Unclear on the concept: shouldn’t we want LOWER housing prices?

I understand why mortgage-documentation fustercluck could be very bad news for the banks. But can someone explain to me why slowing down the foreclosure process would tend to depress housing prices? It ought to increase them in the short run. Last time I checked, reducing supply tends to increase the market-clearing price, and fewer foreclosures now means fewer properties on the market now.

I’m also obviously unclear on the concept about housing prices overall. Again, I understand why banks and under-water homeowners want prices to go back up. But from a social perspective isn’t it obviously better for housing to be cheaper?

Similarly, I understand why a revival of home construction seems like a good idea to the construction industry, and why people worrying about having adequate demand to return to full employment are hoping for help from that sector. But I can’t see any good reason to want housing to take a larger, rather than a smaller, share of consumption and investment.

The whole notion that it’s “normal” for housing prices to rise faster than inflation or income, and for families to plan their financial futures around capital gains in the housing market, is an artifact of what looks, in retrospect, like a long bubble. If we got back to the house-price-to-income ratios of 1980, that would be fine with me. And I’d hate to see the maintenance of inefficient disequilibrium conditions adopted as goal of public policy.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com

16 thoughts on “Unclear on the concept: shouldn’t we want LOWER housing prices?”

  1. http://www.clevelandfed.org/research/commentary/2

    tl;dr –

    1. the presence of homes awaiting foreclosure can lead buyers to wait, expecting to be able to purchase them at a steep discount when they finally hit the market

    2. homes awaiting foreclosure often are not cared for, since the owners expect to get very little back when the home is finally sold. Having homes in poor condition in a neighborhood makes other homes less desirable

  2. Mark,

    If you really want to be an iconoclast, extend your argument beyond houses. To corporate stocks, for instance.

    Stocks are good things to own, just like houses. For people who don't have any, and want to buy some, lower prices would be a good thing, no?

    I'm not being snarky. Since before the turn of the millennium, I have marveled at the fact that when the price of Diet Coke rises at the supermarket we call it "inflation" and shudder, but when the price of Coca-Cola rises on the NYSE we call it "growth" and rejoice.


  3. I think FuzzyFace gets it.

    Foreclosures are effectively inventory for the time-insensitive, and most home-buyers are time-insensitive. Also, since the number of foreclosures is uncertain, their impact is uncertain–and in the current environment, downside uncertainty will be estimated generously.

    I think that housing taking a larger share of consumption and investment is a concept that needs to be handled carefully, since housing cost can be a substitute for other things like energy consumption. (Insulation, good-quality windows, lead mitigation–all those move costs from another line item to housing, but are almost certainly net lower cost.)

  4. To the extent that the price of a typical house is below its construction cost, you've got a market that's badly out of whack. I've heard builders say that's the case in California, or at least most of it.

  5. I agree with you, but the other side is that if home prices fall, mor homeowners will be deeper underwater, with more incentive to default, hurting banks more. Not that I care.

  6. High home prices are a transfer of wealth from the younger generation to the older generation. As the older generation is more powerful politically, politicians like high home prices.

  7. I think this is simply the product of a favored consituency, i.e. homeowners. I'm sure pretty much every politician in Washington owns a home, and a majority of their voters own homes. So keeping the home price ponzi scheme process going indefinitely is a major goal of politicians. Until, of course, it can't keep going.

    I have no desire to own a home any longer. And I'm sure I'm not the only one.

  8. The mechanism in the housing market that keeps housing prices tied to household incomes and market rents is the integrity of the mortgage underwriting process.

    The Obama Administration, lacking populist and prosecutorial genes, is not going to do anything to restore integrity to the processes of mortgage origination or securitization.

  9. But from a social perspective isn’t it obviously better for housing to be cheaper?

    I think you may be confusing the value of the existing housing stock with the cost of building new houses. It would be good if construction costs were lower, since that would make it easier to expand housing, but I don't see the benefit of a reduction in the prices of existing homes. That's just a transfer from owner to buyer. It doesn't increase the amount available.

    Of course there is interaction between the two. So if construction costs come down – better technology? – then so will the prices of existing homes. OTOH, if the prices of existing homes drop because of foreclosures then it looks like that will discourage new construction, won't it? I tried it with two demand curves and two supply curves and that's what it looked like to me, anyway. An increase in supply of old houses (asking price declines) reduces demand for new ones.

    I could be confused.

  10. The value of existing housing stock contains a significant component, which is land rent. Land rent is a function of transportation infrastructure, zoning, and the like, as well as access to opportunities to earn household income. Increasing rents allocate land to its highest and best uses, so proximity to a significant source of household earning potential will tend to drive up rents, higher land rent will tend to drive up housing density, if infrastructure and planning rules permit it.

    The U.S. experienced a breakdown in its system of mortgage finance, which, where there were significant constraints on land-use, predictably, drove up land rents significantly. The story that says, people lost their minds and could no longer properly value a house or calculate their own household budget, is a distraction, from the lost integrity of the banking system and financial markets.

    It is worth noting that some of the areas hardest hit by the wave of financial fraud did not experience significant housing bubbles: Michigan, Ohio, suburban Atlanta stand out.

    Financial markets provide the information that drives investment. Their loss of integrity was bound to result in significant malinvestment, which included the building of a lot of housing, where it was not particularly needed. Funny how that works.

    The Obama-Geithner Treasury is committed to keeping the fraud, and the fraudsters, in finance. This will not end well. Housing is very cheap in Detroit, though.

  11. It's not just the transition costs of going from high to low after a concerted campaign to get people to have most or all of their saving in the form of real or potential house equity. It's the fact that we're talking about imposing these transaction costs at a time when when we're also talking about destroying the social safety nets that would allow people to survive without those savings.

    Perhaps a good analogy would be the german currency reform of 1948. That worked in significant part because of strong signaling that the national government and the allied powers intended to ensure the welfare of all the citizens affected. Here the powers that be are pretty much signaling the opposite.

    The other argument is the halting foreclosures will make home prices fall because mortgage originators (deprived of their get-out-of-loss-free card) will be unwilling to lend to buyers at current prices. Make up your own punchline.

  12. All of the above are RATIONALIZATIONS. From a pure social policy perspective, you want housing costs to be as low as possible, and the way you get there is by lowering the value of residential property. In economic terms, that creates a consumer surplus that can be spent on other things; in non-economic terms, it lowers the cost of something that eats up the income of low and middle income people, thereby lowering the poverty line, lifting people out of poverty, and increasing disposable income.

    And even if this is thus a transfer between current owners and future owners, the lowering of the prices means that the future owners will be, on balance, less wealthy, so it is a progressive redistribution of wealth.

    However, homeowners vote and won't stand for it.

  13. Dilan,

    From a pure social policy perspective, you want housing costs to be as low as possible, and the way you get there is by lowering the value of residential property.

    I'm having a hard time with this. Making it easier for market prices to adjust to current realities is a good idea, but just saying housing costs should be low obscures a lot, I think. Suppose there had been no crisis, and you had the power to somehow lower all residential property values by 10%. Would you do it? Why would it be a good idea? Would you lower all rents by 10% as well?

    Consider. This likely would reduce new construction, and so the housing stock would expand more slowly than otherwise. Owners whose houses were half paid for would see their equity cut by 20%, for no good reason I can see. This could easily affect a couple's retirement plans, or their ability to meet care expenses as they age. Or suppose you want to downsize from a paid-for $500K house to a $300K condominium to have $200K for some purpose. Suddenly you're going from $450K to $270K instead, leaving you with $180K instead. And those numbers get worse in a hurry if you still owe something on your house. And of course some owners would be put under water by such a reduction.

    I think, as I said above, that it would be good if housing were cheaper in real terms just as it would be good if food, or college tuition, or dry cleaning were cheaper in real terms. But that's only so if you are talking about the marginal cost of extra units. To just reduce the price of existing units does not make sense to me.

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