David Leonhardt has an interesting column in the NYT discussing ideas for bailing out homeowners. He could have gone much further in his analysis if he asked what bailing out homeowners means. As everyone should know now, the basic problem is that tens of millions of people (urged on by bankers, financial advisers, economists, and politicians) bought homes at bubble inflated prices. The bubble is now bursting so tens of millions of people now live in homes that are worth substantially less than what they paid, and in most of these cases, much less than what they owe on their home. In this context, "bailing out homeowners" can have three obvious meanings: 1) It can mean protecting homeowners and banks from the loss they incurred from the fall in their home's value; 2) It can mean protecting them as homeowners, by allowing them to get mortgage terms that allow them to stay in their homes; or 3) It can mean allowing them to stay in their homes as tenants, if they can't afford a mortgage workout at the current price. It would be difficult to argue on either moral or economic grounds for the first type of bailout. Homeowners would not share any capital gains on their homes with the general public, nor would the banks share their profits. It is difficult to see why the taxpayers should be asked to pick up their losses. Some prominent economists, like Alan Blinder (who is mentioned by Leonhardt) have argued for some sort of house price support program, which presumably would be comparable to a farm price support program, to try to keep house prices at bubble-inflated levels. However, such plans make much less sense economically than farm price support programs. (Blinder also called Alan Greenspan the greatest central banker of all-time back in 2005.) Hopefully, this sort of bailout for homeowners will not go far. 2) The second type of bailout focuses on workout arrangements that allow homeowners to stay in their home as homeowners. This approach centers on forcing the banks to eat most or all of the price decline associated with the bursting of the bubble. If the homeowner really can't absorb the loss, which will be true in many cases, then banks will have little alternative to eating the loss. Even if they foreclose, the bank will not be able to resell the home at a bubble-inflated price. In many cases, a workout involving a write down to current value will be the best route for the bank as well. While the government can encourage such workouts, there is an inherent problem that if it makes workouts too easy, then people who can afford to eat some of the loss opt to instead pass the losses onto the banks. This becomes a concern for the public, and not just the banks, if the government then has to cough up money to keep the banks alive, as is the case at present. 3) The third type of bailout keeps people in their homes as tenants, but allows the bank to take ownership of the house. This bailout has the benefit of providing housing security to homeowners without giving them any real windfall. In other words, they have no real reason to lie about their economic condition to benefit from it. After all, they will still end up losing ownership of their home. (Actually, rather than become landlords, many banks may opt to do workouts, if throwing homeowners out on the street is not an option.) This is also by far the most simple route to deal with administratively, since it can be put in place by just changing the foreclosure laws. It requires no new bureaucracy and no taxpayer dollars. The biggest obstacle is that the same financial advisers, economists, and politicians who blindly pushed homeownership even in the middle of a housing bubble still can't think about renting as a serious housing option. One point on which it should be possible to agree is that we should want the bubble to deflate as quickly as possible. While many economists have hugely exaggerated the problem caused by deflation (who cares if prices are rising 0.5 percent a year or falling 0.5 percent a year?), there is a real problem associated with falling house prices. Declining house prices mean that the people who buy homes in the current market will see a loss on their home. If they can't absorb this loss, then the bank that makes the loan (or whoever holds it) will absorb the loss. Rather than a program of house price supports, the country would be best served by a crash the bubble policy. The big problem in this story is that the folks who somehow could not see the largest housing bubble in the history of the world are still running economic policy. Unlike custodians and dishwashers, economists are not held accountable for their job performance. For this reason, we should expect many tough times ahead.
--Dean Baker
