The Cost of Hitting Bottom

September 18th, 2012 at 11:45 pm

Here’s an interesting oped by a few of my former White House economics colleagues.  They’ve come up with an estimate of how much further home prices would have fallen in the absence of the government’s home loan modification policies.  That, in turn, is basically an estimate of what it would have cost homeowners if we’d kicked back and gone the route of Pontius Pilate/Hayek—i.e., wash your hands of the whole mess and just let the market carve out its own bottom.

According to Shapiro and Noel (kind of a Chanukah/Christmas collaborative there), the problem is that bottom would have been 7-9 percent lower (home prices would have fallen that much further) than the one we seem to have acquired, and they make a solid case that the modification programs have helped, both directly and indirectly, by building the framework from which a bunch of private sector lenders could launch their own mods.

First, about 2.4 million American families received permanent mortgage modifications through either the Home Affordable Mortgage Program (HAMP) or the Federal Housing Administration (FHA). Second, building off of the procedures and standards set by HAMP, the private sector has offered mortgage modifications to an additional 2.9 million families. Third, about 1.7 million families have been able to refinance their mortgages and lower their monthly payments due to government-supported programs through Fannie Mae, Freddie Mac and the FHA. Fourth, Treasury and Federal Reserve interventions to keep interest rates low, and to make mortgage credit more easily available, have allowed an additional 11 million families to refinance.

In sum, out of the 50 million American families with a mortgage, there have been 18 million mortgage modifications and refinancings since President Obama’s housing programs went into effect. All together, these homeowners are saving well over $30 billion per year in mortgage payments.

One reason this is a big deal has to do with spillovers.  When it comes to foreclosures in your neighborhood, ask not for whom the bell tolls, brother (silly housing pun…sorry).  It tolls for others on the block whose home values take a significant hit.  One recent paper found that a one percentage point increase in foreclosures led to about a 1.5 percentage point decrease in housing prices over a two-year period.  

Avoiding such price declines became very important over the past few years, especially in places where the bursting of housing bubble was particularly nasty.

That additional 7-9 percent decline translates into $14,000 in additional lost housing wealth for the typical homeowner and $1 trillion in lost housing wealth in our economy as a whole. In Nevada, the impact would be even more acute. Beyond the severe damage this state’s homeowners have already endured, letting the housing market hit bottom would have caused the typical Nevada homeowner to lose an additional $25,000 in housing wealth.

There’s a broader lesson here.  As these authors stress, policy interventions are not always appropriate, especially when the “correction” can be expected to occur quickly without a lot of collateral damage along the way—a scenario the very clearly does not describe the housing crisis.

So the next time you hear someone going on about how policy measures just make things worse and we should just let the market hit bottom, remember that the bottom they’re talking about could be a lot lower than it needs to be.

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One comment in reply to "The Cost of Hitting Bottom"

  1. rjs says:

    dont housing prices eventually have to find an equilibrium based on the range of incomes among the home buying public?

    we’ve seen several census reports showing the real median income has been going down, its like 8.9% lower than 1999; and there was a Fed report before that which showed household wealth had contracted as well, on the order of 40%..

    i’m all for the mortgage mods, but we’re fooling ourselves to think prices will remain elevated without a corresponding increase in incomes…the only reason home prices are up now is that interest rates are down a percent from a year earlier, allowing a potential 30 year buyer to pay for 13% more principal with the same monthly outlay…

    i know the Fed is going to be highly accommodative for a considerable time, but a considerable time is not forever..