Archive for category housing crisis

The Federal Reserve Weighs in on Housing Policy

Last month, the Federal Reserve released a study, titled “The U.S. Housing Market: Current Conditions and Policy Considerations,” which offers prescriptions on how to cure the housing mess. Given the importance of this issue to the nation’s economic wellbeing—a large portion of our assets are tied up in real estate, and the associated housing-wealth effects are large—I am surprised how little attention the housing market is getting in the Republican debates. Debate sponsors, presumably driven by ratings, seem more interested in Newt’s love life and Mitt’s finances than in economic policy.

The concluding comments of the Fed study are worth repeating here:

The significant tightening in household access to mortgage credit likely reflects not only a correction of the unsound underwriting practices that emerged over the past decade, but also a more substantial shift in lenders’ and the GSEs’ willingness to bear risk. Indeed, if the currently prevailing standards had been in place during the past few decades, a larger portion of the nation’s housing stock probably would have been designed and built for rental, rather than owner occupancy. Thus, the challenge for policymakers is to find ways to help reconcile the existing size and mix of the housing stock and the current environment for housing finance. Fundamentally, such measures involve adapting the existing housing stock to the prevailing tight mortgage lending conditions–for example, devising policies that could help facilitate the conversion of foreclosed properties to rental properties—or supporting a housing finance regime that is less restrictive than today’s, while steering clear of the lax standards that emerged during the last decade. Absent any policies to help bridge this gap, the adjustment process will take longer and incur more deadweight losses, pushing house prices lower and thereby prolonging the downward pressure on the wealth of current homeowners and the resultant drag on the economy at large.

Translation: If we can expedite the transition of our housing stock, we can turn this economy around faster. The study offers several policy prescriptions, including facilitating the conversion of foreclosed properties to rental properties, minimizing unnecessary foreclosures through the use of a broad menu of types of loan modifications, and supporting policies that facilitate deeds-in-lieu of foreclosure or short sales.

On page 14 (of a 26 page report), the study offers yet another approach: land banks, which are described as “public or nonprofit entities created to manage properties that are not dealt with adequately through the private market.” Before the free-market crowd gets worked up, they should recognize that a string of abandoned homes generates a negative externality in a neighborhood, which is precisely the occasion for intervention. Properties acquired by land banks may be rehabilitated as rental units or demolished, as market conditions dictate, which could harness deflationary forces caused by excess supply and neighborhood blight.

My only nit with the section is that the Fed limits the land-bank option to “low-value properties,” which they seem to define as properties below $20,000. This is too timid: If land banks are successful at revitalizing neighborhoods—imagine a park in every neighborhood—then why limit the policy to homes that are effectively worthless? Despite this limitation, the Fed calls for increased funding and technical assistance to existing land banks and for creating a national land bank program.

Kudos to the Fed for taking such a bold stand! If only we could get the debate moderators to ask candidates how to solve the housing mess.

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The Bulldozer Solution to the Housing Crisis

My inaugural blog on two-sided markets did not elicit much reaction from TOTM readers. Perhaps it was too boring. In a desperate attempt to generate a hostile comment from at least one housing advocate, I have decided to advocate bulldozing homes in foreclosure as one (of several) means to relieve the housing crisis. Not with families inside them, of course. In my mind, the central problem of U.S. housing markets is the misallocation of land: Thanks to the housing boom, there are too many houses and not enough greenery. And bulldozers are the fastest way to convert unwanted homes into parks.

(Before the housing advocates lose their cool, an important disclaimer: Every possible effort should be made to keep a family in their homes, including taxpayer-financed principal modifications for deserving, underwater borrowers. My proposal applies only to vacated homes that have completed the foreclosure process.)

Until the Washington Post ran an article last week, titled Banks turn to demolition of foreclosed properties to ease housing-market pressure, I was reluctant to admit my position in public. I had whispered my idea into the ears of several finance professors, but none was willing to stand behind it. And for good reason: How can one advocate bulldozing a home when so many families are losing their homes?

According to the Post, some of the nation’s largest banks have begun giving away abandoned properties to the state and even footing the $7,500 bill per demolition. In 2009, Ohio passed a law creating “land banks” with the power and money to acquire unwanted properties and put them to better use, like community gardens. Similar laws were passed in Georgia, Maryland, and New York. Wells Fargo donated 300 properties nationwide last year, and Fannie Mae donated 30 properties per month to the Cuyahoga (Ohio) land bank. The story even identified a “land bank expert” at Emory University. Now that the Post has given me cover of plausibility, let’s discuss the costs and benefits.

One of the first lessons in an undergraduate microeconomics class is that bulldozing homes to create construction jobs is a bad idea. Even after those new construction workers rebuild the bulldozed homes, society has the same amount of homes as before but lacks whatever output those workers could have created in the alternative. The objective of economic policy is not to maximize jobs—if that were the case, entire cities would be bulldozed and reconstructed—but rather to allocate resources efficiently. Because so many economists have this lesson in mind (and because so many are pacifists), it is hard to embrace any policy that involves a bulldozer.

But this bulldozer scheme is motivated for different reasons. Too much land has been allocated to homes, many of which were built in bubble during the early half of last decade. As a result, too many neighborhoods in America are afflicted with abandoned properties. A vacant house is estimated to be worth half its normal market value. Imagine trying to sell your house at market rates when a close facsimile is available across the street for half the price! To add insult to injury, the excess supply of abandoned houses invites vandalism and neighborhood blight—the textbook negative externality—further depressing home values. Using data from foreclosures in the Cleveland area, Kobie and Lee (2010) show that the length of time that a home is in foreclosure has a significant drag on neighboring home values.

Well-functioning markets tend to equilibrate supply and demand, but housing markets are highly inefficient in this regard because of the time lag between beginning construction and selling a home: A housing boom sends signals to builders that new construction will be profitable. By the time the housing bust comes, the new builds become permanent mistakes.

To illustrate this “market failure,” consider downtown Miami. A drive down Brickell Avenue reminds one of New York City. Whereas there used to be one row of high-rises on the bay-side, the avenue now boasts rows and rows of developments as far as the eye can see. Had the developers known that many of these complexes would stand empty—the Census Bureau estimates that a whopping 18 percent of Florida’s homes stood vacant in March 2011—they would have tempered their enthusiasm. According to the Florida Association of Realtors, the inventory overhang has sent home prices plunging: the median price for homes sold in January 2011 was seven percent less than January 2010, and prices are expected to fall by another five percent in 2011.

And why is this so troubling for the economic recovery? According to the Fed, the nation’s stock of household real estate declined by $6.5 trillion since 2006. A family spends its income based in part on its perceived wealth; when housing values decline, families spend less. Economists call this the “housing-wealth effect.” Case, Quigley and Shiller (2006) found a statistically significant and rather large effect of housing wealth upon household consumption, and weak evidence of a stock market wealth effect.

A robust stock market might offset this decline in wealth (and hence spending), but the Dow hasn’t cracked 13,000 since April 2008. In the meantime, families are hoarding their cash. The $6.5 trillion elimination in household wealth puts the President’s $300 billion jobs-stimulus program in perspective: If the housing-wealth effect is dragging down spending, then a one-time injection of $300 billion dollars won’t have much of an impact. In contrast, a 10 percent increase a housing wealth—housing values are off 30 percent since 2006—would increase consumption between 0.4 and 1.4 percent according to Case, Quigley and Shiller.

When applied to vacated homes that have completed the foreclosure process, the bulldozer scheme would eliminate some of the excess supply of housing, which would temper the downward pressure on home values. In the place of a cluster of abandoned homes sucking the life of a neighborhood, imagine a children’s park, a dog park, or a community garden. Now that the banks have figured out bulldozing can be cheaper than maintaining the properties, paying taxes, and marketing the properties, the only thing stopping this idea from gaining traction is public sentiment.

My lunch crowd, comprised of economists, retort that the elimination of excess housing supply via bulldozers might be a boon to existing homeowners but would punish future homeowners. But wouldn’t a future homeowner prefer to invest in a slightly more expensive asset class with expected growth over a less expensive asset class with negative expected growth for the foreseeable future?

Finally, the bulldozing scheme need not be mutually exclusive with other schemes to relieve the housing crisis. Other ideas are worth trying, even if they wouldn’t spur much economic activity. Some are calling on Congress to eliminate the barriers keeping underwater homeowners from refinancing their mortgages. According to Macroeconomic Advisers, such a plan might boost GDP growth by 0.1 to 0.2 percentage points, as it merely redistributes money from lenders to borrowers. Others have called for massive debt forgiveness, achieved via a federal program to purchase troubled mortgages and give homeowners better rates. As Ezra Klein of the Post points out, however, the politics of using taxpayer dollars to pay off mortgages are impossible to crack. To stabilize the housing market, Larry Summers calls on government sponsored enterprises to finance mass sales of foreclosed properties to those prepared to rent them out, and to drop their posture of opposition to experimentation for programs such as principal reductions.

Whichever course we take, speed is of the essence: The housing drag is not going away on its own. According to RealtyTrac, the nation’s banks, along with Fannie Mae and Freddie Mac, have an inventory of more than 816,000 foreclosed properties, with an additional 800,000 working their way through the foreclosure process. Insisting that each of those homes be paired with a family—a noble cause—is tantamount to pushing off recovery for several more years.

I modestly propose to remove a fraction of these homes from inventory. If you don’t like the ring of a bulldozer scheme, how about “The Neighborhood Parks” scheme? Even if I can’t convince any economists to get on board, environmentalists should be pleased.

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