by Calculated Risk on 8/28/2010 06:01:00 PM

From Tom Petruno at the LA Times: Time to let home prices fall?

A few excerpts:

[A] grim reality has set in: Despite the still-rich basket of tax breaks for residential property owners, and the lowest mortgage rates in a generation, the pool of willing or able buyers is dwindling. [CR note: These are the lowest mortgage rates in far more than a generation - these are the lowest since at least the '50s if not even longer. Freddie Mac's surveys only go back to 1971.]
...
Government policy has been aimed at slowing or stopping the decline in prices, for obvious reasons: A further drop in home values would push more owners underwater, meaning their homes would be worth less than their mortgage balance.
...
Dean Baker, co-director of the Center for Economic Policy and Research in Washington, believes home prices still are overvalued by 15% to 20% in many areas.

For government to stand in the way of a further price decline is unfair to the next generation of buyers, he said. "The people who get hurt the most are those who are overpaying for houses today," he said.

Robert Shiller, co-creator of the S&P/Case-Shiller price indexes, said that although he doesn't forecast prices, "I think the scenario of declining home prices for years to come is underemphasized by people."

Supporting house prices has helped the banks, but I think the idea was generally flawed. The key to the housing market is to absorb the excess inventory. That means more households and fewer new housing units. Luckily housing starts are very low right now, but unfortunately there is very little job growth (and therefore little new household formation).

Petruno quotes NAHB economist David Crowe:

Historically, housing has led the way in recoveries. "But this is a case where housing is going to follow the economy, not lead it," [said David Crowe, chief economist for the National Assn. of Home Builders].

This is correct. Usually housing is a key engine of recovery, especially for jobs. But this time housing is going to follow the economy.

That means policy needs to be aimed at making sure that many existing households stay in place (like unemployment benefits, although I'd prefer something along the lines of Minsky's approach) and trying to add new jobs (like infrastructure jobs). More jobs mean more households. More households will absorb the excess inventory. And then eventually housing will recover and help the economy.

Let house prices fall.