The Daily Caller

The Daily Caller

Housing problem was the bubble, not the bust

Photo of Mark Calabria
Mark Calabria
Director of Financial Regulation Studies, Cato Institute

As sales of new homes reach historic lows, there are increasingly strident calls for Washington to do something. These demands for action, however, fail to recognize that it was government, mostly Washington, which got us into this mess in the first place. Decades of subsidies for the housing industry have resulted in booms and busts that have repeatedly undermined the strength of our financial institutions while leaving the nation with a massive inventory of vacant homes.

The rental vacancy rate is just shy of 11 percent, while owner vacancy rate is approaching 3 percent, both close to double their historic average. In a nation of about 130 million homes, we have almost 19 million that are vacant. Almost 7 million of these are being “held off the market’ awaiting better market conditions. Seven million is close to annual record for combined new and existing home sales. It should be painfully clear that our housing markets are facing a problem of way too much housing. Any increase in new housing starts should be a signal for tears, not optimism.

Basic economics teaches that holding prices above their market levels will decrease the quantity sold. The low homes sales numbers are the direct result of continued government efforts to boost prices. In addition to creating a wedge between supply and demand, housing stimulus efforts have created an expectation that prices will fall once these efforts are curtailed. Who would want to buy into a falling market?

With almost 2 million of the over 7 million job losses during this recession coming from the construction industry, Washington has latched onto believing that getting construction going will reduce unemployment. This is the rationale for infrastructure spending and incentives for homebuying, as well as Federal Reserve policies to prop up the mortgage market.

It is also the absolute wrong policy for job creation. Rather than encouraging the unemployed to go back into unsustainable sectors of the economy, such as construction, we should be creating and encouraging flexible labor markets that allow the private sector to create sustainable, non-bubble, job growth.

The housing market is especially sensitive to interest rate changes. The lower rates go, the more prices can be bid up while keep monthly payments constant. In addition, lower interest rates encourage builders to extend the construction process, building ever larger and luxurious homes. For this reason, at the center of almost every housing bubble you can find a central bank. The Federal Reserve’s extremely loose policies earlier this decade resulted in a massive reallocation of resources from the rest of the economy into housing. With the help of Fannie Mae and Freddie Mac, foreign governments were also able to funnel their savings into the U.S. housing market. Once it became clear that production was being driven by speculation, rather than fundamentals, the bubble burst.

Ultimately home sales, and hence, home construction, will be determined by family incomes and basic demographics, such as population growth. Neither the level of subsidies or aggressive monetary policies will change that fundamental relationship. America’s cycle of housing booms and busts is the result of government pretending these fundamentals don’t matter. Every decade or so we are painfully reminded they do.

Washington must stop and re-learn basic economics. First, when you’re in a hole, stop digging. In the case of housing, as a country, we built too much. The cure is to build less. Second recognize that for markets to clear, for supply to equal demand, prices must be allowed to adjust, or in the case of housing, fall. The solution is to get our government out of the housing markets; only then do we have any chance of achieving economic stability and avoiding financial crises.

Mark A. Calabria is director of financial regulation studies at the Cato Institute in Washington, D.C.

  • qofdisks

    It wasn’t Government per se that caused this disaster. It was the lack of Government REGULATION restricting WALL STREET greed that has caused this disaster. What would be called for is MORE Government regulation and restriction of finance.

    • logic

      It is government regulation that greatly contributes to the problem. Regulations sound good until you find out they are not enforced for lack of resources, because the politicians have been bribed, or because the bureaucracy is so thick it is tripping over itself. Look no further than the Toyota/NHTSA scandal brewing now or the cozy relationship between the US Treasury, Federal Reserve and big banks. Regulations also add extra cost for companies. They pay to comply with regulations and that expense gets passed on to their customers. The free market is the only true and reliable regulator. It’s easy to pile on the big bad companies (that’s what the government wants you to do) but it is the corrupt relationship with the government that is the problem.

    • sawdustking

      The reason for the mess (as I touched upon in my earlier post) was that during the 90s the interest rates were too high, discouraging home buying (building) and creating a shortage. I built a house in 1998(?) for a banker who informed me that it would be a long time before we saw mortgages as low as 6.5% again. They haven’t been that high since. In the 2000s the interest rates were much lower and a wave of building ensued until there was an oversupply. During the wave of building, mortgage backed securities became popular since housing prices were rising so fast that there was no way you’d lose money (a theory that proved to be wrong). When the bubble popped the whole house of cards came tumbling down. Regulation had nothing to do with it, it was the Fed’s monetary policy.

      Now they need to keep rates down to encourage economic growth, including home building, but all the spending runs counter to low interest rates. As government debt rises the rates go up, stifling the recovery.

  • clairesolt

    Current admin housing policy is not what it seems. O’Reilly and Juan Williams keep saying the gov can’t take your house, but the gov is accumulating mortgages in losing ventures like Fannie Mae. There is also the Resko factor. Slumlords like Valerie Jarret push weatherization or rehab of substandard city housing where we pay $2,000 per window. Also, while the administration denounces fat cat bankers who won’t loan, they are borrowing $200B amonthfrom Wall street leaving littlemoney for anyone else.

    Imagine how different a free market would be. We would tear down the roach motels and build new.

  • sawdustking

    The foreclosure crisis has obviously left a large glut of houses on the market for the time being. However this glut is driven by household incomes (and availability of mortgages) not population growth. In the last decade a little over 15 million homes were built (including multifamily units). In the 1990s, 12.5 million homes were built while the number of households increased by 13.6 million (according to the US Census Bureau). If another 13.6 million households (probably more) were added in the 2000s that would only leave about 600,000 new homes to replace old homes over the course of 2 decades.

    Judging by this I would say that the glut has already been worked through and we may soon be facing a shortage of homes as pertaining to population. We are currently producing 1 million fewer homes each year than what our population growth would dictate and many of the skilled tradesmen that leave the industry won’t be coming back. Eventually the people who lost their jobs and had their homes foreclosed will find new jobs and move out of their relatives’ homes. The longer this process takes the more severe the coming shortage will be.

    There is one thing I wish the government would do to alleviate this situation. STOP THE SPENDING! Every penny the government borrows has to come from somewhere. Whether it’s foreign or domestic someone has to buy the US bond and if they didn’t buy the bond they would have invested it elsewhere. Why buy a risky mortgage backed security when you can have the security of a government bond? The stimulus has probably cost 2 or 3 jobs for every one it has created. Banks are now overly picky about their lending. And soon the massive debt will bring higher interest rates, so we will all end up paying too much for smaller homes which is all we will be able to afford with mortgage rates at 9 or 10%.

    • qofdisks

      Government spending is serving the purpose of filling a huge deficit of DEMAND in the economy. Given that fact that this nation has been wealth stripped by Wall Street and all the big investments are going to other countries and wages have been depressed for 30 years, there not enough money for people to buy. Government spending is trying to jump start business, but we have to ensure that our money goes to local businesses that hire here.

      • sawdustking

        The most American made product you can buy is a new home. If you have the means now is the time. Low prices, 5% mortgages, and once the unemployment rate drops, big gains in value.

  • lamecherry

    And the biggest problem is the real estate pimps who have jacked up prices all across America and are the one’s demanding that this unsustainable inflationary price is what people across America are supposed to pay for homes not worth $50,000.

    It was not that long ago that in numerous parts of America that one could find in the older burbs, homes which went for $12,000 at starting prices. Those homes now are in the ridiculous $70,000 range and real estate taxes are shooting through the roof impoverishing people.

    All of this false projection and market hoarding.

    I tried to tell John McCain’s people that a survival shelter grant to homeowners would have been a bubble fix, to get the economy going in all homeowners would be provided a $30,000 grant to build a disaster shelter and stock it. That would have added home value, provided good jobs and spread out into the American manufacturing sector in food to appliances.
    This would have cost less than Obama’s plan and would have moved things to a recovery by now. It was not the end fix, but a jump start as oil production would have followed to balance the budget and I advocated a national high speed rail which would have combined all the major industries in creating this.
    Added to McCain’s or Dick Cheney’s all of the above in hundreds of nuclear electric plants going up on a decade schedule, America would have had good jobs, a sustained recovery and free from the terror oil wars along with Chicom debt.

    All of this could have been fixed, but it was not meant to by Pelosi and Obama in their managed crisis.

    It is a sad thing in this world when NeoProgs are ruining the American dream for thee Obama nightmare.

  • logic

    I always suspect that our “leaders” do what they are doing on purpose, but sometimes wonder if they really even have a clue about free market principles. We may be so used to government intervention and manipulation in the market that people in general, and surely our elected officials, have forgotten or ignore that there is an option of nonintervention. This “we have to DO SOMETHING” mentality is crushing our way of life as it destroys the economy left, right and sideways. Let the market correct itself, then let it regulate itself. It works.

  • mordechai

    In addition, the moment the banks know that Big Brother is not going to bail them out, the faster they will renegotiate longer term loans, so they will get their money and people will keep their homes.

    • qofdisks

      What indication is there that the government would not bail them our again? As far as I can tell it is back to business as usual on Wall Street as congress as failed to pass any significant regulation over finance and trade.