Wednesday, August 29, 2007

Deflating the Housing Bubble

Now that the air has gone out of the too-cheap credit that helped inflate the housing bubble, the question becomes how to undo the bubble with as little damage as possible.

When the internet bubble popped, this happened fairly rapidly: failed dot-coms closed down, their investors took a beating, and their employees moved onto other jobs, some of them still internet related but at better firms. Some went back to grad school. The end result was that the economy overall was fine, people who had invested in internet firms lost money, and the internet overall continued to grow apace, but now focused on better companies.

I think one inevitable requirement of unwinding the housing bubble market is that housing prices have to come down to fall in line with historic trends. In some areas this means very dramatic decreases -- maybe 40%+ in real terms? I'm not sure what a "deflated housing bubble" would look like if it did not bring prices back to historic norms. We are not going to see price declines of this magnitude unless we have very very motivated sellers, which means banks for older properties (which have been foreclosed on), and builders for newer properties. If prices do not fall, then transactions will dry up. I can see the government stepping in and helping owners (and their lenders) but I'd be surprised if builders will be helped that much. This means that areas that have had the most new construction should see the most dramatic price corrections.

I would add that I'm not a fan of Freddie or Fannie stepping into the jumbo loan market. We've seen what happens when subsidized lending fuels real estate acquisition, and I thought we'd all decided we want less of that. Also, if Freddie and Fannie do step in, all the lower rates will do is enrich current homeowners (and Freddie and Fannie) at the expense of current renters by further driving up (or supporting) the price of real estate. I see no reason why those who did worst in the housing bubble should be punished further.


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