Fixing Housing Prices By Encouraging A Free Fall

There are a number of market reasons that housing could continue to fall over the next two or three years. Robert J. Shiller of Yale makes the point, writing in The New York Times, that people may delay buying homes because of their fear of unemployment and sellers, in some cases, may not need to move and can wait the market out. Each of those things may be true.

The major impediment to a bounce in housing prices is not that the market is being forced down by reluctant buyers and patient sellers; it is that the government is willing to underwrite people remaining in their homes. A person who can get a lower monthly payment on his home because of the Administration’s desire to prevent foreclosures will not leave that home as part of the normal order of the economic collapse that is part of the recession.

Fannie Mae has created its own program to help keep current owners in their homes. The “HomeSaver Advance” project can put as much as $15,000 in the hands of people who have missed mortgage payments. These loans are unsecured.

The effect of giving significant assistance to people who would otherwise sell or desert their houses is that it creates an artificial floor for the residential real estate market.  Freddie Mac and information from several studies have said that a great many people who are given special breaks to keep their homes default anyway. That means that the government’s efforts only serve to delay the inevitable in many cases.

Real estate prices are down 20% from their peak in some markets and as much as 50% in parts of Florida, Nevada, Michigan, and California. While there has been a small increase in sales in some of the most devastated markets, prices are not picking up. Smart buyers understand that there is a reasonable chance the home values could drop another 10% or 15% nationwide and do not want to be trapped in the same “underwater” position that millions of current homeowners are. Time is a friend for those who believe housing’s bottom is still well below where prices are today.

The government has a chance to push the market to the bottom quickly and then let the normal forces of economic demand begin to drive values up again. The Administration would have to withdraw any support it is giving to homeowners who cannot make monthly payments. It would also have to indicate to banks, especially those which have taken TARP funds, that an acceleration of foreclosures would not be used against them.  The government would agree not to complain that the capital the banks have received to rebuild their balance sheets is being used improperly because it is not being loaned to homeowners. The Fed and Treasury would have to specifically and publicly say that underwriting home loans is not part of the expected process of loosening consumer and business credit.

Home prices could slip sideways or drop very slowly for a number of quarters. Buyers will remain wary and homeowners will hold out hope of a price rebound. Neither of those forces does anything other than prolong the time at which houses are so cheap the buyers believe that they will not get any cheaper.

Douglas A. McIntyre