Housing: The see-no-evil muddle-through approach

By Felix Salmon
January 10, 2011
David Streitfeld reckons that if mortgage delinquencies continue to pile up without turning into foreclosure actions, that could be good for the economy as a whole:

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David Streitfeld reckons that if mortgage delinquencies continue to pile up without turning into foreclosure actions, that could be good for the economy as a whole:

Foreclosure activity fell 21 percent in November from October, the biggest monthly decline in five years. Here in Phoenix, foreclosures fell by more than a third in the same period…

If the slowdown continued through this month and into the spring, it could be a boost for the economy. Reducing foreclosures in a meaningful way would act to stabilize the housing market, real estate experts say, letting the administration patch up one of the economy’s most persistently troubled sectors. Fewer foreclosures means that buyers pay more for the ones that do come to market, which strengthens overall home prices and builds consumer confidence in housing.

“Anything that buys time, that reduces the supply of houses coming onto the market, is helpful,” said Karl Guntermann, a professor of real estate finance at Arizona State University.

I think he’s probably right. Consumer confidence is a key factor in the health of the housing market and there’s an obvious connection from lower supply to higher prices, to higher confidence in housing as an asset class. That confidence might well turn out to be misplaced, of course. But a warm occupied home is a much happier thing, economically speaking, than a cold and empty one, even if the occupiers haven’t made a mortgage payment in years. Foreclosures carry a large economic cost and all things being equal, the less of them there are the better.

There’s something conceptually attractive, especially to small-government libertarians, about ripping the bandage off the patient harshly. Foreclose on anybody who’s delinquent, stop providing massive government subsidies to the mortgage sector and let the market find the true market-clearing level for house prices. But we simply can’t do that — it would mean a financial crisis much larger than the last one, with substantially the entire banking system becoming insolvent; the resulting plunge in stock prices and global economic growth could make the last recession look positively tame.

The realistic alternative is to muddle through — to artificially support the housing sector and mortgage valuations for however long it takes, which might well be forever. As Bethany McLean notes, “federal involvement in housing has been a constant since the 1930s” and it’s hard to see any politically-acceptable way of changing that.

The big winners in all this will be the delinquent homeowners who continue to live in their houses without making their mortgage payments. The losses, meanwhile, will be spread around a large number of banks and investors, all of whom can cope with — and even fully expect — smaller streams of cash flowing from their mortgage portfolios.

Some potential buyers, worried about the shadow inventory of homes which could be foreclosed upon at any minute, will choose to rent rather than buy — that’s fine, and indeed is probably a good thing. We want the homeownership rate to fall. Other buyers, seeing rising prices and a shrinking supply of houses coming on the market, will jump in regardless. And so long as there’s enough government support and buying interest to keep prices from falling further, everybody will be more or less content. The tail risk will still be there, of course. But merely running the risk of a catastrophic outcome is surely a better idea than actually triggering that outcome.

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