As the reader(s) of this blog may remember, I have worried a lot about the inflation that I thought would come with all of the money the Federal Reserve has been pumping into the economy. (Here and here) Obviously, that has not happened. That is because: (i) as the amount of money in the economy increased its velocity slowed down (which would mean that the increase in the money supply was not that much, if any), (ii) the inflation is still coming, it is just not here yet; or (iii) I was flat out wrong.
In this regard, it seems only fair to note this article by Kartik Athreya: “Economics is Hard. Don’t Let Bloggers Tell You Otherwise.” Here is Dr. Athreya’s abstract of his article:
“In this essay, I argue that neither non-economist bloggers, nor economists who portray economics – especially macroeconomic policy – as a simple enterprise with clear conclusions, are likely to contribute any insight to discussions of economics and, as a result, should be ignored by an open-minded lay public.”*
So, with both of those caveats/warnings in place, let me make a couple of comments on the situation in the housing market. An interesting comment I read somewhere (unfortunately, I do not remember where) is that for decades federal policy, including the roles of Fannie Mae and Freddie Mac and the deductibility of home mortgage interest and property taxes, has been to keep housing and home ownership affordable.
Now, federal policy, including Fannie and Freddie and things like the first-time buyer’s credit, seem more focused on stopping housing from becoming more affordable; i.e., the government is striving to keep housing prices up, which makes housing less affordable.
Clearly, the federal government is worried about the housing sector of the economy. There seem to be several concerns. If housing prices drop further, more people will be underwater,** which could increase defaults, foreclosures, etc. Falling housing prices scare people and damage the confidence that is necessary for a recovery. Falling housing prices could discourage spending by even people who still owe less money on their houses than they are worth because they feel less wealthy and more fearful for the future. Etc.
The federal government also wants to increase new housing starts, i.e., construction, as a way to boost the economy. But with house prices falling, do people really want to buy/invest in a new house? Why not wait to see if prices drop further before buying, whether a new house or an existing unit. This problem is worsened by the overhang of unsold houses on the market. We overbuilt during the bubble. All those overbuilt houses are creating an excess of supply, at least at current prices, which inhibits new construction.
Those are reasonable arguments/concerns, and I understand them. But on the other hand, we have had a real housing bubble. Prices rose way above what they should have been. And now that the bubble has burst, prices have to come down. Who is to say that prices today are right? Prices are down, but maybe they have to go down further. Maybe they are not down to their proper level yet.*** Is it realistic to expect the housing market to pick up before prices get to their proper, non-bubble level? Of course, no one can know what the “proper non-bubble level” is, though if houses are not selling, that may be an indication that prices are not there yet. Also, it is entirely possible that, in reacting to the bubble, the housing market will over-react, such that housing prices may actually go below a fair non-bubble level before they finally settle at some reasonable non-bubble value.
So what is the role of government in all this? Clearly, its role to this point has not been particularly helpful. Whether government created the housing bubble (by keeping interest rates too low, too long in the 2002-early 2005 time period, the roles of Fannie and Freddie, “encouragement” of lenders to lend to poorer people who had problems keeping their houses once things started going wrong) or merely aided and abetted, it had a role. Similarly, it has tried to do a lot of things since the bubble burst. There have been mortgage modification programs, first time home buyer credits, increased activity of Fannie and Freddie, etc.
It is disheartening (though to some, not surprising) that, in much of what it did, the government did not succeed in what it was trying to do and may have, in some cases, actually caused more problems than it solved. Was trying to expand home ownership among people who were on the edge a good idea? Did the Fed’s low interest rates from 2002 to early 2005 encourage people to use cheap money to buy and flip houses in a housing market that was already expanding too quickly? What about the role of the rating agencies in giving AAA ratings to securities that apparently did not deserve them, a role that government ordained with legal requirements? And what about Fannie and Freddie, which were not appropriately supervised because their friends in Congress assured us there was no problem?
It seems to me that what we need is less government encouragement (i.e., subsidization) of home ownership. Fannie and Freddie need to be phased out (even Barney Frank agrees with that). Mortgage rates need to reach a more market-based level. Until Fannie and Freddie are phased out, they need to increase the minimum down payments on mortgages they insure. As I have commented before, 3.5% is too low of a down payment because buyers and sellers can game the system to turn that into virtually zero. Maybe the tax deductibility of mortgage interest and property taxes needs to be looked at as part of a broad-based tax reform.
But – and this is important – it is unclear whether the system is strong enough to handle a sudden change. While these should be the goals that we work toward and the basis on which we judge proposed actions (i.e., will they help us get closer to our goals), our movement toward these goals must be measured. We should work to get there, but we need to take it slowly and one step at a tine, so that any shocks to the system are minor and the system can adjust to the changes as they are implemented.
In other words, while the goals should be clear, government needs to be less ambitious, and more modest, in how it gets there. It may take longer, but it won’t create as many problems in the process of getting there.
----------
* Dr. Athreya has a PhD in economics and works in the Research Department for the Federal Reserve Bank of Richmond.
** In this case, a house is considered to be “underwater” if the mortgage is more than the fair market value of the house. It does not mean that the house is literally underwater. That is more of a concern of Al Gore and his global warming/climate change acolytes. They fear that global warming will raise the levels of oceans to such a degree that houses will literally be underwater – in which case they will probably also be financially underwater since it is hard to see how a house that is underwater would be worth much – either literally or financially.
*** Actually, it seems fairly likely that housing prices are still above a proper non-bubble level, especially given the state of the economy. Certainly the first time home buyer’s credit artificially increased the demand for housing (for a few months). Now that the credit is gone, demand is down, both because people have less money to spend on houses and because at least some people who would have bought now, moved up their plans and bought before April 30. That increased the demand in the spring. But since those buyers bought in the spring, they are not part of demand for housing now. Less demand now means lower prices and/or fewer sales now.
Update (8/31/10 9:00 am): Corrected a typo in the fifth paragraph.
Comments