Home Prices Should Not Go Up

The collapse of home prices in the United States is a major cause of the financial sector's current woes and the severe economic decline we are currently suffering. I do not dispute that. But I do dispute the notion that using government money to attempt to stabilize or increase home prices is the correct policy response.

Home prices declined because they were far too high to begin with. They got so high because fancy mortgage products enabled people to buy homes that were more expensive than they could actually afford. And people bought homes that were more expensive than they could afford because they assumed (wrongly) that they could refinance on more advantageous terms sometime later or sell the house at a price higher than they paid for it. The government exacerbated the bubble by encouraging the GSE's (Fannie Mae and Freddie Mac) to subsidize the mortgage market, thus making it easier to borrow money for a home purchase.

There are many reasons why government policies designed to prop up home prices are a bad idea. The first one is that low home prices are a great thing. Like milk, gas, and healthcare, housing is something everyone needs. The lower it costs, the better. It is pretty straightforward to understand why the approximately 1/3 of Americans who do not own homes would benefit from lower housing prices. Of course, many Americans own their homes. And they seem to want their homes to be worth more money. But if you think about it, the vast majority of homeowners do not realize any benefits when home prices rise. Higher home prices mostly make people feel wealthier; owning a more expensive house does not result in more money in someone's bank account unless she is willing to sell that house and begin renting or buy a smaller house. Most homeowners, however, aspire to live in their homes for a long time or to move up to a bigger and better house when they can afford to do so.

The government has enacted many policies designed to make home ownership more affordable: tax credits for first-time home buyers; an aggressive policy of printing money to buy mortgage-backed securities from financial firms designed to drive down mortgage rates; and propping up Fannie Mae and Freddie Mac to make it easier for Americans to obtain mortgages. These policies may make homes more affordable for people in the near term. But they also create more demand for housing and result in higher home prices: people are willing to pay more for houses because interest payments on their mortgages are lower and they can receive tax incentives for buying.

Unless the government is going to continue to plow money into the housing industry forever, these policies are creating future problems. If the government cuts these subsidies, housing prices could fall, perhaps drastically. Because current policy encourages people to buy homes today at artificially high prices, we might have a whole new wave of people who owe more on their mortgages than their houses will be worth in the future. This might create yet another economic crisis. And it would ensnare a whole new group of homeowners who managed to escape the current crisis and are fortunate enough to be able to buy a new home today.

Another unfortunate consequence of policies that prop up home prices is that they result in resources being diverted from more economically productive industries toward home construction. Building bigger and better homes is nice. But it does not result in a more productive economy. (It does lead us to consume more energy, however). By increasing the demand for homes - and the resources that go into home construction - we take resources from other industries that create economic progress and make America more competitive.

The dangers of a housing bubble are clearer than ever. The United States needs to stop feeding a new one and let housing prices decline to a natural equilibrium. Although this may upset some banks and those homeowners who are planning to sell, it will benefit the broader economy by reducing the risk of a future housing collapse and increasing our economy's productivity.

TARP Repayment: Good News, But Banks Still Have Government Money

Today the Treasury announced that 10 large banks would be allowed to repay funds they received under the T.A.R.P. program. This is good news for the American taxpayer. However, it hardly signals some sort of "all clear" for these institutions. Banks that repay T.A.R.P. money are not necessarily operating without massive amounts of government financial assistance. Remember that the T.A.R.P. represents only a fraction of total government support to the financial sector. The Federal Reserve, through a variety of other bailout programs, has lent billions of dollars to Wall Street. Perhaps this has received less attention because reporting on it is so difficult: the Fed refuses to disclose who it has loaned to and on what terms. Meanwhile, the F.D.I.C (and ultimately the taxpayer) continues to guarantee billions of dollars of debt issued by some of the very same banks that have repaid T.A.R.P. funds.

If every single bank were to repay every dollar ever lent through T.A.R.P., Wall St. would still have lots of government money. And the government would still be on the hook for massive amounts of bank liabilities if some of these institutions ever become insolvent in the future. It remains unclear when and how the Fed and the F.D.I.C. will untangle themselves from these arrangements.