Why Housing Is Even Worse Than You Think

Shocking. More than three years after the housing bust began, forecasters are still overestimating the strength of the housing market. The latest sales numbers for existing homes, which took a steep, unexpected plunge, triggered a fresh bout of national gloom and stock-market selloffs. Record-low interest rates aren't luring buyers, and neither are falling prices that are 30 percent below their peaks, or more. The pace of sales is the lowest in 15 years.

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None of that is the shocking part, however. What's really unnerving is that all of this has happened despite a government effort to prop up housing that has been the biggest stimulus package of them all.

The plunge in sales startled the markets because earlier this year it looked like sales were picking up. Of course that's when the federal home-buyer tax credit was still in effect, offering buyers an extra few thousand dollars' worth of incentives. Everybody knew sales would fall after the credit expired at the end of April, which is exactly what happened.

We're now remembering that, oh yeah, maybe sales were artificially high because of artificial incentives to buy a house. But we're forgetting lots of other extraordinary incentives that aren't the usual workings of a free market, either. The Federal Reserve has helped drive interest rates to record lows by purchasing about $1.5 trillion worth of mortgage-backed securities, creating demand for mortgages that dried up during the financial crisis.

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Most home loans written by banks today are backed by the wrecked mortgage agencies Fannie Mae and Freddie Mac, which would have exploded in 2008 without a federal takeover that could ultimately cost taxpayers $300 billion. The government has also spent $75 billion to help struggling homeowners at risk of defaulting, a program that prevented a few foreclosures but in other cases simply delayed them. Those three efforts alone have accounted for more than half of the $3.5 trillion the government has spent or committed since 2008 to help combat the recession.

All of that aid comes on top of longstanding housing subsidies that are considered every American's birthright, such as the mortgage interest deduction, which dates to 1913. That tax credit amounts to a $120 billion homeowner subsidy every year.

And still, the housing market is a disaster.

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There's actually some good news in the lousy numbers, which I point out in another post. But it's astonishing that housing could still be so underwater despite all those government bailouts. How bad would the housing market be if the government wasn't piling up sandbags? Nobody knows, and nobody wants to find out. The recent financial overhaul reforms left Fannie and Freddie untouched, even though they represented one of the worst distortions in the entire financial system. The housing market is so fragile that trying to fix Fannie and Freddie could fracture the last lonely pillar that's providing any support to the market.

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Conventional investors watch the housing numbers to see when the market might be able to stand on its own two feet. But the government is so deeply entwined in this sector of the economy that it may never return to anything resembling a free-market system. Bill Gross, who runs the huge bond fund PIMCO, said recently that the government should just go ahead and overtly nationalize the housing market. "To suggest that there's a large place for private financing in the future of housing finance is unrealistic," he said. "To suggest that the private market come back in is simply impractical. It won't work." Maybe, if we stop waiting for the phantom free market to assert itself, we'll stop being so disappointed when it fails to happen.