With new and expensive government programs being announced almost daily, I sense a little fatigue already about how much the government is doing. The housing plan in particular seems to be raising questions about moral hazard and how much the public should insure private risk. On OPBs "Think Out Loud" this morning I heard the opinion that hosing prices should be left to fall without intervention and this would help lower income people afford a home.
The problem with this argument is that if the housing market continues to fall and households net wealth continues to drop and banks continue to hoard capital, demand, which is already plunging, will continue to fall, businesses will fail and these lower income people are not going to have jobs to make them able to buy the houses.
But it does lead to a good question (that I was asked the last time I was on Think Out Loud and did a poor job of answering): if the government did nothing in terms of fiscal stimulus, housing market interventions, etc., how would the downward spiral end?
Well the classic Keynesian story is one of depreciation: over time households and firms who have resisted investment due to belt tightening find that their stuff is starting to wear out. For business this is their productive capital - the machines they use to make stuff to sell, and for households these are consumer durables - cars, washers and dryers, refrigerators and the like. Thus after some time people are forced to start to make these investments again and this starts to turn the tide. Add to this the fact that while households can economize, there is generally a minimal level of consumption that they need, so decreases in demand by households can only fall so far. But this can take a long, long time...
It should be noted (and Krugman has a nice piece on this) that the more typical (post-Keynesian) business cycle theory tells a story of recovery that is based on falling prices which makes the money supply too large and forces down interest rates and spurs on more investment and output. However, we are in a situation currently where the interest rate is a low as it can go and it is not spurring on this new investment. Essentially the aggregate demand curve is near vertical so this mechanism is no longer working.
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I remember commentary during the bubble that predicted housing prices in the SF bay area to level of when only 20% of median households could afford the median house. I think it dropped to below 12% (in spite of dropping interest rates). With prices down 30% and lower rates the affordability is better now. But real estate has lost it's appeal as a "golden ticket", guaranteed to always be worth more than you paid for. People who bought in the last few years suffered the indignities of extreme sellers market. Now they are suffering the opposite on the other side. It makes a home feel like a trap.
When I bought my first house it made sense: It rented for more than the mortgage. The right to own water beds, pit bulls and large fish tanks is worth something but is now offset by the sense that unemployment could cause loss of nest and egg. I don't think people will be in the mood do buy homes until they can be reasonably sure that a lost job won't wipe out their efforts at ownership. Being able to rent the house out for the mortgage will help. Better job protection/unemplyment options will help too. I have always marveled at the willingness of american consumers to take risk. People would take out a mortgage but not health insurance. Don't people know that appendicitis or a kidney stone are common and likely to cause finacial ruin for the uninsured? I guess the risks was proportionate to the potential pay off (ever rising value). That incentive gone consumers won't be willing to risk as much.
Back when we bought our first house (metro Portland 20 years ago) I was wondering why not everybody was doing it. Even with rent=mortgage it was a buyers market. Looking back I think prices and rents had long been low. A sizeable investment (20%) did not promiss big gains in just a year or two and people did not have to fear being prized out forever next month.Todays housing climate has similarity to two decades ago. Then interest rates where high (12% or so) now prices are. Buyers are waiting for conditions to impove (prices now rates then). I think once rents are at mortgage rates for awhile people will consider buying. Polulation increase and inflation would help with rents rising but mortgage rates would rise too. Maybe that would create a sense of urgency again. I think rates would have to get incredibly low (my trusty amortization table starts at 5% and is currently useless!!) and there needs to be the threat of rising rates or rising prices on the horizon to motivate people to buy homes. Everything else would follow.
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