Housing Prices: Let the Market Crash?

[This is the third (and final) installment in my series on housing prices. You can read the first two here and here].

In the last couple weeks, the NY Times published two provocative – and seemingly contradictory – articles about possible prescriptions for the weak housing market. The first one lent support for the view that the government should simply allow the housing market to crash, while the second one proposed for the government to prop up the market by buying up all the currently performing, non-prime mortgage debt. The articles created an online firestorm, with virtually every media outlet weighing in.  The consensus is that at this point, the government should just let the housing market alone.

Based on available data and current trends, the government’s complete exit from the housing market (no more tax credits, loan modifications, Fed-engineered low interest rates, support for Fannie/Freddie, subsidized FHA loans, moratorium on foreclosures, etc.) would spur a drop in housing prices. As hard as it is to believe and in spite of the double-digit declines that we have already seen, there is apparently still room for prices to fall. While the Billions of Dollars already injected into housing undoubtedly succeeded in stabilizing the market, it only forestalled the inevitable. As any free-market economist will tell you, you can’t fool the markets.

There are strong arguments to be made for both sides of the debate. On the one hand, the benefits of leaving the market alone are manifold and obvious. Prices would be able to fall (and eventually, rise) based on actual supply and demand factors. As long as government support remains in place, this will be impossible. In addition, while government programs have been effective, they shouldn’t be seen as more than a stopgap measure which means that continuing to throw money at the market can only ever serve short-term objectives. Not to mention that these programs are very expensive and only make it more difficult for the government to achieve a balanced budget. Finally, continued support for the market unfairly prioritizes current homeowners, at the expense of (potential) future homeowners that are locked out of the market because of prices that are perceived as being too high.

On the other hand, stability in the housing market is a desirable outcome. While the merits of boosting the stock market are somewhat abstract, boosting the housing market should yield tangible results. For example, more people can stay in their homes and/or have additional cash for non-housing expenditures. I think we can all agree that an explosion in foreclosures (that might result from the government pulling the plug) is not justifiable on the grounds that it will make housing prices cheaper for future buyers. Proponents also argue that given the weak economy, now is not the time for austerity measures. Maybe after the economy recovers, the government can withdraw, but not now.

Personally, I’m in favor of a gradual withdrawal. I think the government has done all that it can to support the market, and given the limited tools available, it has done a satisfactory job. At this point, however, there really isn’t much to be gained from continuing to throw money at what has become a lost cause. If housing prices are indeed destined to fall, then eventually they will fall. In this context, the government can only delay the reckoning. Given that politicians have constituents to appease, however, it’s hard to say whether they will acquiesce to this inevitability.