Finally somebody has said it like it is - Home Prices in this country are supported by the government and if government were to leave the mortgage market to private enterprise, the availability of credit to buy homes would suffer significantly and thus (like for any other asset) prices would fall in tandem with the adjusting of the credit availability.
This is what Bill Gross said after visiting Washington DC last week:
"The private market was nowhere to be found because they charged too much (during the last 12 months, when gov't has been responsible for 95% of mortgages). It was the cost of private origination and securitisation, perhaps more than any other factor, that justified government involvement. Prime, but non-conforming, mortgages (jumbos, insufficient down payments) were being purchased by PIMCO in the hundreds of millions of dollars every week, but at yields of 6, 7, and 8%. If that was the risk/reward tradeoff, compared to FNMA and FHLMC yields at 3.5–4%, how could policymakers pretend that the housing baton could be quickly and cost-effectively passed back to the private market? Few, if any, could afford a new home at those interest rates. If you were a believer in the dominance and superiority of private markets, how could you deny the signal that markets were sending – that the risk was too high given the substantial losses of recent years?... Americans now know that housing prices don’t always go up, and that they can in fact go down by 30–50% in a few short years. Because of this experience, private mortgage lenders will demand extraordinary down payments, impeccable credit histories, and significantly higher yields than what markets grew used to over the past several decades. Could an unbiased observer truly believe that housing starts of two million or even one million per year could be generated under the wing of the private market? In front of Treasury Secretary Geithner and the assembled audience, I said that was impractical. Let me amend that to “ludicrous.”.... Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending. The cost would be enormous in terms of yields – 300–400 basis points higher than currently offered, crippling any hopes of a housing-led revival to the economy."
I believe the adjustment we just went through is the first phase of what could be another large adjustment if the government decided to get out of mortgages. The adjustment in home prices is a reflection of removing all the loans that should not have existed in the first place: liar loans (no doc), no down payment loans, reverse amortization loans, interest option, among others - these loans were permitting people to buy homes they could not afford and because there was new demand for every particular price point, asset prices went up - we all felt rich, we all spent more, we all got more indebted, ultimately society created this bubble.
The second phase could be equally hurtful or worse - if government stopped guaranteeing mortgages, mortgage rates would go up significantly, and with them, demand for homes at any particular price point would also drop significantly. I don't think government will leave the mortgage market (guarantees, mortgage interest deduction, etc) for this specific reason.... which then leads to another question -> how can we create the right incentives as a society to stop so much investment into dead assets - i.e. homes. Homes don't deliver any economic growth - outside of providing an abode to those that do - at least not in the same fashion as investment in assets that are tied to the production of goods and services. The other negative effect of homeownership - in periods like today - is that it removes flexibility from the labor market. Owning a home does not allow people to move to find work as easily as if they were renting. Obviously owning a home provides many positives for people, famiilies, and society, yet this last argument is purely an economic one.
Going back to the beginning of the article - politics are playing a big part in the public's perception of the economic reality today - are future deficits good or bad? did an increase in government spending do any good for employment and growth? what would tax cuts do relative to spending? etc... and I have seen a lot of people denounce Fannie and Freddie and the government's involvement in the housing industry and a call to allow the private market to run its course... I question if these people are also willing to put the country into another 20-30% adjustment of home prices and the carrying risks to the financial systems that go hand in hand with that.
In the end, at a minimum, we should do everything we can to not allow ourselves to fuel these types of bubbles going forward because as we have seen its almost impossible to get out of them (at least in an optimal fashion).
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