US Housing Woes: It's The Affordability, Stupid!

Source : The Business Times, March 6, 2008

GLOOM. Doom. Calamity. Home prices are tumbling. We're bombarded by sombre reports. But wait. This is actually good news, because lower home prices are the only real solution to the housing collapse. The sooner prices fall, the better. The longer the adjustment takes, the longer the housing slump (weak sales, low construction, high numbers of unsold homes) will last. It's elementary economics. Say, houses are apples. We have 1,000 apples, priced at US$1 each. They don't sell. We can either keep the price at US$1 and watch the apples rot. Or we can cut the price until people buy. Housing is no different.

Even many economists - who should know better - describe the present situation as an oversupply of unsold homes. True, there is about 10 months' supply of existing homes as opposed to four months a few years ago. But the real problem is insufficient demand. There aren't more homes than there are Americans who want homes; that would be a true surplus. There's so much supply because many prospective customers can't buy at today's prices. By definition, the 'housing bubble' meant that home prices got too high. Easy credit, lax lending standards and panic buying raised them to foolish levels. Weak borrowers got loans. People with good credit borrowed too much. Speculators joined the circus.

Look at some numbers from the (US) National Association of Realtors. From 2000 to 2006, median family income rose almost 14 per cent to US$57,612. Over the same period, the median-priced existing home increased about 50 per cent to US$221,900. By other indicators, the increase was even greater. But home prices could not rise faster than incomes forever. Inevitably, the bust arrived. Credit standards have now been tightened, and the (false) hope of perpetually rising home prices - along with the possibility of always selling at a profit - has evaporated. For many potential buyers, prices have to drop for housing to become affordable.

How much? No one really knows. There is no national housing market. Prices and family incomes vary by state, city and neighbourhood. Prices rose faster in some areas (Los Angeles, Miami, Phoenix) than in others (Dallas, Detroit, Minneapolis). Some economists now expect an average national decline of about 20 per cent. The Federal Reserve estimates that owner-occupied real estate is worth almost US$21 trillion. A 20 per cent reduction implies losses of about US$4 trillion.

The largest part would be paper losses for homeowners: values that rose spectacularly will now fall less spectacularly - back to roughly 2004 levels; that's still 30 per cent or so higher than in 2000. But hundreds of billions of dollars of other losses are already being suffered by builders (from the lower value of land and home inventories), mortgage lenders (from defaulting loans), speculators and homeowners (from lost homes). Mark Zandi of Moody's Economy.com estimates that mortgage defaults this year will exceed 2 million, up from 893,000 in 2006.

To be sure, all this weakens the economy. No one relishes evicting hundreds of thousands of families from their homes. Eroding real estate values make many consumers less willing to borrow and spend. Some economists fear a vicious downward spiral of home prices. More foreclosures depress prices, increasing foreclosures as people abandon houses where the mortgage exceeds the value. Losses to banks and other lenders rise, and they curb lending further. Particularly vulnerable would be Fannie Mae and Freddie Mac, the two government-sponsored housing lenders.

Up to a point, there's a case for providing relief to some mortgage borrowers. In many cases, everyone would gain if lenders and borrowers renegotiated loan terms to reduce monthly payments. Losses to both would be less than if their homes went into foreclosure and were sold. The Treasury has organised voluntary efforts. Some measures being considered by Congress (for example, overhauling the Federal Housing Administration) might help. But other proposals - particularly empowering bankruptcy judges to reduce mortgages unilaterally - would perversely hurt the housing market by raising the cost of mortgage credit. Lenders would increase interest rates or downpayments to compensate for the risk that a court might modify or nullify their loans.

The understandable impulse to minimise foreclosures should not serve as a pretext to prop up the housing market by rescuing too many strapped homeowners. Though cruel, foreclosures and falling home values have the virtue of bringing prices to a level where housing can escape its present stagnation. Helping today's homeowners makes little sense if it penalises tomorrow's homeowners. An unstoppable free fall of prices seems unlikely.

Slumping home construction and sales have left much pent-up demand. What will release that demand are affordable prices. -- The Washington Post Writers Group

By ROBERT SAMUELSON