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Dean Baker: 'We’ve lost about $6 trillion in housing wealth, and I expect we will lose more.'

baker_thumbnail.jpgWhen I looked over the invitees to the Treasury Department's forum on housing policy today, I noticed one of the names that wasn't there: The Center for Economic and Policy Research's director, Dean Baker. Back in the early aughts, Baker was perhaps the most persistent and vocal voice warning of a housing bubble (see, for instance, this 2002 publication). Invitations get lost in the mail, of course, so I gave Baker a call to see what he thought of the housing market now, and going forward. A lightly edited transcript of our conversation follows.

How’s the housing market doing right now?

It’s softening big-time. The first-time buyer’s credit was extended, and it did have a big impact in boosting the market. Housing prices rose from the second half of 2009 till the expiration, then the extension of the credit gave a modest boost up until April 30. Then the market just fell out. Most of our data takes six weeks or two months to come back, so we don’t know exactly what the new contracts look like. But sales have dropped through the floor, so my expectation is that prices are falling sharply. We should see declines through 2010 and possibly into 2011.

How would you rate the administration’s housing policy response?

It’s been painful. There’s been no clear thinking about what they were trying to do. There was talk about supporting the market. But what’s the logic in supporting a bubble? There were markets where the bubble has fully deflated and maybe has gone too far. Places like Phoenix and Las Vegas. It would’ve made sense to support those markets. But we didn’t do that. We were indiscriminate with our policies.

Our housing intervention always seemed very small in comparison to our stimulus and financial market interventions. Was that part of the problem?

The amount of money was small, which may have been good because it’s not clear that what you should’ve been trying to do was support house prices. Supporting house prices would’ve taken a lot of money. It would’ve been like agriculture subsidies, but cost more and made less sense.

How much is weakness in the housing market doing to slow the recovery? At this point, is the economy as intertwined with the housing sector as it was a few years ago, or have they been more effectively cleaved from one another?

They’re tied up. The basic story is that the loss of demand in the economy has come first from lost construction, which is largely housing. That’s been about 3 to 3.5 percentage points of GDP. Then we had a bubble in nonresidential real estate, which was another 1 to 1.5 percentage points of GDP. Then on top of that, we had the consumption driven by housing wealth. The administration talks about consumers being pessimistic, but it’s not consumer attitudes that are the problem. It’s their wealth. We’ve lost about $6 trillion in housing wealth, and I expect we will lose more.

Are there any major policies you’d like to see us do to help the housing market in the short term?

To my mind, the best thing to do is help the homeowners who are losing their homes. The basic story there is to give them the right to rent their places for some period of time.

And how about the long term? How should our general approach to housing policy change?

First, we definitely did too much to promote home ownership. Even at the peak of the bubble, over 30 percent of households were renters. It just doesn’t make good sense to have a policy saying 30 percent of the country are second-class citizens. We should try to ensure people have good rental options.

In terms of ownership, I think it’s fine to help middle-income people buy homes, but the current structure is crazy. Most of the benefits go to higher-income people. If you go back to 2005, Bush’s tax commission actually had a very good proposal on housing: They proposed switching the mortgage tax deduction to a credit, and it would be capped at $450,000. Currently the cap is $950,000. That would orient it much more towards moderate-income people.

And then in terms of Fannie and Freddie, go back to the old model where you have them as government companies and they just hold the mortgages. They don’t securitize them. The government can bear the risk. But this will be difficult. First, there’s the ideological issue, and people say they don’t want the government doing more. Then there’s the political issue, which is that it’ll make the government’s debt look bigger. If you can’t get that, it probably makes the most sense to just do away with them. We don’t really need them. The market for “jumbo” mortgages -- mortgages bigger than Fannie and Freddie will take -- works reasonably well.

Photo credit: CEPR.

By Ezra Klein  |  August 17, 2010; 3:36 PM ET
Categories:  Interviews  
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Comments

Thanks for talking with Baker. (Brings you about halfway back from talking with Ryan :P )

Posted by: bdballard | August 17, 2010 4:14 PM | Report abuse

good (albeit) brief talk. Would have liked to hear what he thought about the FED holding down rates does to help reinflate the bubble.

people need to realize that its going to be a long and arduous process. Its easy to inflate something quickly that was never there in the first place. True growth and wealth development takes a long time.

Posted by: visionbrkr | August 17, 2010 4:26 PM | Report abuse

i think i know the answer to this already,

but did anyone at the housing conference mention how valuable a reasonable inflation rate is in the aftermath of a financial crisis/in the presence of an underwater mortgage market?

Posted by: eggnogfool | August 17, 2010 5:03 PM | Report abuse

Hi Ezra,
I'm glad you pulled Dean's 2002 paper, which proves his recognition of the housing bubble was several years premature. At that time, the Case Schiller national home price index stood at 125.42, about where it was in late 1980s before entering a near ten-year plunge. For instance, when I bought my home in the DC suburbs in 1998, the C-S index stood at 89.54.

In the first quarter of this year, it stood at 134.1 after peaking at 190.47 in the first quarter of 2006. If it should go down another 10 percent in the next two years as Dean predicts (to about 120), my home's value would have appreciated about 25% over the 13 year period I've owned it (by the end of 2011) or approximately in line with overall inflation.

The more relevant data now are the price to rent and price to income ratios. According to this blog (http://www.calculatedriskblog.com/2009/02/house-prices-real-prices-price-to-rent.html), they were about ten percent over historic norms at the end of 2008. I assume they've fallen even more in the past 18 months and reached their historic average. However, there is a likelihood they will overshoot on the downside because of depressed incomes due to high unemployment.

So here's my housing advice. If employment begins to recover (a big if, read Robert Reich's latest column), it will be an excellent time to buy a home, especially if you're a young family with a stable income and can get into a very low 30-year fixed rate mortgage.

Posted by: GoozNews | August 17, 2010 5:39 PM | Report abuse

"There was talk about supporting the market. But what’s the logic in supporting a bubble?"

It's so true. High housing prices cause a lot more harm than good over the long run. It's the chief reason why over the last generation spending on fixed costs by a typical family increased from 54% to 75%, even while adding an extra earner (and thus losing that spouse as a reserve earner in emergencies). Very high fixed costs make it easy to be pushed into a debt spiral if things don't go just right,thus this generations epidemic of financial distress.

Housing prices can't go low too low (demand can be increased in other things, like high return investments by the government, education, alternative energy, basic science, etc.). The lower they are the lower the fixed expenses of the typical family. The good far outweighs losses by people who, for the most part, already have a lot of wealth.

For more on this, see this senate testimony by Elizabeth Warren (a fantastic little report):

http://finance.senate.gov/imo/media/doc/051007testew.pdf

and

http://economistsview.typepad.com/economistsview/2008/08/wishful-thinkin.html

Posted by: RichardHSerlin | August 17, 2010 5:46 PM | Report abuse

"First, we definitely did too much to promote home ownership. Even at the peak of the bubble, over 30 percent of households were renters. It just doesn’t make good sense to have a policy saying 30 percent of the country are second-class citizens. We should try to ensure people have good rental options."

This seems like a contradictory statement. We did "too much" to promote home ownership (meaning more people should rent). Then he goes on to say renters are second class citizens.

I've rented my entire life and until I read this post I always felt like a first class citizen. Thankfully, liberals will always tell us how bad off we all are so the government can save us.

Posted by: kingstu01 | August 17, 2010 7:05 PM | Report abuse

He wasn't saying renters are second-class citizens. Rather he was saying that the government policy of promoting homeownership treats renters like second-class citizens (as it subsidizes the former, at the expense of the latter).
Funny how these 'liberals' (read leftists) tend to be the most prescient economists. Besides Dean, Monthly Review articulated this bubble in 2003 (http://mrzine.monthlyreview.org/2008/foster031208.html). Peter Schiff (an Austiran Economist) came later in 2006.
In congruity with the above posts sentiment, Dean's Right to Rent idea is by far the best on the table as a way to dampen the destructive effects of this housing market. It gives someone currently underwater on their mortgage a viable option other than strategic default (thereby abating foreclosures). Conservatives should love it because it needs ZERO tax dollars.

Posted by: lduende | August 18, 2010 12:40 AM | Report abuse

ldeunde,

sure i'd love it. But i've got one question for you. Who's the landlord? The bank? The government?

As a conservative I'd choose the bank but I'd expect a liberal to choose the government. Then what if the landlord (whoever it is) wants to sell the property at a later date. Does the renter (former owner) have right of first refusal and ability to purchase?

still a lot of landmines out there to navigate.

Posted by: visionbrkr | August 18, 2010 9:58 AM | Report abuse

It's funny how so many other liberals are looking to prop up the housing market. It's good to see one that at least recognizes that it's not worth it, wants to get rid of Fannie and Freddie, etc. He even mentions the functioning jumbo market as good evidence that government meddling in the mortgage market is unnecessary. He doesn't want principal reduction, he wants to allow rent backs. His disagreement with the leading direction of Ezra's question on whether the amount of money devoted to propping up the bubble was too small was also great- "The amount of money was small, which may have been good because it’s not clear that what you should’ve been trying to do was support house prices."

Let's face it, the first time home buyers credit was a give away from future taxpayers to temporarily cause price distortion in the market. The mortgage interest deduction is ridiculous. The US consumer lost a lot of nominal wealth, and no stimulus is going to recreate that. Time to adjust to the new normal.

Posted by: staticvars | August 18, 2010 10:02 AM | Report abuse

@RichardHSerlin "Housing prices can't go low too low ....The good far outweighs losses by people who, for the most part, already have a lot of wealth."

I beg to differ....our family of 5 is single income making less than $60K annually. We've lost $40,000 in equity in the last 12 months - we bought under appraised value 6 years ago so we weren't part of the "bubble" where we purchased a home that was over-valued. Do you consider us among "the most part (who) already have a lot of wealth?"

Our MIL passed away in 2009 - in 2007, the home she bought in the 1960's for $40,000 was valued at close to $700K - today, we have a contract on that river front home for just $400,000 even though it appraised in January 2010 at $525,000......she was a widow on a fixed income who had bought and kept a house for the majority of her adult life where she raised her children, lost her husband, and herself passed away at age 74. Do you consider her among "the most part (who) already have a lot of wealth?"

Your argument speaks more of "class envy" and "savings envy" then it does of what the reality is. This bursting of a bubble didn't hurt those who already "have a lot of wealth" it hurt those who played by the rules while others got their homes through fancy financing backed by fancy marketing tools backed by a government who felt that it is a RIGHT that everyone should be able to afford a home even when they can't afford that home.........

The cost of maintaining her house and hoping for a better market is too high to wait and so the one thing she wanted to give her four children has devalued dramatically because of an inflated bubble driven by Fannie and Freddie and a Barney Frank mentality that George Bush was crying that "the sky is falling" when he tried as early as 2003 to get Congress to act on this.

Posted by: LMW6 | August 18, 2010 10:15 AM | Report abuse

"I beg to differ....our family of 5 is single income making less than $60K annually. We've lost $40,000 in equity in the last 12 months - we bought under appraised value 6 years ago so we weren't part of the "bubble" where we purchased a home that was over-valued. Do you consider us among "the most part (who) already have a lot of wealth?"

Not to be inconsiderate about what sounds like a tough situation, but if you bought in 2004 you were indeed part of the bubble. Nearly any home in a bubble market back in 2004 was bought at over-valued levels, even if bought below the appraised value at that time. Losing $40,000 in equity even as the homebuyer tax credit propped up prices suggests a bubble market location.

"Our MIL passed away in 2009 - in 2007, the home she bought in the 1960's for $40,000 was valued at close to $700K - today, we have a contract on that river front home for just $400,000 even though it appraised in January 2010 at $525,000......she was a widow on a fixed income who had bought and kept a house for the majority of her adult life where she raised her children, lost her husband, and herself passed away at age 74. Do you consider her among "the most part (who) already have a lot of wealth?"

Assuming no other assets other than a $400,000 house, well yes that's actually fairly wealthy.

In 2004, that would have put her at the 80th percentile (and house prices are lower today that 2004, and most net wealth at that percentile is home equity).

It's not robber barron wealth, but more than ~80% of the country.

http://www.clms.neu.edu/publication/documents/Wealth_in_America.pdf

"This bursting of a bubble didn't hurt those who already "have a lot of wealth" it hurt those who played by the rules while others got their homes through fancy financing backed by fancy marketing tools backed by a government who felt that it is a RIGHT that everyone should be able to afford a home even when they can't afford that home........."

While I'd argue the bubble bursting hurt nearly everyone (repo men and short-bias hedge fund managers notwithstanding), I agree with your analysis here.

"The cost of maintaining her house and hoping for a better market is too high to wait and so the one thing she wanted to give her four children has devalued dramatically because of an inflated bubble driven by Fannie and Freddie and a Barney Frank mentality that George Bush was crying that "the sky is falling" when he tried as early as 2003 to get Congress to act on this."

The $700,000 her home was worth in 2007 was a value inflated by the bubble. The absence of the housing bubble wouldn't have led to this home being worth $700,000 in 2009. The $300,000 decline over 2007-2009 was the bubble valuation premium melting away.

Posted by: justin84 | August 18, 2010 11:26 AM | Report abuse

"Are there any major policies you’d like to see us do to help the housing market in the short term?

To my mind, the best thing to do is help the homeowners who are losing their homes. The basic story there is to give them the right to rent their places for some period of time."

I wish you had asked him his opinion on judicial mortgage modification, aka bankruptcy cram-down as an alternative here.

Posted by: jnc4p | August 18, 2010 11:33 AM | Report abuse

"Our MIL passed away in 2009 - in 2007, the home she bought in the 1960's for $40,000 was valued at close to $700K - today, we have a contract on that river front home for just $400,000 even though it appraised in January 2010 at $525,000......she was a widow on a fixed income who had bought and kept a house for the majority of her adult life where she raised her children, lost her husband, and herself passed away at age 74. Do you consider her among "the most part (who) already have a lot of wealth?"

You say that she was a widow on a fixed income who remained in the home until she passed away. I don't see that the rise in the value of her home did the MIL a lot of good (unless she was doing a reverse mortgage or in some other way was taking out the equity), and I wonder how the rise in equity impacted the burden of the property taxes she had to pay, but perhaps if you inherited the property or a share in the property it was a major benefit to you.

I agree with RichardHSerlin that the concept of widespread home ownership as a social good only makes sense when home ownership is affordable, so that a person of average income can accumulate a down payment and afford the monthly mortgage payments, without destroying the family budget for other necessities. I feel for all the people who ended up "under water" but I think even the depressed current prices are still irrational.

It is better to think of owning a home as securing one's domicile, rather than as getting the keys to a magical machine that grows in value at mysteriously rapid rate, unrelated to the normal laws of supply and demand, as so many people come to believe during housing booms and bubbles.

Posted by: Patrick_M | August 18, 2010 11:29 PM | Report abuse

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