Housing Incoherence
Lance on May 13 2008 at 12:42 am | Filed under: Housing Market, Politics, Valuation, economy, monetary policy
From the New York Times:
Earlier this year, Mr. Bush derided a modest plan to provide $4 billion to states and localities to buy foreclosed properties, saying that buying up empty homes helps only “the lenders or the speculators.” Actually, it protects entire neighborhoods and local economies from the effects of foreclosures by preventing a greater buildup of unsold homes and a further drop in prices.
This site is not about politics, but before I discuss this some disclosure is necessary. I am a fan of free markets. I do not however belong to that group of fans who believes that the market left to its own devices comes up with an optimal outcome (however one might define optimal.) There are a number of reasons to favor free markets, that isn’t one of them.
Still, one reason to favor markets, and all the pain and inequity they come with, is that even if one believes that well thought out policies could cure whatever evils (however one wishes to define them) that the market (or our world in general) afflicts us with, it is highly unlikely that we will ever get such policies. This kind of solution is exhibit 10,549 of that truth.
I only address the politics of this, because as investors we are forced to analyze things which will undoubtedly rub some peoples political beliefs the wrong way, and this is one place where I cannot avoid it, no matter how much I might wish to do so.
The absurdities
So what exactly have our leaders in Washington, and pundits on the board of the Times, come up with?
First let us deal with the absurd aspects of this plan. The government buys up a bunch of foreclosed properties that are theoretically driving down the prices of other homes. Uh, does anyone else see the big gaping hole in this logic? After the government buys them, they are still abandoned! Unless the government just takes them off the market indefinitely (thus restricting supply) rather than sell them, how does that solve the problem of excess inventory?
What it does do is allow the lenders to get a price higher than they would if the homes had to sell at a price that people could actually afford. So, bankers and other lenders get bailed out, taxpayers have a bunch of homes they have to sell at prices lower than they paid for them. Personally, I would rather have our taxes not be used to bail out lenders.
One problem homeowners are facing is abandoned homes becoming a drag due to lack of maintenance. Will the government keep all these homes up? As little faith as I have in the lenders, the profit motive will likely make them better stewards (if only marginally, given the enormity of the issue) than the state.
A Little Reality
Most important, is that we investors need to avoid falling for simple sounding solutions that will in the end not help that much. The ultimate problem with housing is not greedy lenders (greed is nothing new) or deadbeats, government policies (a personal favorite post of mine) or incompetent regulators (though all had their role in getting us to this point.) It is that housing prices are too high.
For reasons stated above this particular solution is not going to help keep prices high, but what if they could? Is that really good? Housing is extremely unaffordable in many markets. Prices will come down. Is dragging that out the best answer? I find that in isolation a dubious, and at best a marginal, good. Given the cost, in tax dollars, inflation, misallocation of resources and the moral hazard of lenders and borrowers believing that risk can be taken with some portion of it underwritten by the state, the benefits should have to be huge. As investors we should be skeptical that the end result will be good for the rest of the economy.
The same problem comes even with trying to keep interest rates low. Let us assume that these various measures, combined with low interest rates, slows, or even temporarily halts, the decline in housing prices.
Much as with claims about the “fed model” there is the belief that lower interest rates will allow people to afford a home that they could not a higher rate, ( also that lower prices will result in demand curves that shift) etc. All of these arguments miss a key point. Interest rates change. A stock price that is “justified” by todays interest rate, says nothing about whether it will be similarly “justified” in the future. Nor does a high price being “justified” by low current interest rates mean you will get a satisfactory return. It just means it will be better (actually that isn’t a given either) than a bond yielding 3% (or whatever the low rate happens to be.)
So it is with housing. Absent a speculative bubble such as we just went through in housing, low interest rates might encourage people back into the market. It might halt the slide in housing prices from going back to an economically reasonable level as fast, or temporarily. However, those buyers will not be selling to people with similarly low rates in the future. In an efficient market (stop giggling Barry and Jeremy) markets would see through temporary low rate periods and price housing at sustainable levels that vary little around interest rates. I suspect in this instance gun shy homeowners will (or even lower.) At the end of the day however it doesn’t matter even if they do not. All that means is that down the road prices will fall when interest rates go up and prospective buyers cannot afford them any longer. The same for being able to “afford” a house at a lower credit score. Prices still have to be affordable for succeeding groups of home buyers. In much of the country they just are not. This not just “gonzo” pundits beating some fantasy bear drum, but yes Jeff, “real” economists such as Martin Feldstein (who has some trenchant comments on the health of the economy and misreading of the GDP data as well)
I’ll tell you what worries me. We saw house prices overshoot by 60% relative to costs of building and relative to rents. And I worry about the possibility that they will keep falling; they will spiral downwards. In the same way that they went much too high, they could go much too low. And if that happens, then we are going to see individuals feeling a lot poorer, cutting back on their spending, defaulting on mortgages, and we’re going to see the holders of those mortgages see their assets, their capital being cut and therefore their ability to make loans being cut.
Incoherence
Bill Gross should know better, but unfortunately he doesn’t seem to realize that after decrying the destructive potential of housing prices rising faster than inflation and incomes, that keeping them from correcting that rise is destructive as well, and unlikely to work.
So let us end with one more political (if non partisan) note. If all these policies could help keep prices up, if other policies suggested are effective as well, what have we done?
Encouraging people to buy houses at prices that were economically too burdensome, and likely to eventually lose value, is what got us into this mess in the first place.
Why is it a virtue for the government to do exactly what we are criticizing mortgage companies, banks and even the fed for encouraging home buyers to do in the past? Isn’t the end result just the same thing if possibly a bit more drawn out? Investors beware.
Update: Dean Baker (another “real” economist) takes up some similar themes:
Have the NYT editorial writers not noticed this bubble or do they think the housing bubble was a good development that the government should try to foster?
The level of incoherence of the housing policy advocated by the NYT is astounding. Why on earth should Congress act to keep house prices above their market level?
House price supports will not work in the long-run. If we keep house prices high, builders will construct more houses and the over-supply will grow even larger. In this way, a house price support program is like a farm price support program, except we have a $20 trillion stock of housing. The market for most farm products is in the tens of billions of dollars annually.
A house price support program will end up costing the government billions and possibly tens of billions of dollars. Is it better for the government to spend this money (most of which will be paid to banks) supporting house prices than to pay for health care, child care or good rental housing?
Furthermore, since house prices will eventually fall to their market clearing levels, will the NYT policy even help moderate income homeowners? They will be paying far more in housing costs for the years they still in their home than they would to rent a comparable unit. This will be diverting money that they may have otherwise used for their kids health care and child care or other necessary expenses. And, since the house price will fall, they will never accumulate any equity.
Jon Henke also smells the whiff of the farm support program.
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