2-3% support house prices falling much more? I don’t think so.Report
There’s a reason my house is on the market. It’s not because I need to sell. It’s because it will not be worth what it’s going for now for another decade.
@ Boonton
Most of the boom has not already disappeared. The price to rent ratio is out of whack as an indicator, it has limited value.
There are two rules of thumb that have been grossly violated in the last 10 years. The first is that a house that is for rent should be for rent at a monthly rate roughly 1/100th of the sale price of the house. This means a property that sells for $250,000 rents for $2,500 a month. In the southern California market, this is still completely crazily off-base; houses that are for sale for $500,000 are still being rented for $3,200 a month.
The second rule is that the median house price in a given market should trend very closely with the median income for the target demographic. A 4 person house in a middle class neighborhood should be bought by a household that puts 20% down and can pay a mortgage payment on a 30-year fixed at 8% with a third of their bring-home income. The median income in southern California can’t build up a down payment, let alone make that payment plus real estate tax.
I know, you’re going to say that California is an outlier, but the point generally stands. California real estate needs to explode, as do dozens of other markets. Right now about 1/10th of the outstanding mortgages in the U.S. is in foreclosure, and a full 1/10th is more than 30 days past due.
You can ignore that as long as you want, but it’s not going to ignore basic reality much longer. Banks might let people live in houses rent-free for a year if the Fed keeps letting them postpone foreclosures to keep that crud off their books, but the fact remains that the house isn’t worth $700,000 any more, and sooner or later you have to mark it to market…Report
@Pat Cahalan, The problem with these rules of thumb is they don’t really hold when you consider all the factors that affect a rent/buy decision, even if you limit yourself to purely financial costs, especially not in the current interest rate environment. Right now buying a $500k home that would rent for $3200 gives you a total monthly housing outlay thats less than the rent would be, without even considering the tax implications or the fact that some of the mortgage payment is principle, not interest. For buying to actually be worse than renting for your balance sheet in the medium term given those numbers, you need to be looking at interest rates on a 30 yr fixed of over 7%, assuming a 25% tax bracket and static house prices, which you pretty much have to be if you’re spending $500k on a house. I’m not sure where the 1/100th rule came from, but it just doesn’t really work out here.
I made endless spreadsheets of this stuff when making my own personal rent/buy decision – given the vagueries of the US tax system and uncertainties about the direction of interest rates, and the various different consumption values from owning a house, there really aren’t any general rules that can be applied. You have to do the sums yourself for your specific situation – if you’re in a high tax bracket and have kids, things make sense that certainly wouldn’t if you were in a low tax bracket and single.Report
@Pat Cahalan, My view is from NJ where home prices did not fall as much and haven’t come down as much but the job situation is not as dire. But this is tricky because wherever you live you can only see a tiny piece of the picture.
For the nation as a whole, though, I’m still skeptical. When I last looked, even during the boom there was not a huge amount of actual housing created. We went into the boom with something like one house per 2 point something people and we still have one house per 2 point something. The price of housing overall is driven by taste. If all in the sudden people decide they feel comfortable living with 4 people rather than 2, if they decide they’d rater spend no more than 20% rather than 40% of their income on housing then yes prices would fall down fast. I’m not seeing that. People still like to have their own house, still are comfortable putting a good piece of their income to housing. Yes some are doubling up but that’s mostly due to the job situation.
Over the long run yes things will change but you have to think about why they change. OK interest rates will go up. Higher interest rates is bad for homebuyers. Check. But why would interest rates go up? Either because inflation picks up or because the economy picks up. It’s very hard to see serious inflation with home prices falling dramatically. Likewise if the economy is doing so well interest rates rise to cool it, it’s hard to see home prices collapsing even more.
The fallback for additional collapse here is based on finance. But for decades people make their mortgage and rent payments. The finance system is indeed pretty sick right now but I don’t see any particular reason why the traditional mortgage (which was the standard even as recently as, say, 1995) cannot be supplied by the finance industry….esp. as the crash has caused an increase in individual savings rates. Yes banks still have bad loans on their balance sheet but the Fed is pumping banks full of easy money and easy profits and every year that goes buy the hump of those bad loans gets more and more digested. There’s no particular reason I see to assume that it would be impossible for finance to supply good loans going forward.Report
http://d-squareddigest.blogspot.com/2010/09/hardy-perennials-i-suspect-that-there.html makes a good point.
You can’t ignore interest rates in evaluating how much a piece of capital is worth. If interest rates are high, a piece of capital is worth less. The reasoning is simple. If some machine will give me $12000 in 2040 I have to consider its price today. If the machine costs $10,000 today the fact is I can just put my money in a savings account and have more than $12K by 2040. The higher interest rates are, the less I’d be willing to pay today for that $12K in 2040. The lower the rates are the more I’d be willing to pay (if real rates are negative, i.e. deflation, I’d even be willing to pay more than $12K) Houses can be thought of as machines that provide a place to live. If it costs about $1K per month to rent a decent place then owning a home will give you that in 2040 (and every year before then, as well as after).
Anyway we are in a period of very low long term interest rates. No that is not because the Fed ‘set’ them that way. The Fed can only set the 3 month rate. All other rates are set by the market and if it thinks the Fed is printing too much $$$ it will make long term rates jump. Low long term rates makes houses worth more and it looks like rates will be low for a long time to come.
I think the idea that the nation as a whole still requires another real estate price collapse doesn’t hold water. Individual regions might be in a holding pattern where owners are waiting to see what happens to prices when the recession ends. But this itself means that the people holding are able to hold on (whether they be individuals underwater who continue to pay or banks holding off foreclosing). That’s better than people who can’t hold and have to sell regardless of price.Report