The Housing Mess

That the real estate market played a key role in bringing about the current economic mess is accepted as fact now. What remains to be decided is what should be done about it. The Obama administration recently proposed a program that would help home owners bring their payments into the range of what is considered a sustainable level, that is 30% of household income spent on either rent or PITI (principal, interest, taxes and insurance). The Republican “plan” so far is to stop the fall in home prices with incentives, such as the $8,000 tax credit for first time homebuyers in the stimulus bill. There seems to be little debate though that the housing market is not working and needs to be kick started. Perhaps there should be.

It should not be a surprise that housing prices rose rapidly in the last decade. What I find so discouraging is that policy discussions appear to focus on keeping housing prices at the bubble levels. Is that a bit nuts? It can’t just be me. The problem with trying to fix the economy by “stabilizing” housing prices is that the approach cannot address the fundamental problems that exist in the economy. If falling housing prices is a symptom of the economic turmoil then stopping that slide is not going to “fix” the economy. If the fall in housing prices is indeed a cause of the wider problem then they are falling because of natural economic forces and attempts to stop the slide will merely be delaying actions.

I would argue that it’s a mix. The rise in housing prices should be viewed as a consequence of the cheap credit and ensuing loose lending policies that affected other markets as well, such as hedge fund acquisitions. The fall in housing prices that we are seeing now is likely a return to what would have been market prices had the bubble not occurred. The real hitch is that credit markets seem to have over shot in their effort to move to safer practices. It seems clear to me that the real problems are in the credit market and they always were. The best policy should be targeted at the banks that are in real trouble.

Examining U.S. median home price data as well as median income data from over the last 30 or so years reveals a troubling trend. From the first quarter of 1985 through the first quarter of 2006 (the peak of the bubble) the real (adjusted for inflation) median home price in the U.S. rose 95.82%. That is the median house price nearly doubled in that 31 year stretch from $134,213 to $262,816. That is not so troubling if incomes are rising at a similar pace, but over roughly the same span (1984-2006) real median income rose a grand total of $6,206. Household income, after adjusting for inflation, grew 14.8% over 32 years from $41,817 to $48,023, actually peaking in 1999. It doesn’t take an advanced degree in… well… anything to realize that that trend is not sustainable. It’s clear that housing prices needed to fall, why didn’t any of the traders in mortgage backed securities figure that out sooner? More importantly, why are the President, Congress and the media ignoring it now? It’s happening and it’s going to continue happening.