The Endless Dream of Re-inflating the Bubble
I don’t have any deep thoughts on this housing plan, except to say that it appears that it won’t deliver any kind of substantial economic benefits to me. Which, while too bad, is probably a sign of a good plan since there’s no good reason the government should be trying to deliver assistance to me.
Unfortunately, though, this means that the plan probably won’t do what most Americans want. Lots of people looked at what houses were selling for in 2006 and 2007 and decided that the houses they owned were worth a lot of money. In fact, their houses weren’t worth nearly that much, the 2006-2007 buyers were overpaying. But people adjusted their psychology to a world in which they owned an extremely valuable asset. In 2008, and now again in 2009, sale prices are coming down to a more sustainable level. Which is creating a foreclosure crisis among a minority of people, people who may be helped by Obama’s plan. But it’s also leaving a much larger set of people feeling poorer than they felt in 2006 and 2007 when their homes were “worth more.” What they really want is the government to come up with a plan that will somehow get them their money back. Make them rich again—as rich as they were in 2006 and 2007. But the problem here is that that wealth never actually existed. There wasn’t enough income in the United States to bid up the value of prices that high. And there’s nothing anyone can do about that.
But this impossible dream of re-inflating the housing bubble and making all the wealth reappear is going to die hard. Clever, but stupid, politicians are going to try to convince people that they have plans to make this happen, and they’ll criticize the Obama administration for not getting the job done. It’s important to understand, however, that we’re not talking about real assets that vanished. The houses are still there, and they’re still as good or bad or useful or non-useful as they ever were. What’s vanished is a speculative mania, and public policy can’t—and shouldn’t—create a new one.
57 Responses to “The Endless Dream of Re-inflating the Bubble”
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February 18th, 2009 at 1:30 pm
But the prices of those tulips was not the result of speculative mania.
February 18th, 2009 at 1:31 pm
The idea that everyone should own a home is as misguided and unattainable, except by mass dumbing down, as the idea that everyone should graduate college.
One is tempted to say high school.
February 18th, 2009 at 1:37 pm
your general point is well-taken, but actually, insofar as “worth” has any meaning at all, houses were “worth” what people paid for them, even in a bubble period.
now, the buyers may have been misguided, or they may have believed in the “bigger fool” theory, or they may have purchased with (since-justified) trepidation, but “worth” is set by the intersection of buyer and seller.
now, the house may not have embodied as much “value” as the price suggested it was “worth,” but that’s a subtly different matter.
February 18th, 2009 at 1:41 pm
Well, Team Obama is setting expectations that this is just about “not making things worse” and “avoiding foreclosure”, which I think at this point a reasonable goal.
Or rather, prices are going to keep dropping for about a year anyway, which is probably fine, but if the spiral were to keep going for another two or three years, then things could be seriously bad.
I have no sense of whether or not $75B is too much, little, or whatever.
February 18th, 2009 at 1:46 pm
Housing prices are either too low or too high. It can’t be both (although it can be different things to different groups of people). In all likelihood, they’re still too high but we’re behaving as if they’re too low.
February 18th, 2009 at 1:52 pm
NB, I just don’t see how this is going to work as intended. Intentionally or not, this will artifically inflate housing prices, which will exacerbate the core problem.
February 18th, 2009 at 1:52 pm
You’re right it might not work, but wrong in why it is being tried.
It is being tried because if the 3m people who just lost their jobs walk out on underwater mortgages they can’t afford…it’s game over. Take your ball and go home-Depression time.
…Then the protectionist forces come in.
…Then the wars start.
We should not doubt the seriousness of this moment.
February 18th, 2009 at 1:54 pm
The people who overpaid at the top of the bubble may take a while before they realize they are screwed, but eventually the psychology will adapt to new conditions. The short-term aim of policymakers is to try to keep the deflation of the real estate bubble from causing more collateral damage than necessary, while the longer-term goal should be to make the housing sector less prone to bubbles, i.e. reduce price increases to something sustainable. (The longest-term goal should be to redensify our cities so we can deal with the end of the oil era.)
The tricky part is keeping the pursuit of the short-term aim from interfering with the longer-term goals.
February 18th, 2009 at 1:57 pm
Alex — A non-rhetorical question for you: what exactly happens if those 3m people walk out? Aren’t they already priced in as worthless? Isn’t that the whole problem with the endless line of derivatives?
February 18th, 2009 at 1:59 pm
Just a question: is money spent on avoiding foreclosures stimulative? And if so, what’s the multiplier here? Similarly, is money spent on the expanded S-CHIP stimulus? If not, how is it different from other healthcare-related funds in the stimulus bill?
I am asking this because sometimes I get the sense that our discussion of the size of the stim bill is too narrow: there are other legislations involving large sums that may have similar effects.
February 18th, 2009 at 2:02 pm
If price rent ratios look like they are going to dip below historical averages, it would probably be worth taking steps to boost house prices. We don’t need bearish speculation making any more banks insolvent. I’d rather my tax money got to the banker via a strapped homeowner rather than have my tax money go directly to a banker and a homeless shelter, while a house sits empty. One way or another, we all know where our money is going. We just don’t know how it will get there.
February 18th, 2009 at 2:04 pm
Surely whoever figured out to price futures (alas, it was the guy behind Long-Term Capital Management in the late nineties, wasn’t it?) can figure out a formula for two-tiered monthly payments for mortgage-payers: the nominal payment, to keep amortizing towards outright ownership according to the provisions of the mortgage (heck, I can figure out that price…it’s what’s in the coupon book, if anyone uses those any more), and the stop-the-clock rental payment, which stops amortization-towards-ownership but keeps you in the house without being designated a delinquent.
February 18th, 2009 at 2:12 pm
Bingo. We hit a foundational issue. The same applies to all assets across all classes. In one way or another every penny of the $9 trillion or whatever it is that has been spent on bailouts or promised in guarantees has been motivated by the desire to bring asset prices back up. It has been a mistake. Period.
February 18th, 2009 at 2:16 pm
This is semi-OT, but it reminds me of an article in the newspaper this morning about how some people are stopping or at least stalling foreclosures by asking the bank to produce the original mortgage, the signed legally binding document outlining what both parties agreed to, and the bank can’t because the mortgage has been bundled and re-sold and stuff. It’s not a panaecea and I’m not a lawyer so what do I know, but it sounds awesome to me.
February 18th, 2009 at 2:20 pm
This is exactly the thing that’s been baffling me from the outset of the Federal rescue and the constant calls from lawmakers to re-inflate housing prices. If the housing bubble is viewed as a sort of accidental ponzi scheme itself, then we can see how absurd this demand really is. Speculative value and real value are not the same thing, and when the speculation is bad, the only way to ever fix the problem is to get back to the real value of things.
February 18th, 2009 at 2:25 pm
But the problem here is that that wealth never actually existed.
No, the main problem is that too many people borrowed the inflated amounts (either to buy or to refi), and now they can’t pay them back due to a variety of circumstances (job loss, divorce, reset of exotic mortgages, etc.). This means foreclosures, which means financial stock declines, which means illiquid credit markets, which means more job losses, which means more foreclosures. And around and around we go.
The issue isn’t that people are upset because their house is worth less now than it was. That’s painful but fixable (mostly by sticking around until the price recovers, or by selling for a loss if you have the equity). The issue is that when people are massively overleveraged on housing, they can’t weather bad life events for as easily or as long.
February 18th, 2009 at 2:29 pm
Great. So we’re bailing out both the banks who sold mortgages to people who couldn’t pay AND the idiot buyers who paid too much for houses they couldn’t afford.
Why are we giving money to the fools who got us into this mess in the first place? Maybe the stimulus dough should be directed towards the people who DON’T have a track record of fucking everything up?
Just a thought.
February 18th, 2009 at 2:43 pm
I simply can’t believe that nobody saw the housing bubble coming. Bankers are not bumpkins. They know most of the value of a “house” is the land and what surrounds it. When the prices of houses are going up sharply and there is no increase in economic activity or wealth in the general vicinity of that house, then something is wrong.
The prices should come down. I think people should get help staying in their homes or a home, but the house prices were hysterical.
February 18th, 2009 at 2:44 pm
Housing prices still have a ways to go before they reach the pre-bubble long-term average.
http://www.econ.yale.edu/~shiller/data/Fig2-1.xls
February 18th, 2009 at 2:44 pm
AND the idiot buyers who paid too much for houses they couldn’t afford.
I think this is precisely the opposite of what the housing bill is intended to do. Buyers who paid too much for houses they couldn’t afford are pretty screwed no matter what. We’re trying to prevent underwater homeowners who can afford the payments but have no incentive to do so from just walking away.
February 18th, 2009 at 2:55 pm
“We’re trying to prevent underwater homeowners who can afford the payments but have no incentive to do so from just walking away.”
Somehow “helping” a homeowner make payments on a $250,000 mortgage for a house that’s now worth $175,000 (and may be worth even less farther down the road) strikes me as a favor to the bank, not the homeowner.
February 18th, 2009 at 3:07 pm
One thing to keep in mind is that there are a lot of houses, whole subdivisions, which could only look appealing in our speculative environment. They could be poorly built, poorly designed, poorly located, and just too bland.
These houses and subdivisions may never find a market for traditional home-buyers, those looking for a long term investment in an attractive home or a nice neighborhood with nice neighbors.
In other words, the housing bubble didn’t just inflate prices, it lead to the construction of “speculative houses” not homes or communities. My guess is that these houses will distort the statistics for the housing market. They will not be able to compete with the real market unless prices for these houses drops very significantly in relation to the real market.
February 18th, 2009 at 3:16 pm
Is there some poll showing that people want the Gov’t to re-inflate housing prices? Yes, people are poorer, like in 2001, but nobody is clamoring for Gov’t to re-inflate Cisco systems. I think people know what is going on. They want the Gov’t to avoid a Depression, not to reinflate housing bubbles.
If someone is at 90% equity, they cannot get a refi right now, even if they can make the payments. This new plan simply allows these types of people to refi. Every foreclosure saved (and only people who can afford their homes can avoid foreclosure), is less inventory for sale. Less inventory is closer to the bottom in prices and a light at the end of the tunnel for this depression.
February 18th, 2009 at 3:30 pm
Your views on this probably depend on whether you have a house or not.
I don’t, so of course I feel we should try out a speculative bubble in a different market.
Somehow “helping” a homeowner make payments on a $250,000 mortgage for a house that’s now worth $175,000 (and may be worth even less farther down the road) strikes me as a favor to the bank, not the homeowner.
Think of it this way, the banks are like the old temperamental Pagan gods. We have to keep giving them offerings and sacrifices until hopefully one of these days they get the credit markets working again.
February 18th, 2009 at 4:07 pm
If someone is at 90% equity, they cannot get a refi right now, even if they can make the payments. This new plan simply allows these types of people to refi.
Why are they entitled to a refi? What’s wrong with holding homeowners to the terms of the contract they signed a only couple of years ago?
February 18th, 2009 at 4:16 pm
Here, here, MY.
February 18th, 2009 at 4:32 pm
Why are they entitled to a refi? What’s wrong with holding homeowners to the terms of the contract they signed a only couple of years ago?
Nobody is entitled to anything. As I understand it, this means that if you are so desperate that you have to go into bankruptcy (which is never a very pleasing option), the court can lower your mortgage payment along with credit cards, etc. You still get knocked back to one vehicle, your credit is still shot to hell, and you won’t be able to get a decent loan for at least 7 years. But you won’t get kicked out of your home, and your neighbors won’t have to deal with having a foreclosed home sitting vacant for months, bringing their home prices down.
February 18th, 2009 at 4:56 pm
Why are they entitled to a refi? What’s wrong with holding homeowners to the terms of the contract they signed a only couple of years ago?
It’s not that they are entitled to a refi. It’s that there is some debt-to-value ratio close to (maybe above) 100% where the homeowner is going to buy a new house at the lower rate and just walk away from the old one. That puts a foreclosed home on the market, which kills property values for everybody in the neighborhood. This way, people who would stay in their current home all things being equal can.
The 105% figure is the key. This tells me that the Obama administration thinks that a nonnegligible percentage of people who bought or cash-out refi’ed (at still affordable levels) in nonbubble markets in the last few years are going to walk unless they can get current rates. If that’s true, they’re right that this is a fixable problem. (Contrast it with the situation in Florida or California, where housing has dropped so much that taking advantage of the lower rates really won’t change the fact that you’re paying a $500k note on a $300k house).
February 18th, 2009 at 5:07 pm
What is the healthy amount of speculation when computers which can’t read the date are allowed to tank the transportation economy.
We need card check so that traders can unionize and prevent being taken over by robots, as a matter of national security.
February 18th, 2009 at 5:09 pm
The best bad way out of the situation is massive amounts of printed up money being put into the hands of the working & middle class though wages (redressing the inbalance between the uberrich & the rest of the country). The resulting inflation would make most of the bad debt (of which mortgages are only a small part) workable again. Of course, there is a chance of the inflation getting out of hand; but it is the least worst path open to us.
February 18th, 2009 at 5:11 pm
I’ve read in a couple places about the government printing a bunch of money. What do you think the risk is of the US entering a period of nasty inflation? I suppose that higher inflation would help restore home prices.
February 18th, 2009 at 5:11 pm
Is there some poll showing that people want the Gov’t to re-inflate housing prices? Yes, people are poorer, like in 2001, but nobody is clamoring for Gov’t to re-inflate Cisco systems. I think people know what is going on. They want the Gov’t to avoid a Depression, not to reinflate housing bubbles.
I see this kind of argument all the time, and it bugs me. No, no one says they want to reinflate a temporary bubble based more on speculation and overextended credit than on actual value. Who would say that? But people like policies that make it easier to own homes, and if those policies work by making it easier to get credit or flip homes, well, who are we to look a gift horse in the mouth? Until bubbles burst, yes, people do indeed like them.
February 18th, 2009 at 5:22 pm
jps:
We need card check so that traders can unionize and prevent being taken over by robots, as a matter of national security.
We need a speculative bubble in Japanese robots.
February 18th, 2009 at 5:41 pm
Re: It is being tried because if the 3m people who just lost their jobs walk out on underwater mortgages they can’t afford…it’s game over.
I’m guessing that a significant fraction of those people are renters. A much smaller fraction may own their homes outright. Others have secondary sources of income (working spouse, second job etc). And of course some with mortgages bought their homes well before the boom and have affordable payments.
Re: What do you think the risk is of the US entering a period of nasty inflation?
As of right now, effectively zero. There a multi-trillion dollar sinkhole in the US economy. Before you can get inflation something has to fill that hole in first.
February 18th, 2009 at 5:56 pm
JonF,
I’m going to have to disagree with you on your inflation prognosis. The government has been spending money like drunken sailors to stabilize this situation (as well as pay for things like Iraq and social services). At some point, WE are going to have to pay for that…especially because other countries (China, Japan, Europe) are not terribly interested in further financing our debt. Thus, the solution is either going to be to tax people more (which probably isn’t a good idea given the circumstances), cut spending (which this government, like every other, is pathologically incapable of doing) or print more money. Out of those three choices, I’m going to bank on a combination of 1 and 3…Which will lead to inflation.
February 18th, 2009 at 5:57 pm
I’m not sure if Obama’s plan here is a good thing.
But if it can stem the tide of foreclosures without partly (and temporarily) reinflating the housing bubble, it’s a lot more useful than msot of the stimulus, and at least it’s attacking the root of our problem.
February 18th, 2009 at 6:08 pm
Glaivester,
Obama’s plan is a terrible one. The FDIC has already been working with banks on loan and payment modifications, and do you know what they discovered?…It didn’t work at all.
The reason for this is enormously simple. For the most part (and this is not true in every case), you’ve got a bunch of completely irresponsible people that entered into contracts far beyond what they could afford (if something like this happened). These efforts do nothing to change the essential reality that these people are not going to change their irresponsible behavior for the five year maximum. Sure, there’s some folks out there that have had some bad luck that one might be able to help…but the majority of these loans that are tanking everything, went to people that never should have received them in the first place.
These guys are grasping for straws. Like the Bush administration, they don’t have a clue…because they’re so beholden to these nutty “progressive” ideas of how to solve this. How have they been working out so far?
If you want to solve it…Remove mark to market and take on some of the debt that these banks hold (TARP I). Don’t worry about foreclosures (the banks will take care of them on a case by case basis as they are recapitalized)…and for God’s sake let these idiots in GM fail.
And please…Spare me the rhetoric on conservatives and lassiez fair, etc…I agree, smarter rules would have made all of this less likely…as would adequate oversight of Fred and Fannie…two institutions that the left ignored since their inception.
February 18th, 2009 at 6:56 pm
ed smithe, if you want the living definition of grasping for straws, i’d say removing mark-to-market is that.
but i actually wanted to note something else: when you see evidence in the marketplace that foreign bankers aren’t interested in financing our debt, then we’ll know they aren’t interested. right now, there is no such sign, and it’s my opinion that there won’t be such a sign because the world has concluded that the US is too big to fail.
now, i could be wrong, and when i’m wrong, we’ll see evidence of it in the market for long government paper, but until then….
which is not to say that i don’t expect inflation: the fed pretty much has acknowledged that, although to get to inflation, the current deflationary environment has to get turned around thanks to stimulus doing something….
February 18th, 2009 at 7:01 pm
Ed Smithe –
I was talking about the tax credit portion of the plan, not the re-writing mortgages portion. My thought is that if Obama isgoing to hand out money, trying to get people to use that money to pay off mortgage debt would be a good thing.
Although I’ll admit that I haven’t researched the details of the tax credit portion.
My preferred policy would be a tax credit going to people who agree to pay interest + a certain percentage of their principle every month, to encourage those who are on the edge between making the payment and not making it.
People who are totally underwater should get foreclosed on, obviously.
February 19th, 2009 at 10:13 am
I have this same thought about the housing bill. Or waste of money in my eyes.
This bill isn’t going to help me after just getting married and having a child and not being able to afford my home because of the economy crashing and being on the edge of losing my home and not trying to screw my credit just to get help.
This just doesn’t help
February 19th, 2009 at 10:16 am
This is as well-said as I’ve heard it said. If one can imagine how preposterous it would have seemed to be debating government plans to re-inflate dot-com stocks in, say, January of 2002, one should be able to see how preposterous some of this discussion is.
February 19th, 2009 at 10:16 am
There is nothing in a mortgage contract that says you cannot pay off early. Sometimes there is a penalty, but it is certainly within the contract.
February 19th, 2009 at 10:39 am
If you look at public policy, there are reasons to believe that even historical housing prices are higher than what they would be in a world without all kinds of policies aimed at keeping them high.
To cite two examples, first the mortgage interest deduction is a fine example of preferential treatment that encourages people to buy more home than they otherwise would. My tax law professor is fond of recalling that in the early 1980s when Reagan proposed eliminating this deduction from the tax code, tens of thousands of calls shut down the White House switch board. The campaign was orchestrated by the Real Estate lobby.
Second, the bankruptcy code since the 1970s has an anti-cramdown provision for primary residences. While the debtor’s plan for most other debt-laden assets can require the creditor to accept the present value (at the time of the bankruptcy petition) of the asset to determine the upper-end of the debtor’s new obligation, for mortgages on primary residences this isn’t permitted. When they made their pitch for preferential treatment in the 1970s, the mortgage industry argued that an cramdown provision would hinder credit in the real estate market.
February 19th, 2009 at 3:27 pm
The problem with the new wave of government interventionism is going to be that governments are always bubble cheerleaders, not bubble-poppers.
What we need are more short sellers. Party poopers. People who make a profit by betting against the hype.
You ain’t ever going to find that in an elected politician.
For obvious reasons.
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