So the White House released the details of its housing bailout plan. The meta-message of the plan (besides that there is often no justice for people who "work hard and play by the rules") is this: Markets don't work. Supply and demand doesn't work. At least not the way the White House would prefer. A few observations
1) Stop trying to pump a bit of air back into the bubble. Let homes move from weak hands (who have a tedency to keep defaulting even after their mortgages get modified) and speculators into strong hands such as former renters and young families. Let homes become more affordable. The faster, the better. Take a look at battered California where home prices are down 41 percent. In January, the number of months needed to deplete the supply of single-family homes on the market was 6.7 months. That's less than half the 16.6 months from the year-ago period. Home sales doubled while the number of days it took to sell a home fell by a third. Supply and demand works.
2) And lowering interest rates isn't going to pump much air back into the bubble. As economist Ed Glaeser has found:
Interest rates, and credit availability, do affect housing prices, but the impact is modest. The figure shows the time series of housing prices (according to the price index assembled by the Office of Federal Housing Enterprise Oversight) and the real 10-year interest rate, before the current downturn. Over the whole period, a 1 percent cut in the real rate is associated with a 3.3 percent increase in prices. Further interest rate reductions are unlikely to undo much of a 20 or 30 percent housing price decline; no credit market policies can keep housing prices above construction costs forever in areas where there are few legal or physical restrictions on building new houses, as in Phoenix and Atlanta.
3) The Obama plan treats a symptom rather than the illness. If you are worried about defaults and foreclosures, the target should be the unemployment rate not falling home prices. JPMorgan economist Jim Glassman explains:
Even more important, when it comes to understanding the impact of falling prices on defaults, further declines in house prices would be expected to have a diminishing impact on defaults, because most of the weak hands—the speculators—already have been washed out. Folks who actually live in their houses and send their kids to neighborhood schools, are not going to walk away just because house prices are down, unless they hit hard times and cannot make their monthly payments. Many homeowners saw the price of their houses fall in the early 1990s, following the stock market crash of 1987, and yet they did not walk. For that reason, it is quite likely that the worst is over for mortgage defaults, at least when it comes to strains related to falling house prices. Rising unemployment poses a continued threat to defaults, but the link to house prices almost certainly is a thing of the past.
4) And nudging lenders to play ball on modifying mortgages today could lead to higher rates down the road since the contracts don't like so solid any more thanks to the impending cram-down legislation.
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