Dean Baker's View of the Housing Bubble

From a paper written in May by Dean Baker of the Center for Economic Policy Research:

The housing bubble in the United States grew up alongside the stock bubble in the mid-90s....

The stock wealth induced consumption boom also led people to buy bigger and/or better homes, since they sought to spend some of their new stock wealth on housing. This increase in demand had the effect of triggering a housing bubble because in the short-run the supply of housing is relatively fixed. Therefore an increase in demand leads first to an increase in price. As prices began to rise in the most affected areas, prices increases got incorporated into expectations. The expectation that prices would continue to rise led homebuyers to pay far more for homes than they would have otherwise, making the expectations self-fulfilling....

As the house prices grew further out of line with fundamentals, the financial industry adopted more sophisticated financial innovations to support its growth. A key part of the story was the growth of non-standard mortgages....

The bubble began to unravel after house prices peaked and began to turn down in the middle of 2006. This led to rapid rises in default rates, especially in the subprime market....

[The] financial meltdown also has important feedback effects on the housing market. On the supply side, the flood of foreclosures ensures that a large supply of housing will be placed for sale, since banks are generally anxious to sell properties on which they have foreclosed....On the demand side the growing stress in financial markets has helped to dampen demand, since banks are far more reluctant to make loans than had been the case two years ago....The continued flow of houses for sale, coupled with the sharp cutback in demand, is leading to rapid declines in house prices in many markets....

Through the run-up of both the stock bubble and the housing bubble, the Fed took the view that financial bubbles are natural events, like the weather, which cannot be prevented. In fact, financial bubbles can be contained and there is nothing more important that the Fed or any central banks can do than to ensure that they do not grow to such dangerous proportions.

The Bursting Housing Bubble is Causing Homeowners to Become Renters

From a paper by the Center for Economic Policy Research and the National Low Income Housing Coalition:

The bubble that developed in the U.S. housing market from the years 1996 to 2006 pushed prices in many markets far out of line with fundamental values. The correction that began in the middle of 2006 has helped to bring house prices back in line with their long-run trend growth path. Nonetheless, house prices in some of the most inflated markets are still hugely out of line with rents and income....

In bubble markets, renting is becoming an increasingly attractive refuge for homeowners saddled with a depreciating asset. Nationwide households evicted as a result of foreclosure are also likely to turn to rental markets for housing. Additionally, homeowners who are making a transition in their lives or households or individuals entering the housing market for the first time are even more likely to put off the decision to own in the current market....

With or without proactive policy, the transition from owner-occupied housing to rental housing is happening. There are a variety of factors that make it likely that the transition of the housing stock may not keep up in many areas. In these bubble markets, policy makers must not only be less committed to sustaining ownership and home values, but also must proactively facilitate the conversion to rental of vacant, foreclosed and delinquent units to limit the pressure on the rental market. Even in slack markets, it is necessary to limit the impact on the most vulnerable renters and more importantly to use the opportunity provided by the current market to relieve the pressure on these households by providing additional affordable housing through programs to purchase, renovate, and reuse foreclosed and vacant units to house those at risk of homelessness.

Dean Baker's Recommendations to Congress Regarding the Housing Bailout

From the introduction of congressional testimony in April by economist Dean Baker of the Center for Economic Policy Research.

The current situation in the housing market is potentially the largest economic crisis in the post-World War II era both for the country as a whole, and the millions of homeowners facing the loss of their home. By its actions, Congress can help to either ameliorate some of its worst effects, or exacerbate the problems. For this reason, it is crucial that it consider carefully the implications of any legislation.

The Hope for Homeowners Act of 2008 is an ambitious effort to address the crisis created by the collapse of the housing bubble, and the epidemic of predatory subprime mortgages over the years 2003-2007. In assessing the merits of this proposal, it is important to realize that there are large differences in the state of the housing market across the nation. Policies that may be appropriate for some parts of the country may not be appropriate for other parts of the country.

In my comments, I argue that the mortgage guarantee program that is at the center of the Hope Act may be useful for parts of the country where housing prices are not abnormally high, but that this program is not well-suited for areas that still have bubble-inflated house prices.

Specifically, the program in bubble-inflated areas:

1) Will lead to situations in which homeowners spend far more on housing than renters would pay for comparable units;

2) Will lead to situations in which homeowners are unlikely to accumulate any equity at the point when they leave their home;

3) Will fail to stabilize prices.

I also argue the effort to stabilize prices in bubble-inflated areas is counter-productive. Insofar as it succeeds, it makes homeownership less affordable for young people and families moving into the area. I also briefly describe an alternative "own-to-rent" proposal that would guarantee moderate-income homeowners facing foreclosure the right to remain in their home as long-term tenants paying the fair market rent.

How Congress Should Address the Foreclosure Crisis

A paper by the Center for Economic Policy Research and the National Low Income Housing Coalition provides recommendations for how Congress address the foreclosure crisis. (Sorry about the length.)

This paper compares ownership and rental costs in twenty major metropolitan areas. It shows that in many areas, ownership and rental costs are more or less in balance. This means that it might be practical and desirable to craft policies for these cities that are focused on keeping homeowners in their homes as owners.

However, the paper also shows that in many cities homeownership costs are greatly out of line with rental costs. These are cities, mostly on the two coasts, that have seen an extraordinary run-up in house sale prices over the last decade that have not been matched by any comparable increase in rents. In these markets, homeownership costs could easily be double, and even close to triple, the cost of renting comparable units. Paying these inflated ownership costs will take away money that might otherwise be used to pay for health care, child care or other necessary expenses. Similarly, a government that intervenes at these prices will have less money for other needs.

Furthermore, because prices are now falling rapidly in many of these markets, homeowners are unlikely to accumulate equity. In fact, it is likely that many homeowners will end up selling their homes for less than their outstanding mortgage, even if new mortgages are issued with substantial write-downs from the original mortgage. In these bubble markets, government efforts to support homeownership are likely to do little to help homeowners and could leave taxpayers with a substantial bill in cases where homeowners leave their houses with negative equity.

The paper notes that in these markets, a policy of ensuring suitable rental options is likely to be more helpful to many current homeowners. This policy can encourage the rapid conversion of vacant and abandoned units to rental properties, as well as policies that facilitate the conversion of ownership units to rental units for the same households.

In addition, the paper also notes that many of the properties facing foreclosure are already rental properties. In these cases, foreclosures often result in the displacement of the current tenants. Congress should recognize this problem and consider policies that provide greater security to tenants in such situations....

The analysis shows that for several cities with bubble inflated house prices such as Los Angeles, Boston, and Washington the cost of homeownership is likely to be two or even three times as high as the cost of renting a comparable unit. Furthermore, since house prices are likely to continue declining towards long-term trend levels, homeowners in these markets are unlikely to ever accumulate equity in their homes.

In these markets, encouraging people to remain as homeowners, even with substantial write-downs from their original mortgage terms, is likely to lead to situations in which they pay far more of their income in housing costs than necessary. The result could be that these families forego health care insurance for their kids or quality child care, since they will be forced to continue to make extra sacrifices to remain homeowners, with considerably less likelihood of a long term financial benefit relative to renting.

By contrast, in markets where house prices do not appear to be inflated, such as Atlanta, Cleveland, and Detroit, there is not a serious imbalance between the cost of renting and the cost of owning. In these markets, it is reasonable to implement policies that attempt to keep people in their houses as homeowners and stabilize house prices.

Backdoor Bank Bailouts

Economist Dean Baker saw the "Bank of America Bailout Bill" for what it really is.

Back in March, Dean Baker of the Center for Economic Policy Research wrote a paper about the effects of the type of bill that the Senate is voting on this week. Not only will the bill be a backdoor bank bailout, but it will actually be harmful to many of the people it purports to help. Here is his conclusion:

The proposals currently being circulated to have the government buy up or guarantee mortgage debt for homeowners facing foreclosure are likely to benefit banks more than homeowners. Under proposals similar to the one developed by OTS, most homeowners aided by the plan would never accumulate any equity in their home. Furthermore, they would be paying nearly twice as much in monthly housing costs for the period that they stayed in their homes as if they rented a comparable unit. While this proposal does little to aid homeowners, it could lead to the transfer of billions of dollars, or even tens of billions of dollars from taxpayers to banks.

The current housing crisis was allowed to develop because those in positions of responsibility somehow failed to see an $8 trillion housing bubble. This bubble created an average of $110,000 in housing bubble wealth for every homeowner in the country, hugely distorting the housing market and the economy. It would be unfortunate if the same people who were responsible for this massive failure were allowed to compound the economy’s problems with ill-conceived bailout plans that ostensibly are designed to help homeowners, but really only benefit banks and other mortgage holders.

Everybody thank Senator Chris Dodd and Congressman Barney Frank for the bank bailout.