Propping Up Housing Prices Would Be A Disaster

There is a disturbing chorus of otherwise reputable individuals calling for government intervention in housing prices. This drum beat is concerning as these arguments are based on mistaken conclusions about current home prices and ignore the consequences of such government intervention.

This growing list of individuals includes Columbia's Glenn Hubbard and Chris Mayer, the New York Times' Joe Nocera and David Leonhardt, Yale's John Geanakoplos, Investment Banker Daniel Alpert and a laundry list of economically challenged politicians.

These people have come to recognize that falling housing prices are causing our economic turmoil. Unfortunately their conclusion ignores the reality that housing prices are wildly overvalued based on post-bubble fundamentals. Recent price declines have not reversed the unsustainable gains that occurred from 1996 to 2006. No amount of government intervention can prop up housing prices given the dramatic change in value determining market forces. Even worse, government initiatives which slow price declines or impede the market clearing function will extend the length of our economic downturn and deepen its impact.

How is it that we as a society understand that it is a bad idea to prop up internet stock prices but a good one to attempt to fix prices on housing? How is it that we understand that government can not control prices for gold, oil, a gallon of gas, corn, bread, art, stocks and currencies yet we believe that we can prop up housing prices regardless of supply, demand, mortgage terms, available credit, consumer confidence, perceived risk and expectations?

Recent proposals have called on government to provide "financial incentives to renters to buy homes". This is the scenario which created the Housing Bubble in the 1990s. Widespread proliferation of subprime, 100% LTV and Teaser mortgages caused this mess precisely by encouraging renters to become highly leveraged owners.

I have posted my responses to both Dean Hubbard's propsal (WSJ 10/2/08) and Joe Nocera's article (NYT 10/18/08). Should you have the time and inclination you may find them interesting.