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Should we let housing prices fall?

Tyler Cowen isn't sure:

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.

By Ezra Klein  |  September 8, 2010; 11:10 AM ET
Categories:  Housing Crisis  
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Yes, we should institute austerity, WHEN THE ECONOMY HAS RECOVERED.

It's not rocket science.

Posted by: theamazingjex | September 8, 2010 11:20 AM | Report abuse

Housing, education, health care, etc. Is there anything the government sticks its stupid nose in that doesn't end up on the horns of the same dilemma? And for very good reasons, too, though Klein can never quite wrap his purty little head around them.

Posted by: msoja | September 8, 2010 11:23 AM | Report abuse

"Our government would end up nationalizing these banks and it still would be on the hook for their debts."

Not debts. Insured deposits. Which DONK (Dodd Frank) did was increase the amount we are on the hook for. Stupid, stupid, stupid thing to have done. Really, really stupid.

What DONK was supposed to do was provide a streamlined method for reorganizing insolvent financial institutions. It's absolutely outrageous that the taxpayers have had to bail these institutions out while the bondholders of those institutions are sitting fat and happy on 100% of their investment.

If the deposit insurance amount had been left at $100,000, and Geithner, Blair, DONK et al had the cojones to take out the shareholders and bondholders of insolvent banks, the amount of debt would not be a problem.

And by the way. Housing prices will fall. Just like the economy. And all Obama's horses and all Obama's men can do nothing about it, except borrow billions more that we don't have pursuing the wrong solutions to misunderstood problems.

Posted by: bgmma50 | September 8, 2010 11:31 AM | Report abuse

don't you mean "should we let housing prices fall MORE"

Posted by: visionbrkr | September 8, 2010 11:34 AM | Report abuse

Tyler and Ezra sure love crony capitalism. Prices should be allowed to fall and banks allowed to fail, as should have happened in the first place. As for the "blow to confidence", maybe Ezra and Tyler need to realize the policy of the recent past and present is the confidence killer, and not the idea that banks and homeowners who deserve failure will get it. Under the Tyler-Klein crony system nobody can have faith in the rules or the final outcomes of various choices they might make, and this creates a paralysis and distrust of the system. To move forward economically we need resolution which reconfirms the rules of the game, not the opposite. Maybe if Ezra and Tyler didn't work backward from an outcome with certain narrow and pre-selected desired beneficiaries of economic policy they might be more credible.

Posted by: mrnegative | September 8, 2010 11:40 AM | Report abuse

It doesn't matter what the government does at this point--housing prices are going to fall back eventually. Intervention is just prolonging the inevitable. So it isn't really a question of "should we let housing prices fall?" The real question is what we can do to lessen the impact of falling prices on the economy.

Posted by: AuthorEditor | September 8, 2010 11:59 AM | Report abuse

--"The real question is what we can do to lessen the impact of falling prices on the economy."--

Hey, I know! Let's steal a whole bunch of money from some people, ignore the "impact" that that has on them, and then distribute the stolen loot to other people, via an arbitrary political (i.e., corrupt) process, and then pat ourselves on the back for being so wonderful and moral.

Posted by: msoja | September 8, 2010 12:37 PM | Report abuse

This is where you end up when you avoid dealing with the problem the first time around.

Banks should have been nationalized, investors wiped out, and bad mortgages crammed down. Then the whole mess could have been systematically unwound.

None of that happened. Bad mortgages are still bad, bad debts are still on the books, property values are still under water, and bank balance sheets are still a total fiction.

But Hey! We remained moderate in all things, and Goldman Sachs is back on the gravy train. That's gotta count for something, right?

Posted by: pj_camp | September 8, 2010 12:52 PM | Report abuse

"Hey, I know! Let's steal a whole bunch of money from some people, ignore the "impact" that that has on them, and then distribute the stolen loot to other people, via an arbitrary political (i.e., corrupt) process, and then pat ourselves on the back for being so wonderful and moral."

That's basically what Bush, Paulson, and Bernanke did back in 2008. As much as it sickens me to see Wall St. giving itself record bonuses, it was probably needed for stability and thankfully, the return has been good enough that the overall cost will be much less than expected.

The point is, sometimes the best option contains many sucky things and rewards bad people for doing bad things, but it still beats the alternative. And, just because something is inevitable doesn't mean that the timing of the event doesn't matter. The timing could be crucial.

The economy is a very complex beast. You could argue its too complex to try to mess with because of unintended consequences. But, this overly simplistic, moralistic, and purely ideological stances aren't helping. We need someone pragmatic, not dogmatic.

Posted by: Nylund154 | September 8, 2010 1:04 PM | Report abuse

Yes. The market will clear at lower prices. We won't need to pay people to buy homes - people will buy homes because they are affordable (and we won't need government programs to make homes affordable). In any case, it's not as if the government's efforts to date have been all that effective at keeping housing prices at the government's preferred level.

The banks have been given years to return to profitability and build up capital - if they can't manage another dip in housing prices they deserve to fail.

Posted by: justin84 | September 8, 2010 1:28 PM | Report abuse

What's the relationship between final sales prices and rents? (besides "complicated", I know that much)

As a renter, I'd like to know which side to back out of unalloyed self-interest.

Posted by: rusty_spatula | September 8, 2010 2:37 PM | Report abuse

The solution is kind of obvious, and I'm surprised neither Ezra nor Tyler mention it: we should mark mortgage principal to market. Right now there are at least 4 million mortgage borrowers whose unpaid mortgage principal is at least twice the current value of their homes. Assuming these folks are rational actors, they will default on those mortgages, the lenders will take a big loss, and when the foreclosed homes go back on the already oversupplied market, prices will fall more, putting more people in negative equity. There's no reason to think that a feedback loop of this nature will either arrive at or be stable near a pareto efficient equilibrium.

But if instead the unpaid principal balance for mortgages issued between 2001 and 2008 were reduced to 80% of current market value, the problem of household deleveraging would be solved and housing prices could stabilize. If you think this is too harsh on the lenders, say that for any writedown of 20% or more, the lender gets 20% of equity in the house. If you think this is inadequately harsh on borrowers who made some bad decisions (well, I think you nuts, but ...) then require that the lender gets a bigger cut for delinquent mortgages (say 30% for those less than 60 days delinquent, 40% for those more than 60 days). The long we pretend that real estate prices from 2001-2008 were anything but false prices that require correction, the longer we'll be in this slump.

Posted by: rwclayton7 | September 8, 2010 4:33 PM | Report abuse

Part of the reason Japan hasn't recovered from its real estate bubble is that politicians thought real estate prices were too important to be left to a mere market. They instituted a land transfer tax that discouraged transactions, and lowered interest rates to zero to make bad loans "performing" in name only.

Needless to say, if it hasn't worked over two decades, trying to use policy levers to prevent a market from clearing is a bad idea. Not only that, it isn't like we contemplating stepping into a market where irrationality has taken over and is in a death spiral - some numbers:

Up until the mid 90s, the ratio of median house price to median income had been steady as a rock around 3.0. When Greenspan decided to go into recession prevention mode and bail out every hiccup in the financial markets, that ratio began to climb. By the time the bubble burst, it got around 5.0, I believe.

Latest NAR median house price: 176.9
latest median income (2008) 52k
Ratio: 3.4
Median House fair value: 156k
Percent overvalued: 12%

Real estate has further to fall to reach fair value. Having the government step in and try to support an overvalued market makes no sense at all.

Posted by: sold2u | September 8, 2010 5:17 PM | Report abuse

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