Why Are U.S. Home Sales Plummeting? Huge Waves of Foreclosures Coming down the Pike

Housing-Market / US Housing Aug 27, 2010 - 12:00 PM
By: Washingtons_Blog

The government opted to try to prop up prices. Indeed, as I have repeatedly pointed out, the government's entire strategy has been to try to artificially prop up the prices of all types of assets.

For example, I noted in March:

The leading monetary economist told the Wall Street Journal that this was not a liquidity crisis, but an insolvency crisis. She said that Bernanke is fighting the last war, and is taking the wrong approach. Nobel economist Paul Krugman and leading economist James Galbraith agree. They say that the government's attempts to prop up the price of toxic assets no one wants is not helpful.

The Bank for International Settlements – often described as a central bank for central banks (BIS) – slammed the easy credit policy of the Fed and other central banks, the failure to regulate the shadow banking system, "the use of gimmicks and palliatives", and said that anything other than (1) letting asset prices fall to their true market value, (2) increasing savings rates, and (3) forcing companies to write off bad debts "will only make things worse".

David Rosenberg [former chief economist for Merrill Lynch] writes:

Our advice to the Obama team would be to create and nurture a fiscal backdrop that tackles this jobs crisis with some permanent solutions rather than recurring populist short-term fiscal goodies that are only inducing households to add to their burdensome debt loads with no long-term multiplier impacts. The problem is not that we have an insufficient number of vehicles on the road or homes on the market; the problem is that we have insufficient labour demand.

Indeed, as I pointed out in April, unemployment is so bad that 1.2 million households have "disappeared", as people move out of their own houses and move in with friends or family.

BIS wrote in 2007:

Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand. If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off.

I pointed out in March 2009:

Paul Krugman wrote a couple of weeks ago:

The truth is that the Bernanke-Geithner plan — the plan the administration keeps floating, in slightly different versions — isn’t going to fly ....

Why won't it fly?

One reason is that economic psychologists tells us that consumer psychology has shifted for many years to come, and Americans are hunkering down and not buying anything other than the bare necessities. The Fed can try to play the part of all of the actors in the economy, but it won't work.

Today, Edward Harrison's must-read post explains provides additional reasons why the Geithner-Summers-Bernanke plan to prop up asset prices cannot succeed (if you don't read the whole post, at least read the following excerpts):

The U.S. government's efforts point in [only one direction]:

Increase asset prices. If the assets on the balance sheets of banks are falling, then why not buy them at higher prices and stop the bloodletting? This is the purpose of the TALF, Obama's mortgage relief program and the original purpose of the TARP.

There is only one direction the government is headed: increase asset prices (or, at least keep them from falling). Read White House Economic Advisor Larry Summers' recent prepared remarks to see what I mean. (Summers on How to Deal With a ‘Rarer Kind of Recession’ - WSJ) ....

These plans are not going to work

As aggressive as this campaign by the U.S. government is, it will have limited effectiveness because the extent of the writedowns of assets already on the books is going to be too massive. ...

And Ryan Grim reported in April 2009:

Critics of Geithner, including Nobel Prize winning economist Paul Krugman, insist that the real problem is an asset collapse that led to a crisis of solvency in the banking system. In other words, Krugman argues that home values have come back to Earth, while Geithner hopes to solve the problem by pushing home values back to where they were. The conflict is a serious one because it dictates what response is appropriate.

At a closed-door meeting with House Democrats on Monday night, according two members of Congress who were in the meeting, Geithner repeated that he believed the problem with the financial system was a lack of liquidity and that if he could get credit flowing again, the problem would right itself. Key to this analysis is the question of whether one thinks the rise of housing prices was an artificial bubble or if the collapse is reversible and we can return to those highs. Policymakers have resisted labeling it as a bubble. [head of the president's Council of Economic Advisers Christina] Romer, on Monday, came close, referring to a "run-up in housing prices that sure looks like a bubble."...

If the crisis is understood as one of liquidity, then the appropriate response is to continue injecting capital into the banking system and fiscal stimulus into the general economy until asset prices return toward previous highs. Japanese policymakers initially understood their crisis to be one of liquidity and injected hundreds of billions during the 1990s, to little effect. But if the problem is something different -- a solvency crisis brought on by essentially permanent asset-price declines -- then the policy response needed is different.

So were housing prices in a bubble or not? And - if so - have housing prices now come back to earth?

Well, as liberal PhD economist Dean Baker points out:

Real [i.e. inflation-adjusted] house prices are still 15-20 percent above long-term trend.

In other words, housing was in a bubble, and still has a ways to go before it is back to normal.

As the Wall Street Journal wrote in January:

Housing economist Dean Baker, the co-director of the Center for Economic and Policy Research, laid out his case at a risk conference last week for why we still have a housing bubble. Adjusted for inflation, home prices are still 15-20% higher than they were in the mid-1990s. “There’s no plausible fundamental explanation for that,â€