Should we let housing prices fall?

Many smart people say we should.  It seems increasingly clear that we must.  For how long can the government prop them up?  Are we never to have a private market in mortgages again?

Yet what happens if we let them fall?  Arguably many banks would once again be "under water."  Enthusiasm for another set of bailouts is weak, to say the least.  Our government would end up nationalizing these banks and it still would be on the hook for their debts.  The blow to confidence would be a major one, especially if along the way we saw a recreation of a Lehman or Bear Stearns or A.I.G. episode.

I increasingly believe there is no easy way out of this dilemma and it is a major reason why the U.S. economy remains stuck.  Housing prices must fall, yet…housing prices must not fall.

Here is a very good Dave Leonhardt piece on two different views of housing.  It's where to go, if you are looking for the case for optimism.  I am more pessimistic than David because I see the private sector interest in mortgage securities as remaining quite weak, which suggests the market knows which way prices have to move.


I know it is a simplifying move, but it just seems wrong and misleading to speak of the housing market as if it were like the oil or wheat market. Instead, there are housing "markets" and each one is very different in terms of how inflated it was and how much it still needs to fall. I know you know this - but it is important to point out since people who don't live in California, Nevada, Arizona, Florida, and a few other places are going to face very different situations than the ones discussed here and elsewhere.

I don't see why government must nationalise the banks. If it used the good bank/bad bank idea floated a couple of years ago, the shareholders would be wiped out, the bondholders would take a mighty hit and the directors and executives might end up in clink, but you'd still have a functioning bank system as the "good banks" went quietly about their business. If it worked, that's to say. If it worked.

IF it comes to it, a helicopter drop would both stimulate the economy (quick style) and recapitalize banks. Say, $5K to every household not in a top income bracket. This would also dampen the fall of the housing market a bit, and could prevent banks from going underwater and hence from being nationalized. What must happen will happen, and we'd better start thinking about how best to deal with it.

Somewhat unrelated question: in that David Leonhardt piece there's a graph showing spending on different types of goods as a share of personal income.

The main point of the graph is to show housing, but the shape of the "food" line over time is very odd. It rises gradually to about 16% in 1992ish then has a sharp, inverted-V shaped turn around, followed by a smooth decline to about 13%. Does anyone (either Tyler or a reader) know of an explanation for this? Did food prices drop sharply that year? If so, why?

What right do we have to artificially inflate prices so that first time homebuyers are hurt?

You need to reread your Irving Fisher: The Debt-Deflation Theory of Great Depressions.

40. If all this is true, it would be silly and immoral to "let nature take her course" as for a physician to neglect a case of pneumonia. It would also be a libel on economic science, which has its therapeutics as truely as medical science.

41. If reflation can now so easily and quickly reverse the deadly down-swing of deflation after nearly four years, when it was gathering increased momentum, it would have been still easier, and at any time, to have stopped it earlier. In fact, under President Hoover, recovery was apparently well-started by the Federal Reserve open-market purchases, which revived prices and business from May to September 1932. The efforts were not kept up and recovery was stopped by various circumstances, including the political "campaign of fear."

It would have been still easier to have prevented the depression almost altogether. In fact, in my opinion, this would have been done had Governor Strong of the Federal Reserve Bank of New York lived, or had his policies been embraced by other banks and the Federal Reserve Board and pursued consistently after his death. In that case, there would have been nothing worse than the first crash, but not the dollar disease - the bad cold but not the pneumonia.

As John 4 above says, a $5K per person tax cut (e.g. suspend payroll taxes for a year or two), funded by the Fed printing money, would create both stronger aggregate demand and also a bit of inflation. We could use both for the next few years.

With a higher general price level, RELATIVE housing prices can fall without leading to defaults or putting banks underwater. As per your request, housing prices would fall (in a way that restores equilibrium) but housing prices would not fall (in a way that leads to massive defaults).

As a married 29 yr old who wishes he could buy the 1932 duplex I'm currently renting in a neighborhood where an identical house sold for an increase of 70% in just 3 years, I say BRING DOWN THE PRICE OF REAL ESTATE.

Hasn't Gen-X enriched itself enough?


I'm not arguing that their should be a policy response to save me from my bad misfortune(whose problems are far too local to get into here). But a national decline in housing prices, the likes of which would occur if the fed stopped backstopping the mortgage market, would send this country spiraling into depression. It's basically the same logic that led us to the bank bailout.

What I'm suggesting is that we need to have a healthy mortgage market or this country is in deep doo doo. The private one isn't materializing, so in this case, the government needs to step in to avert disaster.


I'm a gen x-er who has gotten screwed continually, I was too young for the 80s run up in equity, I got crushed by the tech boom, I got crushed on real estate and now I'm going to get crushed by crippling taxes to pay for the baby boomers. I know plenty of people in my situation, and we like to refer to ourselves as The Screwed Over generation.

I think that based on typical income my home which zillow values at $160 should be worth about $95k. I think that lower home prices would be good the quicker we get there the better. IMO a 10% annual decline would be the worst outcome. Slower than that and I think employment can recover. Much faster than that the pain will be worse but we will recover quicker.

I doubt there are enough first-time home buyers to absorb the number of houses for sale. Most sales are people either trading up or moving for work. In these cases, they already have a home they need to sell. This means lower home prices actually keep the market from clearing.

Think of all the goods & services Americans could buy if they weren't wasting so much money paying mortgage interest in connection with overpriced housing.

Irving Fisher's "Booms and Depressions" is relevant. We need a way of scaling down of mortgage debts consistent with the drop in the value of the underlying assets. Securitization has complicated the challenge immensely, but we need more vulture investors buying asset-backed securities from the banks at a discount, unbundling them, and working out individual debt reductions that keep people in their homes and make a profit for the investors. Government isn't capable of doing this.
By all means markets need to clear, but the price declines need not be self-reinforcing.


With a higher general price level, RELATIVE housing prices can fall without leading to defaults or putting banks underwater. As per your request, housing prices would fall (in a way that restores equilibrium) but housing prices would not fall (in a way that leads to massive defaults).

Humans show an inability to learn a simple fact- there are no free lunches. Yes, by all means, let's have some real inflation to solve this problem. Really, inflation is always and everywhere a painless solution to....oh, wait, the problem was inflation in housing prices to start with. Surely, some more inflation can't create another and larger problem down the road, can it?

"As a married 29 yr old .....Hasn't Gen-X enriched itself enough?"

While I think too much is made of this sort of thing, traditionally the generations have been measured in 18 year spans, based off of the 1946 -64 dates for the Baby Boom generation.

So Generation X would consist of people born between 1965 and 1983. Which means you are part of it.

Yes, clearly, housing prices should go down to levels people are actually willing to pay. Any other solution is like hearing the fire alarm go off and just cramming another set of earplugs into your head.

The only downside to this is if a lot of people choose to default, knowing full well they can do this without consequences, and come out ahead.

The solution to this is to make it so that solvent people cannot choose to default, knowing full well they can do this without consequences, and come out ahead.

Maybe it's not such a great idea to tell people they can buy something, decide they don't want it any more, and then just give what is left of it back? With the only downside being they can't buy another one for seven years?

I have yet to see a credible argument that refutes the logic of taking the various stimulus money, in aggregate, buying up empty houses (or entire neighbourhoods) and simply tearing them down.

Back of the napkin calculations suggest that perhaps a million homes could be bought and destroyed. This would reduce the inventory overhang, provide a one time support, and then allow the economy to recover in a more normal fashion using one of the traditionally strong early cycle drivers of residential investment.

This seems like a largely empirical question.
A. We can estimate potential losses from falling housing prices.
B. We can measure excess reserves held by banks.

When B>A by a reasonable margin for error, we can proceed with letting housing prices fall.

Is this not a reasonable explanation for banks stockpiling reserves? If "markets" see the fall in housing prices as inevitable, banks surely should too, and the stealth recapitalization effort of the last two years should serve two purposes. First, to get the banks out of immediate danger and second, to prepare them to weather the storm that's going to hit when prices do fall.

It's an elementary problem to understand, even if it's a devilishly hard one to solve in a world with a zillion independent banks, coordination problems and the possibility of systemic panic.

Perhaps we could set up a system where banks are given an extra incentive to risk money when lending to home buyers. We could call it "interest". If the homebuyer can or will no longer pay the loan, we could come up with some means for the bank to recoup some of their losses. We could call that "reposession". Then, maybe we could allow the home to be sold again at a price a new buyer is willing to pay. We could call that "commerce" or "trade".

Oh, what am I thinking. It will never work. We will have a depression. Instead, let's have the politicians "save" us. Yeah...that makes more sense.

Seems to me that a bank that would be bankrupt if not for the State keeping housing prices high is already being bailed out, just nobody's admitting to it.

Ed, the real tragedy is not the rise in housing values; it's the distortion caused by the speculation in land values that the former encourages. That's why levying taxes on ground rent would be a good idea: yes, it makes local governments "more dependent" on high land rents, but it would actually mitigate the distortionary effects which currently make housing so scarce in some markets.

Compare the financial situation of California before and after they passed Prop 13, which "relieved" local governments of their reliance on real estate taxes. It was not an improvement.

@Frank: "Hasn't Gen-X enriched itself enough?"

Oh that's rich.

I second @WindyCityEagle's response here.

I like to joke that my best "investment" was refinancing my student loans in 2001, which has netted me a loss of only 2% annually. Every other investment I've ever made -- home, retirement, stocks, you name it -- over a span now of decades has returned something worse. Please note these were all "smart" investments that serious minded fiscal conservatives sagely suggested I make.

Well color me stupid. I'd have been better off burying my savings in coffee cans. Or better yet just spending it on vacations and nice cars. Then at least I'd have something to show for it other than a sense of smug superiority in never having "walked away" from a "bad investment."

The punchline is knowing Social Security will go bankrupt right around the time I turn 65.

There might be some generation "enriching itself" here but it ain't mine.

Simple policy proposal:
Feds mail a coupon to certain homeowners ~X years into a 30 year mortgage. If they're still in the same mortgage in ~Y years, government will pay off up to Z% of it. Z could vary by issue date/area.

Say we're looking at 6 million qualifying mortgages at an average of ~$75K(?) each. That leaves us on the hook for around $200 billion (2010 dollars) somewhere around 2025. Even if you double the support, that's prolly less then another round of bank bailouts.

Prices would be free to fall without putting all these people underwater.

Tyler, all this is really simple:

* Real house prices must fall
* Nominal house prices must not fall
* Inflation does exactly that

Dilemma only exists if you confuse real and nominal prices. See Sumner for fine details, but big picture is just that. Inflation is the only way to get out of this. The alternative is not just slower recovery, it is never having recovery - like Japan after their crash.

So we take money away from taxpayers to prop up the banks and expect consumers to spend more. right.

"Should we let housing prices fall?"
There is no 'we'.
To put it another way: 'We' is an abstraction that includes buyers and sellers, lenders and borrowers, government and private sectors, etc.
Their interests are in conflict.
'We' can dump money into the system, but how do we make sure that it will raise the price of milk, not gold, stocks or McMansions?
Real estate prices went up after just such a money-dump.
'We' cannot pay up on all of our promises, to the bondholders, to the pensioners, to the unions, to the speculators, etc. Somebody will have to be shortchanged.
Gen X, probably, maybe the Chinese, or the geezers.
It's a political fight, a political choice.

Outright unwind MBS with foreclosures - auction the properties - ONLY allow private investors (who have stayed current) bringing 40% down to bid. Imagine it as a Fed intentionally taking a $500B loss.

And at the same time, raise Interest rates.

What is the sound of 7M homes being sold for dimes on the dollar?

Growth! Huge changes in expectations because balance sheets of the guys with cash are dramatically improved. This is deal of a lifetime euphoria.

Benefit #1: suddenly the healthiest banks who have been sitting on cash, so they are able to acquire the bad banks loans when the FDIC does its Friday dump - holy shit! they gotta make loans!

Benefit #2: Suddenly the banks who now have to make loans, have 7M guys with good credit, and 40% on deep discounted deals coming in an borrowing at a healthy interest rate.

At most we lose 800-1000 already insolvent banks. Who cares.

Yes there will be a slight bump in more jingle mail as home prices fall, but they will not plummet - certainly not like they have till now. Maybe another 10%.

The plain truth is that the total mortgage debt in this country cannot be paid in real terms. The options are either inflation to reduce the real value of the debt, or allowing bad debts to fail. Inflation spreads the pain to all savers and dollar asset holders in general; allowing bad debts to fail concentrates the pain among those who made bad loans and took out loans they cannot repay.

The only reason to push for inflation rather than allowing bad debts to fail is that those who would lose in that scenario have more political power than the winners. If we really had a transparent, rule based financial system, we would allow politically powerful bondholders to take the losses they have earned and so richly deserve. Unfortunately, we don't, so we won't.

I'm not sure I agree that banks will be hurt by a further decline in housing prices. The Alt-A and Subprime loans from the bubble have pretty much been flushed out of the system. We are left with people making their mortgage payments on time even tho 23% of mortgages are underwater (Case-Shiller). If the underwater mortgages increase to 50% the homeowner's mortgage payments don't change. The risk to banks will be strategic defaults. A lot of homeowners cannot use that option because of collateral damage to their financial circumstances. My CPA, lawyer, doctor, myself can't default in our small community. Notice of Foreclosure in the local paper would be a reputation-killer. So I don't think the banks will be badly hit, rather the damage comes from locking so many people in their homes, unable to default, unable to sell. Unable to sell for years to come. Somebody smarter than me will be able to work out the effect on our housing and construction, but I'm sure it will be horrible.

The sicknesses of the property market are excess liquidity, low real interest rates and the lack of investment alternatives. These structural problems are causing constant worry of a bubble and unless they are resolved, everything else is just a band-aid.

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