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Housing Market Damaged by Ongoing Governmental Interventions

Posted by Steve Markowitz on February 9, 2012

Federal and state officials today announced a $26 billion settlement with five of the country’s largest home finance providers.  The settlement relates to problems with home foreclosures that have been referred to as “robosigning.”  As part of the settlement, the government indicated there will be relief offered about 5% of the homeowners underwater who owe more on the mortgages than the homes are currently worth.

In announcing the settlement, government officials bragged about its benefits that include punishment for the lenders and benefits for homeowners hurt by the housing market downturn.  Both benefits are dubious at best.  First, the penalties to be paid by the banks will be charged to their shareholders, not the employees responsible for the problematic actions.  In addition, those who had their houses repossessed inappropriately will get about $2,000, a very minor benefit. In addition, any benefits underwater homeowners receive in refinancing houses will only be an artificial incentive to stay in the dwellings whose value will fall further hurting their savings long into the future.  Such homeowners would be better served giving these houses back to the banks and forcing them to eat the losses. This would be appropriate punishment two banks who made inappropriate loans in the first place.  This is the type of punishment free markets are supposed to and out, not those dictated by government

The settlement is yet another supposedly plan by the government to help revive the housing market.  Like the previous programs, this intervention will increase the length of the housing downturn.  Inherent in any governmental economic intervention is the belief that bureaucrats and politicians understand the many complex interactions of a dynamic economy better than the free market.  It also demands belief in a “free lunch” whereas the government actions will only have positive effects.  Neither axiom is correct.

The housing downturn is going into its fourth year and is at the heart of the worldwide recession caused by the financial meltdown in 2008.  Before attempting corrective steps, governments must have an understanding of how the economy got into this morbid state.

Economic cycles affecting the housing market have occurred throughout history.  However, the current downturn is the worst in since the Great Depression of the 1930s.  As this Blog has proffered previously, the United States government shares culpability in this downturn and its extent.

In the 1934 the US government began intervening in the housing market with the creation of the Federal Housing Authority (FHA).  The FHA became a backstop for mortgages in order to lower the cost of borrowing and promote homeownership.  The government’s policy of promoting homeownership created the mistaken belief by consumers that home prices always increase making them good investments.  However, home prices increase only as long as demand outpaces supply (basic Econ 101).  An oversupply decreases prices, as occurred in 2007 that occurred because of changing demographics and other governmental interventions.

Fast forward a few decades.  Progressives pushed the FHA’s charter even further.  In 1977 Congress passed the Community Reinvestment Act promoting homeownership to lower income levels, i.e. people who could not afford the mortgages.  In the 1990’s Congress pressured Fannie Mae and Freddie Mac to offer loans to even higher risk buyers to promote more housing.  These interventions increased more demand for housing inflating home prices.

Adding to the housing bubble creation, former Fed Chairman Alan Greenspan and later President George W. Bush pushed interest rates artificially low each time the economy hiccupped.  It also further breached the moral hazard by seemingly indicating that the government through low interest rates can and will resolve any future market disruptions.  The rest is history, as they say.

Remarkably, with the repeated failures of governmental market interventions, the government has doubled down on this same bet with more interventions.  The negative consequences include a lengthening of the housing downturn and more problems to come.

Since his election, President Obama and other Progressive politicians have offered various programs to “fix” America’s housing downturn.  They all failed because they stopped the markets from correcting the imbalances in supply and demand.  Had these interventions not occurred, while initially housing problems would have been greater, it is likely that we would now be in recovery instead of the ongoing housing downturn.  At the appropriate prices as determined by the markets, investors would be buying houses for ownership and four income properties and prices would be on the rise.  This self-correcting process will not even begin until a bottom in the housing market is reached, something that cannot occur until the government gets out of the way.

The low interest rate policies inflicted on economy by the Federal Reserve’s (Fed) will have even more negative consequences.  This policy is flawed on many levels starting with the mistaken belief that the heart of the lengthy economic downturn is a problem of liquidity.  In fact, the problem is one of solvency and cheap money cannot resolve this issue.

Given the complexity of our economy it is not possible to accurately predict the negative consequences that will occur due to the low interest rate policies of the Fed.  However, we can expect more and larger bubbles as investors attempt to improve their returns during a time when they should focus on asset preservation.

Also, it is likely that the Fed’s low interest rate policy will prolong and deepen the housing downturn, inflicting long-term problems on an important part of the American economy.  Not only are current homebuyers obtaining mortgages at historically low rates, but so too are those refinancing existing mortgages.  It does not take a great imagination to understand that when mortgage rates ultimately jump back up from rates of about 3.5% to the historic norm of about 7.5%, , the cost of buying a home with a new mortgage will increase significantly.  This will reduce future housing sales as well as construction of new homes leading to a long-term and ongoing downturn in the housing market.

The law of supply and demand is infallible in the long term.  Progressives have spent trillions and offered massive failed interventions to again prove this reality.  Until governments stop the interventions and get out of the way, the economy cannot begin real recovery.

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