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  • Martin Feldstein's Housing Fix

    Martin Feldstein has a good conversation starter in the New York Times today. While the need to create jobs remains the biggest economic hurdle for policy-makers, the housing crisis is still with us. Consumer spending requires jobs, and strong wage growth, first, of course. But consumer wealth has been tied to housing for a long time in our economy. Housing values will struggle to climb again as long as so many houses remain in foreclosure and/or valued below what people owe on them. To get housing values back up, first we need to stop the bleeding. And Feldstein proposes the following: To halt the fall in house prices, the government should reduce mortgage principal when it exceeds 110 percent of the home value. About 11 million of the nearly 15 million homes that are “underwater” are in this category. If everyone eligible participated, the one-time cost would be under $350 billion. Here’s how such a policy might work: If the bank or other mortgage holder agrees, the value of the mortgage would be reduced to 110 percent of the home value, with the government absorbing half of the cost of the reduction and the bank absorbing the other half. For the millions of underwater mortgages that are held by Fannie Mae and Freddie Mac, the government would just be paying itself. And in exchange for this reduction in principal, the borrower would have to accept that the new mortgage had full recourse — in other words, the government could go after the borrower’s other assets if he defaulted on the home. This would all be voluntary. This plan is fair because both borrowers and creditors would make sacrifices. The bank would accept the cost of the principal write-down because the resulting loan — with its lower loan-to-value ratio and its full recourse feature — would be much less likely to result in default. The borrowers would accept full recourse to get the mortgage reduction. Read How to Stop the Drop in Home Values here .

  • Feldstein: Potential Impact of the Rising Savings Rate

    Twenty-five years ago, American households saved nearly 10% of after tax income, Harvard Economist Martin Feldstein writes over at Project Syndicate . By 2007, the savings rate had plummeted to 2%. And then everything changed. The stock market dropped sharply. Home prices fell 40%, completely wiping out the equity of one-third of all homeowners with mortgages. Household wealth is now $10 trillion dollars less than it was before the recession began. That fall in wealth means that households must save more to prepare for retirement, and that retirees are not able to dissave as much as they did before. Banks and credit-card companies have become much more cautious about extending credit. And, with unemployment stubbornly high, many households are saving in order to have additional cash if they should lose their job or be put on shorter hours. There is no way to predict what the saving rate will do next. Households’ need to rebuild wealth, and the lack of access to credit, implies that the saving rate could continue to rise from the 6.4% recorded in June (the most recent month for which data are available) to the 9% rate that America averaged in the decades before 1985. If that were to happen quickly, total spending could decline, pushing the economy into a double-dip recession. But if households instead become optimistic about the pace of recovery, they might choose to cut back on their saving in order to maintain consumption, despite weak earnings. Only time will tell. Read America's Saving Surprise here .

  • NYT: Forecasting an End of an Era in Housing Investment

    National home sales data will come out tomorrow, and economists are bracing for a big drop in sales from last year. And that may have significant implications on economy overall. It may also signal a shift in long term economic thinking among many families. Over the second half of the Twentieth Century, a lot of Americans built "wealth" through their homes. After the housing bubble burst three years back, and helped drag down the global economy, the days of netting big returns on housing appear to be gone, but for how long? David Streitfeld has a front page article in the New York Times in which he writes that "more than likely, that era is gone for good." And he shares the thoughts of some leading analysts: “There is no iron law that real estate must appreciate,” said Stan Humphries, chief economist for the real estate site Zillow. “All those theories advanced during the boom about why housing is special — that more people are choosing to spend more on housing, that more people are moving to the coasts, that we were running out of usable land — didn’t hold up.” Instead, Mr. Humphries and other economists say, housing values will only keep up with inflation. A home will return the money an owner puts in each month, but will not multiply the investment. Dean Baker, co-director of the Center for Economic and Policy Research, estimates that it will take 20 years to recoup the $6 trillion of housing wealth that has been lost since 2005. After adjusting for inflation, values will never catch up. “People shouldn’t look at a home as a way to make money because it won’t,” Mr. Baker said. Read Housing Fades as a Means to Build Wealth, Analysts Say here . Related Post: Read Richard Green's Is housing the best way for low-income people to build wealth? here .

  • Misreading Home Values

    We humans seem to have a problem understanding value. Last week, Mark Thoma alerted us to a fascinating Scientific American article on how we may want to blame our ventromedial prefrontal cortex (VMPFC) for our inability to battle the "money illusion" that makes us think something is worth more than it really is. And today, economists Hugo Benítez-Silva , Selcuk Eren , Frank Heiland , and Sergi Jiménez-Martín write at Vox that we consistently overestimate the value of our houses by 5 to 10%. And, they write, "Overly optimistic expectations about the evolution of house prices may have planted the seed of the current mortgage crisis in the US." Homeowners, it seems, routinely overestimate the capital gains they expect from sale of their homes, so they report a skewed estimated value. But, the authors found, the problem is much greater if the homeowners purchased their homes during strong economic periods. There appears to be a strong inverse relationship between interest rates and the value estimation: Given the characteristics of our data on house purchases and house sales, we observe properties purchased as early as 1955 until 2000. This information enables us to explore whether the timing of the purchase and the market conditions at that time could have lasting effects on the accuracy of the individual in reporting the value of their homes. We document a strong correlation between the evolution of our accuracy estimates over time and the business cycle. In periods of high interest rates and declining incomes, the buyers are likely to have lower appreciation expectations due to the declining housing prices (see Figures 1 and 2 below), and end up assessing, on average, more accurately the value of their homes, and even in some cases underestimating it. Figure 1 . Interest rates and home sales in the US, 1960-2007 Figure 2 . Home sales and home prices in the US, 1968-2007 Read How well do individuals predict the selling price of their homes? here .