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Looking at Responses to the Failure of Administration Housing Policy

The response to Binyamin Applebaum’s front-pager on Administration housing policy, which left out the part where the Obama Administration purposefully did as little as possible out of an oversized concern for bank balance sheets, elicited several notable responses.

Ezra Klein basically bought the argument that this was a policy failing on the part of the Administration, but that housing policy is difficult and would have created a wave of strategic defaults that “would lead to government expenditures far larger than most taxpayers would accept.” The government spent several trillion dollars to protect zombie banks, so I’m not sure why I should trust an argument based on a public threshold for distaste. Furthermore, once more with feeling, strategic default doesn’t happen. It hasn’t happened in meaningful numbers from any policy during the housing crisis, despite the opportunities. Anecdotally, people don’t want to risk their house by trying to game the government or their servicer.

As for the idea that “the politics of housing are hideous,” the Rick Santelli argument for policy inaction, a policymaker should ask themselves what is more corrosive to their position in leadership – a policy that dramatically lowers unemployment that people grumble about, or a policy that doesn’t generate the same grumbling, but leads to a lost decade of slow growth? Economic determinists would certainly choose the former and suffer those slings and arrows.

Dean Baker, by contrast, takes up a separate argument, saying that the numbers don’t show that reducing mortgage debt would be a major palliative for the economy.

Suppose we had instantly written off all underwater mortgages, would that have kept construction going? That’s hard to see, since the enormous oversupply of homes would still be there.

Would that have sustained house prices? It’s hard to see how or why, the problem is that the bubble had raised prices far above any level that could be justified by the fundamentals of the housing market. House prices today are pretty much in line with their long-term trend as we can see from the real Case-Shiller house prices index.

If house prices are basically right, why should we expect more consumption than we are now seeing. In fact, consumption remains unusually high, not low, relative to disposable income as shown below. (Adjusted disposable income has to do with the statistical discrepancy for those nerds out there.)

If consumption isn’t low, then what is the story of how rescuing underwater homeowners would have saved the economy? There are some economists who argue that the consumption of underwater homeowners has a hugely disproportionate impact on the economy. That seems a bit hard to imagine.

Baker backs up that last point with some numbers. And Matt Yglesias takes Baker’s side. But I have to say that Baker appears to be taking an extremely narrow view of the crisis, and ignores the downside risk. It’s fine for him to say that the current circumstances don’t indicate that a housing construction boom would result from canceling mortgage debt. I don’t agree; the low rate of household formation necessitated by housing woes is an indicator here, and if that reverses then there’s a supply shortage. But this is an example of the dismissal of the costs of foreclosures to communities. I’ve seen them estimated at $250,000 per foreclosure. We’ve had close to 4 million, depending on the numbers you believe. That’s $1 trillion in losses to the economy. Seems to me that would make a difference. This manifests itself in all sorts of ways, from real estate-related employment, the ability of individuals to retire or move for a job (housing lock creates serious employment-related problems on the margins), blight from home vacancies, etc.

And I’m pretty sure that Baker knows all about neighborhood stabilization as a key economic priority. He’s been touting “right to rent” since the beginning of the foreclosure crisis! These are the specific reasons he gives for right to rent:

This would accomplish several important goals. First and foremost it would instantly give homeowners facing foreclosure a substantial degree of housing security. If they had kids in school, the rental period would likely be long enough to let them finish. It would also give them some time to get on their feet financially and make arrangements for appropriate housing.

Second, it would prevent a blight of foreclosures from ruining whole neighborhoods. Renters who effectively have long-term leases have almost as much incentive to maintain the property as owners. At the least they would keep homes occupied so that they would not be eyesores and possible havens for crime.

Third, this right would give banks more incentive to find ways to modify mortgages to keep people in their homes as owners. Banks would generally prefer having a foreclosed house free and clear rather than being a landlord for 5 years. By making the foreclosure option less attractive, Right to Rent would make banks more willing to consider alternatives.

I don’t think we’re saying anything different, then. Neighborhood stabilization, preventing blight, housing security, etc. are crucial economic priorities, the lack of which creates severe economic problems. Why, then, the resistance to reduction in mortgage debt – the end for which “right to rent” is the means, in Baker’s telling!

Finally, you have the effect of resetting the housing market on the financial industry. This would have the effect of either resetting the bank balance sheets to the degree that they would have certainty about the ability to lend, or would force some of them to go out of business, and healthy banks could actually take their place. In my view, either of these would be beneficial for the economy.

I know that Baker has a resistance to the balance sheet-recession theory of the economy. He believes that the housing bubble popping caused a giant demand gap, and that government should fill it with spending. Reducing mortgage debt is a kind of spending. But he refuses to acknowledge the knock-on effects in one context while highlighting them in another.

UPDATE: Just to be clear, it is possible to say, as Dean is, that policies to help struggling homeowners would be desirable without it being enough from a macro-economic standpoint to boost the recovery. But I’m saying that Dean is ignoring the factors that would make helping homeowners a bigger win from a macro standpoint, factors he details pretty definitively when he’s arguing in favor of his own right to rent policy.

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David Dayen

David Dayen