Peering into the Housing Abyss

he New York Times had an interesting article yesterday about the unpleasant prospect facing the Obama administration. The specific problem is that the administration is pretty much out of policy options on housing, which continues to drag. Well, “drag” is perhaps an understatement—July new home sales were 26% below those of July 2009, home sales in July were down 19% over the same period. The same Bloomberg article points out that, on average, median home prices are down 26% from July 2006. The market isn’t picking up, and it’s not clear what else the Obama administration can do about it. Given that two-thirds of Americans own homes, and that homes represent some 80% of Americans’ wealth, this remains a pretty big deal as the economy continues to sputter along as the stimulus efforts fade, and as unemployment hovers around 10%, in part from the horrible state of the homebuilding industry.

The Times article discusses one possible, but thus far pretty unwelcome, policy option—just let home prices collapse further. Get it over with. All the policy options implemented to date have been designed to try to keep people in their homes while maintaining, as much as possible, the listed value of the homes, or at least trying to keep them as high as possible. The reasons for doing this are obvious—preventing homeowners from losing what they’ve invested in their homes, and preventing the number of unsold and foreclosed homes from rising, dropping prices further. Americans have taken a huge hit on their personal finances as a result of the events of past three years, in part because Americans tend to have their personal wealth tied up in home ownership.

But there are advantages to letting prices drop further. First, it would make housing affordable for more Americans. Many of us know of towns where the young can’t afford to buy homes in the towns they grew up in, or where real estate values have escalated to the point where essential service providers, like policemen and nurses, can’t afford to buy. So dropping home prices isn’t necessarily a bad thing—it widens the pool, which means there are more potential buyers. More buyers, more home sales, employment trends up (in theory). And there are a whole lot of people who want to buy.

Second, it’s hard to know whether home valuations are currently priced correctly. The underlying assumption that house prices can only go up has, thankfully, been disproved by the events of the past several years. But the assumption that home values are currently where they should be is completely unsupported by the market. In fact, if the market is telling us anything, it’s that home prices are still too high, and need to come down further.

Here’s the first problem—a small drop is what everyone wants, but they might not get a small drop, they might get a big one, and no one wants that. The Times comments:

A small decline in home prices might not make too much of a difference to a slack economy. But an unchecked drop of 10 percent or more might prove entirely discouraging to the millions of owners just hanging on, especially those who bought in the last few years under the impression that a turnaround had already begun.

The government is on the hook for many of these mortgages, another reason policy makers have been aggressively seeking stability. What helped support the market last year could now cause it to crumble.

Since 2006, the Federal Housing Administration has insured millions of low down payment loans. During the first two years, officials concede, the credit quality of the borrowers was too low.
With little at stake and a queasy economy, buyers bailed: nearly 12 percent were delinquent after a year. Last fall, F.H.A. cash reserves fell below the Congressionally mandated minimum, and the agency had to shore up its finances.

Government-backed loans in 2009 went to buyers with higher credit scores. Yet the percentage of first-year defaults was still 5 percent, according to data from the research firm CoreLogic.

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