Should the government try to stabilize house prices?

December 19, 2008

What if the government was actually able to create some magic program to target the bulk of its money printing effort towards the residential real estate market and suddenly inventories started to drop and house prices stabilized, would it even matter? The stock market would probably rally, the airwaves would probably be filled with people forecasting the next long bull market, every government official would credit his brilliant economic policy, but would it last?

Many vacant houses are owned by banks so buying them is essentially equivalent to depositing cash in a checking account, which should help the banks roll back some of their emergency short term debt, but despite the huge infusions of cash from various Federal Reserve lending facilities nobody is eager to issue new mortgages because most Americans aren’t credit worthy. That raises an important question — who will buy these properties? Where will consumers get the money to buy foreclosed houses if they’re flat broke and all the bailout cash is going directly to the major corporations and financial institutions who refuse to lend it? Even if the banks were willing lend, who would they lend to? If the new magic government program funnels cheap debt directly to already bankrupt consumers or subsidizes more risky lending by the banks, isn’t that just more of what created this crisis in the first place? Did I just hear someone at the Fed say double or nothing?

If by some miracle the magic program was successful, it could be a good deal for the banks, but our lucky new homeowners will still be on the hook for shiny new mortgages with rising unemployment. And what if people simply use the government engineered lower rates to trade houses — if people take one house off the market but add another, we may just be treading water. Also, people typically put their house up for sale before committing to a new purchase; these cheap mortgage rates could actually cause a flood of new inventory to hit the market and escalate price declines, at least temporarily. Oops.

Whether or not reducing inventories by handing out targeted cash would cause general price levels to rise depends on how many of these sales are by banks – what kind of condition are the houses in? I doubt the banks have been maintaining them too well. People could use any government sponsored “quasi-amnesty” to re-negotiate a lower principal then abandon the house in favor of cheaper accommodation (or rent) and keep the cash – will banks be able to reduce the principal of a guy’s house, but not his neighbor, simply because one decided to buy a Mercedes and the other took the bus? (The house prices declined the same amount but one has equity, the other does not). Or people could just re-finance their existing house and use the cash for daily transactions, as many people have been doing for years, re-inflating the credit bubble and once again taking their mortgage under water. Every plan introduces dangerous incentives that could have unexpected consequences.

Regardless, if you believe, as I do, the heart of our problem is that consumers, businesses and governments are over-leveraged with debt, this may delay the collapse but it will not prevent it unless we next experience a massive inflation to wipe away everyone’s obligations. If the malls are already empty because people are too broke to buy televisions and ipods, then how will tricking them with market distortions into allocating what little they have left towards more housing solve anything? You may save the banks and destroy everything else in the process, there just isn’t enough money to go around, Americans have no savings. You can’t cure the problem of excess debt with even more debt, logically it just doesn’t make sense. Usually when things don’t make sense they don’t work in the long run. In other words, perhaps (that’s all I’ll give them) some plan could prevent a total collapse right now, but it will be at the expense of either a worse collapse or destruction of the currency, later.

So at the end of the day, house price stabilization is not the panacea television talking heads claim it to be. The government can’t fix this problem.