House Price Supports
I have heard the leading lights of the economics profession speak contemptuously of farm price supports and trade protection for the last three decades. According to these great minds, we would have overhauled our system of agricultural price supports 50 years ago if not for the power of the agricultural lobby. It is easy to use a simple economic model to show the waste and inefficiency of farm programs that keep the price of wheat, corn, and other farm commodities above market-clearing levels.
The same models can also be used to show the foolishness of trade barriers that are designed to protect the jobs of steel workers, textile workers or other manufacturing workers in the United States. That is why all right-thinking people are against such protectionism.
Since such views are so deeply held among mainstream economists, it is hard not to be amused by the support of several leading economists for a program of house price supports.
The basic story is very simple. We had an $8 trillion housing bubble that should have been easily seen by any competent economist. Unfortunately, almost the entire profession missed the bubble and thought everything was going just great. In fact, many of them even celebrated the increase in homeownership rates that was part of the bubble.
Now the bubble is deflating and the free-traders have become protectionists. They want the government to establish a house price support system. The principle would be the same as an agricultural program, except instead of buying up a few billion dollars of excess supply of wheat or corn, they want the government to buy up hundreds of billions of dollars, perhaps trillions of dollars, of excess housing supply.
Those of us who read the textbooks that these economists write know that such price support programs can't work in the long-run. They will just lead to further increases in supply, creating an even larger surplus. Eventually, the government will have to give up the effort and let the price of houses fall to the market clearing level.
Oh yeah, if the government buys up homes today, then the sellers (effectively banks and investors) get to dump their holdings. The over-valued housing will be the taxpayers' problem.
Now that should be a good lesson in economics. The real tragedy is that these economists are being taken seriously.
I don't disagree with what you've said so far. But consider the average homeowner, a guy who bought a house with an ARM on the assumption SUPPORTED BY THE BANKS AND ALL THE ECONOMISTS WHO ARE SUPPOSED TO KNOW BEST that the house's value would just keep climbing and climbing.
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So here's a little guy functioning in a world where:
1) his pension has been taken away;
2) American industry through "free trade," union-busting and mass illegal immigration has contrived ways for about a generation-and-a-half now to stop sharing the fruits of productivity gains with American workers;
3)where a worker's 401(K) in all likelihood won't amount to anything no matter what he does (due to the truly criminal loss--criminally aided and abetted by the worker's so-called government--of the social insurance function that made traditional pensions secure and reliable) and,
4) where the only capital investment a person could make that was likely to pay off--his home--is now worse than worthless.
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How can anyone say that this homeowner should've known better? All the experts and banks and lenders and economists--indeed, the very laws of the physical universe--were telling him to buy a house and depend on that not only for shelter but also for the one, secure stake in the ground he could depend on for his future.
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Sure, there are a lot of sharp characters out there (among them, as it turns out, the banks) that deserve their ugly fates. But I'm not talking about them. I'm talking about these little-guy homeowners who bought into the conventional wisdom.
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Should we just write them off?
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(And by the way, free trade is baloney. Every major industrialized power--pre-eminently including the United States for about 150 years--built itself up behind huge trade barriers. That's history, those are the facts. "Protectionism" became a dirty word only AFTER the industrialized nations had amassed enormous advantages over potential competitors. We've now lost that advantage and it's time once again to erect some barriers to build ourselves up again.)
March 7, 2008 10:34 AM | Reply | Permalink
You know, I bought my first house just prior to the housing bubble. Somehow, in my lack of finance education, I knew that the ARM method of financing was a bad deal if I was not in the right position at the right time.
Call it conservatism, call it long term planning. But please do not call me to sustain this inflated housing price structure to bail out those of you who could not engage brains prior to making such an important investment.
March 9, 2008 4:06 PM | Reply | Permalink
I agree that the government shouldn't pay at par for these obligations, only to find itself shouldering the losses when the real value emerges. And I'd also agree that propping up current price levels is insane. But does a government bailout need to follow those lines?
I'd actually be delighted with a government-backed corporation set up to take over huge sums of failed CDOs and mortgage pools - provided, of course, that it gets created on reasonable terms. I suspect that most holders of these obligations would be delighted to get rid of them, even at a substantial discount. It would end the uncertainty that's battering stock prices across the financial sector. But wouldn't the government still have to a premium to the returns that the institutions calculate they could receive themselves by holding on to the notes, a spread to be covered by the taxpayer? Not necessarily.
If we're dealing with a bubble, we may be facing a panic. The ideal solution would be to fully deflate the bubble without swinging equaly far (and equally irrationally) in the opposite direction. If we continue down the present path, more and more of the CDOs and related credit instruments are going to wind up being absolutely worthless. More, in fact, than would be worthless in an orderly deflation. But financial institutions have demonstrated that they have neither the wherewithall nor the willpower to restructure the loans they hold along more reasonable terms. So if - plucking a number out of the air at random - a full-fledged panic would result in a 30% deflation in value, but only a 20% deflation is necessary to correct the bubble, there's actually room to manuever. The government could buy up the obligations at 75 cents on the dollar, offering institutions a better return then they could reasonably expect to garner on their own. But if it succesfully manages the deflation, those obligations may ultimately be worth 80 cents on the dollar, covering the administative costs of the operation. It's a win-win scenario. I just don't know whether congress has the political will to pull it off.
March 7, 2008 10:45 AM | Reply | Permalink
"75 cents on the dollar"? How about 55 cents and dropping?
March 7, 2008 2:00 PM | Reply | Permalink
I am torn on this subject. Any type of bail-out really rewards the perpetrators of this debacle - th finance guys and gals that created this mad flush of cash. I have been watching developers jack up the value of my neighborhood backed by loose and easy money, and now I can barely afford to buy into the housing market.
I feel bad for the numbskulls that bought into the hype, but to save them is to save the pariahs that set the stage. Gag me with a fork.
I have yet to hear anyone with a good idea to avoid an over-compensation that will come from a necessary price realignment.
March 9, 2008 4:11 PM | Reply | Permalink
It is bad enough when the government picks between winners and losers in the marketplace (here between tax paying renters and tax preferred owners); it is worse when they use the excuse of aid to homeowners to mask the true beneficiaries (the lenders) of the costs being borne, and to be borne, by working class taxpayers (who we know will bear the burden because our tax system is set up to insure that they, and not the rich, do.)
March 7, 2008 12:21 PM | Reply | Permalink
yeah, if we wanted to do this in a honest way, we can set the purchase/guarantee price at 14 times the market rent, roughly the long-term average. Watch the bailout boys run from that proposal.
March 7, 2008 12:49 PM | Reply | Permalink
When I was a kid the rule of thumb was one percent of the purchase price per month to rent, which gives maybe 8-1/2 as a multiplier. I think the Reagan tax cuts changed the way rental real estate penciled out and somewhat devalued home mortgage deductibility.
That said, may we not profitably enquire how much the real estate value inflation bubble cost the treasury in inflated mortgage and depreciation deductions and consequent foregone tax payments?
March 7, 2008 3:15 PM | Reply | Permalink
Fourteen times the rental value is a difficult way to appraise the assets - you'd have to generate market assesments for millions of individual properties. I suspect it'd have to be a formula pegged to the paper value of the loans - that is, something like 80 cents on the dollar, which amounts to much the same thing.
You're right - financial institutions will kick and scream, and the financial pundits currently pressing for a bailout will blanch. All of which confirms, in my mind, the viability of the approach. Those institutions need to feel some pain; I don't think we should be passing proposals they wholeheartedly embrace. They're still hoping for a bailout that eases the pressure on borrowers, while preserving the potential upside of any recovery in the market. That's obscene. Since they're not willing to reduce the balances of the loans to match the current value of the underlying assets, the government should take the assets and do it for them. I suspect that if the proposal were passed, and it was clear to the banks that it was the best deal that would be forthcoming, they'd still jump at the opportunity to offload these assets, however much they'd grumble.
March 7, 2008 3:26 PM | Reply | Permalink
I think the first year's study (Econ 101?) of Economics is all the value one can get from studying the subject as some things are basics and will never change; the Basics are the things you learn in your first year. I believe any more than one year of study just causes the student to be confused and unable to create an analysis that bears fruit.
I say this because of the gazillion times I've seen how wrong the economist's predictions have been over the years and also for the many times I've seen Economist A say its cloudy and raining out and Economist B saying, not it isn't, its sunny and clear.
We might all be much better off if Econ 101 was all there was.
I think this column by Dean Baker and the resulting posts mentioning "Economists" show there's at least a kernel of truth to what I feel.
March 8, 2008 9:57 AM | Reply | Permalink