To fix the economy, fix the housing market

October 24, 2011

By Lawrence H. Summers
The views expressed are his own.

The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence, more borrowing and lending, and more spending.  Most policy failures in the United States stem from a failure to appreciate this truism and therefore to take steps that would have been productive pre-crisis but are counterproductive now, with the economy severely constrained by lack of confidence and demand.

Thus even as the gap between the economy’s production and its capacity increases and is projected to increase further, fiscal policy turns contractionary, financial regulation turns towards a focus on discouraging risk taking, and monetary policy is constrained by concerns about excess liquidity.   Most significantly the nation’s housing policies especially with regard to Fannie Mae and Freddie Mac–institutions whose very purpose is to mitigate cyclicality in housing and who today dominate the mortgage market–have become a textbook case of disastrous and procyclical policy.

Annual construction of new single family homes has plummeted from the 1.7 million range in the middle of the last decade to the 450 thousand range at present.  With housing starts averaging well over a million during the 1990s, the shortfall in housing construction now projected dwarfs the excess of construction during the bubble period and is the largest single component of the shortfall in GDP.

Losses on owner-occupied housing have reduced consumers’ wealth by  more than $7 trillion over the last 5 years, and uncertainty about the future value of their homes, as well as the inability to refinance at reasonable rates, deters household outlays on durable goods.   The continuing weakness of the housing sector is a major source of risk for major U.S. financial institutions raising significantly the costs of the loans they offer.

In retrospect it obviously would have been better if financial institutions and those involved in regulating them–especially the FHFA–recognized that house prices can go down as well as up; if more rigor had been applied in providing credit; if the GSEs had been more careful in monitoring those originating and servicing loans; and if all those involved had been more vigilant about fraudulent behavior.

The question now is what should be done to address the housing market, given the drag it represents on the national economy.  With virtually all mortgages in the United States provided by the Federal government or guaranteed by the GSEs, this is inevitably a matter of government policy.

Unfortunately, for the last several years policy has been preoccupied with backward-looking attempts to address the consequences of past errors in mortgage extension by addressing homeowners on a case-by-case basis, and decisions regarding the GSEs have been left to their conservator FHFA which has taken a narrow view of the public interest. FHFA has not acted on its conservatorship mandate to insure that the GSEs act to stabilize the nation’s housing market, and taken no account of the reality that the narrow financial interest of the GSEs depends on a national housing recovery.  Instead of focusing on the stabilization of the housing market, its focus has been on reversing its previous policies heedless of changes in the environment, and in treating mortgage finance as a morality play involving homeowners, financial institutions and banks rather than an important component of national economic policy.  A better approach would involve a number of changes in policy.

First, and perhaps most fundamentally, credit standards for those seeking to buy homes are too high and rigorous in America today. This reduces demand for houses, lowers prices and increases foreclosures, leading to further tightening of credit standards and a vicious growth-destroying cycle.  Publicly available statistics suggest that the characteristics of the average applicant in 2004 would make an applicant among the most risky today.  Of course the pattern should be opposite, given that the odds of a further 35 percent decline in house prices are much lower than they were at past bubble valuations.

Second, as President Obama stressed in presenting his jobs bill, there is no reason why those who are current on GSE guaranteed mortgages should not be able to take advantage of lower rates.  From the point of view of the guarantor as distinct from the mortgage holder, lower rates are all to the good since they reduce the risk of default.  Yet, at least until now the GSEs have made refinancings very difficult by insisting on significant fees and by requiring that any new refinancier take on all the liability for errors in underwriting the original mortgage, at a cost to American households of tens of billions a year.

Third, stabilizing the housing market will require doing something about the large and growing inventory of foreclosed properties. The same property sold in a foreclosure sale nets about 30 percent less than if sold in the ordinary way and the knowledge that that there is a huge overhang of foreclosed properties deters home purchases.   Aggressive efforts by the GSEs to finance mass sales of foreclosed properties to those prepared to rent them out could benefit both potential renters and the housing market.

Fourth, there is the issue of preventing foreclosures which was the initial focus of housing policy efforts.  The truth is that it is far from clear what the right way forward is.  While the Obama administration HAMP effort has been widely criticized for overly restrictive eligibility criteria, the reality is that a large fraction of those receiving assistance have ultimately been unable to meet even their reduced obligations.  This suggests that the task of helping homeowners without either damaging the financial system or simply delaying inevitable outcomes is more difficult than is often supposed.  Surely there is a strong case for experimentation with principal reduction strategies at the local level.  The GSEs should be required to drop their current posture of opposition to experimentation and move on a more constructive posture.

Fifth, there were clearly substantial abuses by major financial institutions and most everyone in the mortgage industry during the bubble period.  Just compensation to the victims is a legitimate objective of public policy.  But allowing negotiation over the past to be the dominant thrust of present policy creates overhangs of uncertainty that impose huge costs on the financial system and inhibits current lending.   It is equally in the interests of bank shareholders and the housing market that a rapid resolution of disputes be achieved.  The FHFA should be striving to bring the current period of uncertainty to a rapid conclusion.

While the GSEs are by far the most important actors in the mortgage space (and hence the FHFA that serves as their conservator is the most important player in housing policy), there are others who can make a constructive difference.  Bank regulators could facilitate inevitable restructuring of underwater mortgages by requiring banks to treat second mortgages and home equity loans in realistic ways.  The Fed could support demand and the housing market by again expanding purchases of mortgage backed securities.

With constructive approaches by independent regulators, far better policies could be in place six months from now.  The anticipation of a change to supportive policies could change the tone of the market even sooner.  There is nothing else on the feasible political horizon that can make as a large a difference in driving American economic recovery.

PHOTO: The framework for a single family home currently under construction is seen in Los Angeles, California October 18, 2011. REUTERS/Fred Prouser


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“Just compensation to the victims is a legitimate objective of public policy.”

And what of the “victims” of the underwater homeowners’ reckless spending? That would be banks and taxpayers/

Posted by AndyAE | Report as abusive

Hey Larry,

I lost a few bucks in the stock market a few years ago.

Will you support a program where taxpayers pony up so that I’m no longer a loser in these investments?

You’d better.

Otherwise you’re displaying a double standard. Bernanke has already forcefully argued that boosting the stock market is good for investors and economic growth. So by making underwater stock investors (like me!) whole—at the taxpayer’s expense—you’d help the economy no less than this “housing” program would help the economy.



Posted by PeterMarlow | Report as abusive

I’m be befuddled to read Larry Summers’ article. For one, his analysis and solution to the housing and the genefal economic problems appear reasonable and accurate, and this begs the question of what happened when he headed the treasury. I beleive the GSE and FHFA were under the treasury, and even if they were not, Summers was a member of Obama’s economic team. As an ordinary citizen, burdened by the economic conditions in the country, I will like to know if these solutions just became clear to him or he was simply handicaped by legislation?

Posted by 0okm9ijn | Report as abusive

So, since bailing out Wall Street with trillions of dollars worked so overwhelmingly well (shortages of workers — uhh yes they actually do claim such nonsense), we should bail out the home builders with more trillions taken from the unemployed, the elderly, the disabled and the poor. Great idea.

The basic problem is that an overpriced dollar has priced American labor and goods out of the world market, and with that it has more than halved the number of middle class households in the USA since George W Bush took over in 2001. Middle class people buy and own homes. The working class and the poor rent, mostly. So we have millions of houses for a class of people that gets smaller by the week. The “American market” is almost entirely a middle class market, and the middle class is going the way of the buffalo. And for the same reason. Opening more buffalo robe factories will not bring them back.

Posted by txgadfly | Report as abusive

The true cause of out inexorable financial straits is the hoarding of oil and the associated manipulation by gamers. Without oil at 147 in 2008, there would have been no crash. Oil stifles demand from consumers who instead have to pay for oil. It tacks on a surcharge to everything. Its a monopolistic practice that is completely contrary to free markets and is more akin to medieval barons who would drag a chain across the Rhine and levy a toll upon every barque that approached. That’s basically what it all boils down to anymore. The only solution to the Rhine obstructors was political.

Monopolistic oil and other commmodity hoarding should be outlawed in every free and democratic country and should be considered as an act of economic warfare by any country that harbors commodities hoarders.

Posted by sorestloser | Report as abusive

I am quite familiar with the liquidation of foreclosed properties by the Resolution Trust Corporation (“RTC”). This is the federal agency that handled the assets of the collapsed thrifts during the S&L crisis of the early ’90s.

This agency did a good job. I think the key to the good outcome then was the same as it is today. Foreclosed properties must get through the pipeline more quickly than they are doing now, at new market prices which have been re-set by auction. These properties must be put into the hands of new private owners, who may well fix them up, re-sell or rent them. The sooner the glut of foreclosures gets cleared out, the better off we’ll all be. This is taking way too long. This is a mess that we must clean up now. The longer it goes on the more the perception circulates that nothing will get better for an extended period of years.

I am all for helping needy homeowners, but all proposals for doing so nned to be carefully examined to ensure that we are not creating zombie borrowers who owe payments to zombie banks.

Posted by Yowser | Report as abusive

I choked on this quote:

“First, and perhaps most fundamentally, credit standards for those seeking to buy homes are too high and rigorous in America today.”

1.] since 2 billion new workers came into the market from Asia, do you expect their pay to rise or fall?

2.] given, the astounding replacement of workers by technology and productivity enhancements, do you expect American’s pay to rise or fall?

3.] given globalization, and the transience of any skill or job, do you expect loan applicants to be steadily employed for the next 30 years?

4.] Should housing prices be on a par, that matches America’s purchasing power?

5.] given that prices are still inflated, compared to pre-bubble prices, and relative to American’s earnings….why are you willing to pay these prices?…..

the problem with maintaining high real estate prices, in a labor market where there is excess capacity…… that there is no pressure to raise wages.

housing costs take a bigger bite of the family budget.

The loss of purchasing power, reduces discretionary spending………reducing the opportunities for business growth.

the housing bubble, easy credit, masked the loss of income that came with the shift of jobs overseas, and the technology revolution.

the idea of the taxpayer being the guarantor, in a country where real income is declining for working people, is a double-whammy.

let the current mortgage holders, holders of mortgage securities take the hit….this ‘housing relief’ idea is about making the taxpayer an underwriter of bad loans………(no I am not a Republican).

There will be homebuyers, when prices come down to match purchasing power

Posted by Robertla | Report as abusive

The problem with Mr Summers is he spent his whole life talking. Sometimes sensible talk, often times incomprehensible and hypocritical talk. But talk and more talk.

The housing blow up is caused by capitalism let out-of-control by those in charge of control, and by the millions who spent a decade engaged in stupid recklessness. Most of the people is paying or have paid the price as they should. Those in charge, including Summers, got off completely or with a tiny fine. But we are left with millions of excess and nearly worthless properties.

Therefore the only way to fix the housing market, that is if you want to fix it within a year, is to destroy all such excess properties. Or do nothing and let time and degradation fix the mess.

The beauty of this solution is simple: a) It actually will work, I guarantee you. b) It keep Summers mouth shut.

Posted by TomKi | Report as abusive

How can we trust Larry ? He hasn’t performed well over the last 15-20 yrs. During Clinton”s term he,Robert Rubin and Alan Greenspan combined to create both a surplus and the future Crash and depression that followed. Rubin did quite well for himself and his son, getting jobs w Citicorp. You take a surplus projected multi-billions over the next 10 yrs and totally destroy it and run up a deficit and bring the worlds superpower on the brink of destruction, and bring the rest of the world w you. Yeah, larry’s advice is what we need.

Posted by jbad1 | Report as abusive

Any rational, even-keeled, blue-collar adult could have seen this train wreck coming. The early 80’s ushered in double-income families and latch-door children as the gap between home prices and incomes widened like never before. Real estate became a commodity for the well-to-do and high mortgage payments became a monthly norm and provided the catalyst for a shrinking middle class. Parts of society – not the average working man – were drunk on prosperity, giddy with success; most others looked on in despair watching the American Dream slip further away. Great shifts in age-old financial policies affecting the mortgage and banking industry yielded to pressures from both parties and the race was on to give everyone the American Dream regardless of ability. Mortgages were aggressively generated, bundled and handled like hot potatoes. Nobody held on to them long. New revenue streams flowed everywhere making relatively few wealthy.

Then it crashed.

Sub-prime became a household phrase. Too many white-collars scratched their heads in bewilderment wondering how it all happened. The blue-collar guy in the street, unable to play the ‘Flip that House’ game, clearly saw the train coming and what it was heading for. What goes up must come down. Drunk with prosperity, giddy with success. Even many blue-collars, who knew the end was imminent, were numbed to reality as their 401K’s witnessed unprecedented gains.

So here we are – stuck – and pretty darn good.

We’ve poisoned ourselves and the world with overly-inflated toxic securities and all the King’s horses and all the King’s men are trying to put it back together again. Yes, housing is hugely important to our economy as Mr. Summers points out, but the family house is also the American Dream, our last bastion of safety, and yes, everyone needs one. Indeed, we need to get our economy back on its feet and housing plays a critical role for obvious reasons. But things need to be different next time around – if there is one.

When and if the housing market does begin to heat up and its dividends percolate throughout society, we need to have a policy in place to prevent the past from repeating itself. While this may be a simple prophetic proclamation, ‘simplicity’ is just the medicine all economies need to remain healthy and stable.

We can’t treat the American Dream like a commodity for 20 years and expect anything less than the nightmare we are currently wrestling with. We need legislation to discourage this in the future.

Don Mason, Rockport, Massachusetts

Posted by DonMason | Report as abusive

Mr. Summers, where were you when the economy needed attention and, above all, regulation and control?? I don’t believe anything you say/think/write.

Posted by w.burton | Report as abusive

“The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence”

The adage _If you go through life as a hammer, everything appears to be a nail_ is fitting in this context.

It occurs to me now, and in reflecting on some past articles on how former Fed Chairman Paul Volcker was deliberately left absent from White House staff meetings, it is an absolutely delicious irony to see you in print stumping for the same old-same old.

Posted by Laster | Report as abusive

American Capitalism is broken – we privatize the profits and nationalize the losses – its high time we jailed everyone in the federal government and financial institutions – they have allowed this monster to totally wreck our financial future – they were reckless in causation, now equally clueless in reparations – the dot com boom/bust is now a daily reality folks

Posted by jackdanielsesq | Report as abusive

Mr Summers must be made from Teflon. He was a key player during the Clinton Administration that pushed for policy to allow the banks to take on greater risks ( from 10 to 1 capital ratios to as much as 40 to 1 capital ratios). He also pushed policy to allow the banks to write credit derivatives in a dark market without margin requirements to offset risks.
Both of those policies where central to the blow up of western capital markets.
How can someone with a track record like that even show his face in public.


Posted by Gen | Report as abusive

sed non culpa mea est

He’s taken those words to a whole new level.

Posted by lhathaway | Report as abusive

I’m going to be blunt here. You are a fascist pig. We are in this mess because of your past policies. I am beginning to believe that your sole desire is to impose a form of fascism, socialism and communism all wrapped into one onto the American system. It’s perplexing and quite comical that you openly make suggestions such as these. Your suggestions are exactly what you suggested before. It is obvious that your level of intellect is WAY over rated.

Posted by RSDallas | Report as abusive

“The central irony of obesity is that while it is caused by too much doritos, too much icecream and pudding, and too much McDonald’s, it can only be resolved with more doritos, more icecream and pudding, and more McDonald’s.”


Posted by Linechronix | Report as abusive

He can’t distinguish irony from error. He might as well say that sticking his finger into an electrical socket caused shock, and the cure is more electricity. Try that cure, Larry, and get back to us on how well it works in the real world.
One answer to too much debt is to stop spending beyond your ability to produce and start producing and saving more than you spend for a while. Another is default. Continuing to incur more unsustainable debt is just not a viable option. (Planning to inflate the debt away will just cause currency debasement, which has an even bigger set of problems.)
The solution to falling prices is to make sure your market is transparent and governed by laws that actually punish fraud, which will bring products to a sustainable level. Whether you like that level or not, it is a reality you must respect. A false market you try to create in its stead will ultimately fail. That’s exactly how we got here, remember? It might be an unpleasant process, but the alternative — extend and pretend — is going to be even more unpleasant because it’s really just blowing a bigger bubble.
This is not rocket science. We need to stop pretending these self-styled economic rocket scientists can get us out of this. We screwed up. We can expect to suffer for it. Screwing up more is not the answer. TIme to take the medicine and do the right things for a change.

Posted by oldscool | Report as abusive

“When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it.”

Fredric Bastiat

Posted by OneLessZombie | Report as abusive

“fiscal policy turns contractionary (…) and monetary policy is constrained by concerns about excess liquidity”

See, it’s stuff like this that you can’t just blurt out if you want to be taken even remotely seriously. You would unfortunately need to back up such claims with numbers (annoying, I know).

The numbers I find say that from 2007 through now fiscal policy has grown annual US government spending from $5 to $6 trillion, the gross public debt has grown from ~$11 to ~$16 trillion ( -spending-debts-historical-charts/) and the total reserve bank credit at the Fed (=the total dollars originated by the Fed) has grown from $800 billion to $2.8 trillion ( ries/WRESCRT?cid=32215).

What I would love for you guys to do is to give me a number. How much more are you asking for? How many more government dollars are gonna be just enough to make things better?

Posted by EconomicsJunkie | Report as abusive

“…can only be resolved with more confidence, more borrowing and lending, and more spending.”

Mr. Summers, the only cure for the bubble that will bring about an (eventual) end to future bubbles is to go back to the gold standard and set the price of gold to around $7000/oz – or whatever it takes to make every ‘printed’ dollar convertible to the 261 million ounces of gold the US presumably holds in reserve. At this very high price level, far above the current market price, everyone holding gold will suddenly have a lot more ‘dollars’ and miners around the world will go into overtime to dig up more ‘dollars’ with which to buy American products or pay off dollar-denominated debts. That’s because a gold standard would not only make dollars convertible into to gold but also the reverse – gold would be freely convertible into dollars – lots of dollars. The ‘money supply’ would thus increase (inflation), causing prices to rise. Workers would be paid with cheaper dollars but that is better than losing their jobs as is happening now. Lenders would be repaid with cheaper dollars but that’s no worse than not being repaid at all via bankruptcies and foreclosures. After a few years, other prices and wages would catch up to gold and perhaps there would finally be some stability – until the government finds another way to screw things up again.

Posted by wootendw | Report as abusive

Why would anyone listen to someone who helped create the too-big-to-fail banks is beyond me. One sure fire cure for our economy and curing the crony capitalism mess we’re in is to stop listening to Larry Summers.

Posted by ckeeble | Report as abusive

Interesting: currently there are 13 comments – and not a single one of those in support of Summers’ nonsense

Posted by WalterW | Report as abusive

It is sad commentary at this last stage that this person is even given a forum on Reuters. It is absurd that he is an “advisor” to Presidents and chief mucky muck of one of the “learning” institutions most responsible for the dearth of American “leadership”. Just go to the Cayman Islands, Larry, you’ve caused enough damage.

Posted by russwinter | Report as abusive

Ironic that so much of what’s wrong is the result of policies Summers supported.

Posted by Sechel | Report as abusive