Reality for the individual is an illusion created by the mind in order to enhance the prospects for survival and propagation. Not only the individual, but also the collective mind,creates illusions, and for much the same purpose, except to enhance the survivability of the collective, or state. The Fed is an illusionist for the state. One of its happier illusions, at least at the time, was the one it helped create in the domestic housing market during the mid-2000’s. Apparently, if a speech by its Chairman, Ben Bernanke, to the National Association of Homebuilder’s International Builder’s Show is any indication, the Fed wishes to recreate the illusions of the mid-2000’s such that happiness can again prevail, at least in the housing market, such that the state might therefore survive and thrive. At least Mr. Bernanke can’t be accused of not understanding his audience.
There is a saying in the commodities markets–the cure for high prices is high prices. Applied to the housing market (as if there is such a thing a national “housing market” capable of evaluation–just because the funding comes from the federal government does not mean the housing market is a national creature–alas, a matter for another day), the saying should be turned around: The cure for low prices is low prices. Except. Housing prices are not low, or at least can’t be considered low when, whatever is their level, it is being supported by massive government programs aimed at preventing housing price declines. Vast amounts of capital are about now being allocated (misallocated?) to shoring up housing prices, from direct injections of liquidity into the housing market through Fed purchases of GSE mortgage-backed securities, to foreclosure mitigation programs promulgated by the elected side of the state’s economic overseers. Housing prices have not even declined to decade-ago levels, when they were well into their meteoric and economically unjustified rise, as the following graph clearly shows:
But Mr. Bernanke, the leading economic illusionist, has decided that the tenets of neo-classical economics (that the cure for low prices is low prices) should be ignored in favor of even more active manipulation of the housing market through monetary policy, and other means, in order that it (housing market prices) might cease being such a drag on aggregate economic activity.
Bernanke has rarely so forcefully endorsed specific policy prescriptions as he did in the speech delivered today (February 10, 2012). Even more curious was the neo-Keynesian tilt to the bulk of his proposals. I wonder, have the Republican presidential candidates’ collective pledge to oust Bernanke in 2014 forced him into a Pascal’s wager of sorts? He doesn’t necessarily believe in Keynesianism, i.e. he doesn’t necessarily believe that tinkering with fiscal policy is the best route to economic nirvana, but he knows the guy that will be running against the Republicans seeking to can him does, so has apparently decided he will also believe in Keynesianism, as he’s got nothing to lose in doing so, and possibly everything to gain. If the Republicans win, he gets canned, no matter what. If the incumbent wins, he might keep his job, but perhaps only if he believes in the magic of Keynesian multipliers.
Bernanke made a number of remarkable points in the speech. Allow me to provide a few examples. To begin, he explains that the housing market is vastly oversupplied (itself not remarkable, but where he goes with it is):
For the past few years, the actual and potential supply of single-family homes has greatly exceeded the effective demand. The elevated number of homes that are currently vacant instead of owner occupied reflects the imbalance. According to the most recent estimate, about 1-3/4 million homes are currently unoccupied and for sale. While this figure has declined slightly during the past few years, it is nonetheless up dramatically from the first half of the 2000s, when readings of about 1-1/4 million vacant homes were the norm.
Hmm. According to my econ 101 textbook, if supply far outstrips demand the answer is to decrease supply or increase demand, and the vehicle through which markets accomplish such a feat is the pricing mechanism. Bernanke acknowledges that such an adjustment is underway:
Not surprisingly, the large imbalance of supply and demand has been reflected in a drop in home values of historic proportions. Nationally, house prices have plunged about 30 percent in nominal terms from their peak and nearly 40 percent in real, or inflation-adjusted, terms. The imbalance of supply and demand has also been reflected in the decline in home construction that I mentioned earlier. Since 2009, the pace of single-family housing starts has averaged less than 500,000 units per year. During the 15 years before the financial crisis, the pace of single-family starts had never fallen below 1 million units per year.
But laments that the housing market is just too important to leave to the ordinary workings of the price mechanism:
For instance, consider the effects on neighborhoods and communities. Foreclosures, particularly when they are geographically concentrated, can diminish the values of nearby properties. 3 Many foreclosed homes are neglected or abandoned, as legal proceedings or other factors delay their resale. Deteriorating or vacant properties can, in turn, directly affect the quality of life in a neighborhood, for example, by leading to increases in vandalism or crime. Moreover, the continuing price declines typical in neighborhoods with many foreclosures depress the tax base of the community. A vicious circle can get started: Increasing vacancies together with decreasing tax revenue and consequent cutbacks in services can further depress home prices, putting the goal of neighborhood stabilization even further out of reach.
Not only that, but when housing prices decline, people don’t have as much money to spend, and when people don’t have as much money to spend, they don’t spend as much money, which is inherently and necessarily bad:
For example, by some estimates, declines in house prices have reduced homeowners’ equity by more than 50 percent in the aggregate since the peak of the housing boom, resulting in more than a $7 trillion loss of household wealth.4 Indeed, about 12 million homeowners–more than 1 out of 5 with a mortgage–are underwater, meaning they owe more on their mortgages than their homes are worth. One of the effects of declines in housing wealth is to reduce the ability and willingness of households to spend. While estimates vary, homeowners are believed to spend somewhere between $3 and $5 per year less for every $100 of housing value lost.5 Based on those estimates, it appears that recent declines in housing wealth may be reducing consumer spending between $200 billion and $375 billion per year. That reduction corresponds to lower living standards for many Americans. And, importantly, lower sales of goods and services also reduce the incentives of firms to invest and hire, thereby slowing the recovery. Of course, these consumer-related effects are on top of the direct consequences of low rates of home construction for job creation and income.
As Charles Barkley might say, the supply and demand imbalance in the housing market (incidentally, in large measure created by the Fed), is “turrible, just turrible”. And it seems that no matter how much money is showered on the housing market, transactions are still hard to come by:
The problem of tight mortgage credit will not be solved easily or quickly. The Federal Reserve, in its supervisory capacity, continues to encourage lenders to find ways to maintain prudent lending standards while serving creditworthy borrowers. But the slow recovery of the housing market and the economy, continued uncertainty surrounding the future of the GSEs and the regulatory environment for mortgage lending, the likely continued absence of a private-label market, and more cautious attitudes by lenders are all barriers to rapid normalization of the flow of mortgage credit.
The first-time homebuyer has especially been hard hit, which has possibly prevented some of the salt-of-the-earth American families with kids, from moving on to bigger and better houses as their families grow. Oh, the horror and shame. The republic would surely fail if a point were someday reached when everyone had all the house they needed, and didn’t care to ceaselessly expand their little empires:
First-time homebuyers are typically an important source of incremental housing demand, so their smaller presence in the market affects house prices and construction quite broadly.12 Moreover, the lack of demand from first-time homebuyers may prevent current homeowners from moving up to larger homes, for example, to accommodate growing families.
There is a vast oversupply of housing, which is why homebuilders only built about 500,000 last year. A large contingent of the oversupply is REO’s, i.e., foreclosed properties that are forlorn and empty. So what to do with them, so the housing market, particularly the home building market, might recover? Turn them into rentals! Never mind that doing so would soak up housing demand, making prices wish to further fall. And Bernanke offers that the Fed has even done the quantitative economics proving the owners of these REO’s are foolishly irrational, selling the homes into a bad market, where they could make more money renting. I could not make this up if I tried:
With home prices falling and rents rising, it could make sense in some markets to turn some of the foreclosed homes into rental properties. According to Federal Reserve staff calculations, most REO properties are in neighborhoods with median house values and incomes that are roughly similar to the medians for the metropolitan area overall.15 Moreover, these properties are not unusually far, in terms of commuting times, from where jobs are located.16 We have compared computations of the expected annual cash flows from renting properties to the discounted prices that REO property holders typically receive when selling a home. The comparison suggests that some REO holders might come out ahead by renting, rather than by selling, some of their properties.
And if all that Mr. Bernanke recommends is implemented, working together, we may just be able to create that happy illusion of prosperity we enjoyed just a half decade ago, that now seems like ages:
For these reasons, and because the troubled housing market depresses construction activity and employment, we need to continue to develop and implement policies that will help the housing sector get back on its feet. No single solution will be sufficient. But sustained efforts to address the many interlocking factors holding back the housing market will pay dividends in the long run.
I believe the dividends he refers to are the gains to his employment prospects that adopting an interventionist strategy at goosing housing prices might provide. The cure for low prices remains low prices.