Saturday, February 21, 2009

Housing Price Decline Not Done Yet

Hat tip to Save The GOP where I found the above chart.

As you can see from the chart, from 1997 to 2007, we did not just have a housing bubble, but rather a housing spike. Prices spiked by over 80% and are only half-way back to historical levels. The spike was caused mostly by a combination of the following factors:
  • The growth of subprime loans and other poor lending/borrowing practices
  • The increase in flipping houses and other speculation, especially in certain markets
  • The expansion of Fannie Mae & Freddie Mac into the subprime market, fueled by primarily Democratic support for "affordable housing"
  • The increasing volume of foreign capital from the trade deficit that was used to invest in the US housing market
  • The "easy money" policies (i.e., low interest rates) by Alan Greenspan at the Federal Reserve during the early part of the decade

  • Throwing money at this problem at this point is a losing battle, and it is bad policy as well. Do we really want to attempt to spend enough taxpayer money to prop up the housing market well above its historical level? To do so would be to continue to allocate more dollars toward housing than is necessary, leaving less in everyone's pocket to spend on other needs/wants.

    A lot of people have been priced out of the market (especially under traditional lending standards like 20% down!), and a housing market correction back to more historical levels will allow many to buy their first house or upgrade to a better one at a lower cost.

    The faster the market is allowed to correct and stabilize at a more historical level, the faster people will have the confidence to jump back into the market and buy a house. No one wants to buy a house if they think its value is going to drop by another 30-50%. Once people see that prices have stabilized at what seems like a bargain price, they will start buying houses again. The longer we prevent this from happening, the longer there will be negative spillover effects throughout the rest of the economy.

    However, the housing correction is massive enough it has already caused the financial crisis. Too many banks had too many Mortgage-backed Securities (MBS's) which, with the falling housing prices and the complexity of how mortgages are packaged, sliced, and repackaged, no one knew the price of. Since banks were holding significant levels of MBS's, and other banks didn't know how much they were worth, there was a crisis of confidence and lending between banks ground to a halt, resulting in the frozen credit market. The government had to take action to thaw the market to avoid a severe economic shock.

    So the government must keep a close eye on the effects of the housing correction, and make sure it does not trigger a disaster, but otherwise the correction should be allowed to proceed.

    Once the correction has brought prices back down near historical levels, that is the point at which more government action might be justified in order to prevent an over-correction.

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