The Good News in the Bad Housing Numbers

The fog is finally lifting from the overstimulated housing market.


We've been hoping to avoid this pain, with vast amounts of medication disguised as Federal Reserve asset purchases, home-buyer tax credits, unorthodox mortgage modifications, and other aid meant to anesthetize the housing market. But it hasn't really worked, and we're finally seeing just how deep the housing bust really is.

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The latest numbers on existing home sales startled the markets, coming in far below expectations and signaling deep unease among people who ought to be spending money. All along, there's been a presumption that the government could pull some levers and get the housing bust cleaned up. It seemed to be happening late last year and early this year, when sales stabilized and prices stopped falling. But it was easy to forget that a government tax credit and other federal maneuvers were largely responsible for the boomlet. After the credit expired in April, sales started heading back down all over again—an unmistakable double dip. The pace of home sales is now where it was in 1995, with the latest monthly dip the biggest in 40 years.

This sounds like fresh bad news, but it's more like a delay of what would have happened in 2008 or 2009 had the government not infused massive amounts of aid into the housing market. In a companion story, I point out that government support for the housing market has been the biggest stimulus program of all, which makes it particularly astonishing that the results are so poor. But it's been inevitable that this is all going to happen. The only real question has been whether the government can smooth out the sharpest downturn in decades, so it happens gradually instead of coming all at once, at the worst possible moment.

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What's going on in housing is simple, in a way: Supply and demand got way out of whack during the boom, thanks to easy credit and a surge of buyers who overspent and overborrowed and never should have bought the homes they did. With too many buyers, demand for homes became unnaturally high, which led first to soaring prices and then to an excess supply of homes, as builders responded to the huge demand. We're now returning to some kind of equilibrium, with all that excess supply and a sudden shortfall of demand driving prices in the other direction. This has to happen, and in the long run it will make homes more affordable for people who were priced out of a hot market at the peak of the boom.

But the process is ugly and destructive, and that's what the government has been trying to control. The home-buyer tax credit was meant to goose demand at a time when it was unnaturally low, during the depths of the recession. That it accomplished. But it now appears that the tax credit mainly accelerated purchases by people who would have bought anyway, rather than generating new purchases. That's no surprise: Banks are notoriously tight with money right now, lending only to borrowers considered safe bets. The tax credit didn't change that, thank goodness, because luring marginal buyers into the market would simply have replicated one of the problems that caused the housing bust in the first place.

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With the artificial support of a tax credit gone, the market is now more aggressively seeking its own natural price and sales levels. Demand is far lower, so prices have to come down before sales normalize. It will continue to be choppy, because buyers and sellers don't know where the sweet spot is, and the lousy job market makes them unusually hesitant. Many sellers are putting their homes up for sale for what they hope is a reasonable price, then taking them off the market when they get no offers. That means the price is still too high—but it will take months or years for many sellers to accept that. Some buyers, on the other hand, may be waiting for unrealistically low prices, and they'll have to miss out on several properties before they realize that they're looking in the wrong place for a bottom.

The end of the tax credit, and the subsequent plunge in sales, has removed a bit of fog from the market. We're getting closer to prices that are real, and therefore sustainable. And the faster the process works itself out, the better. One lesson of Japan's "lost decade" in the 1990s—which American economists are now intently studying, since they're worried the same thing might be happening here—is that letting deep financial problems fester can produce chronic stagnation that's worse than a recession. So far, American policymakers have been more aggressive than the Japanese were at identifying and dealing with the worst problems. The housing bust is surely one of them, and at this point tough love is probably the best medicine.

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Some people are calling for a renewed tax credit to help prop up sales, but that would only confuse the market all over again. In fact, government officials should probably do the opposite and declare that there will be no more tax credits, so buyers and sellers get it out of their heads altogether and it's no longer a factor to consider. Sooner or later, we need to take the market as we find it, without a side order of government aid. How about now.