Ryan Avent of The Economist gets it right (h/t to Mark Thoma)

He writes:

"...it's simply not true that the administration has rolled out every programme it can think of. Economists with which administration officials are very familiar have proposed measures to deal with the real problem in housing markets: negative equity. Promising policies like mortgage cramdowns and own-to-rent programmes have yet to get a serious look from Washington leaders. But ultimately, a real fix for housing markets must address underwater mortgages. Absent some attempt to deal with negative equity, a rush of buyers into the market will accomplish little; the problem is that underwater homeowners can't afford to sell at prevailing prices. Driving those prices lower won't change that fact.

The truth is that the trouble in housing is not, for the most part, a demand-side issue. The problem is the millions of homeowners stuck in houses they can't afford to sell. These households represent a significant shadow supply of foreclosures-in-waiting. I agree that it would be silly for the administration to try to support housing prices by offering more goodies to potential homebuyers. But it doesn't follow that letting prices go their own way will magically get housing markets moving again."

John Quigley, Alan Blinder (and I for that matter) have been advocating something like a Home Owners Loan Corporation, and/or a debt equity swap for underwater mortgages for some time. We also need to deal with second liens--investors in such liens are holding up renegotiated mortgages because they will get wiped out--which is of course what is supposed to happen when one interest is subordinate to another.

(Thanks to Jim for filling me in on who RA is).

A downpayment factoid

Canada allows 95 percent LTV loans. Borrowers must get mortgage insurance, either from the government or the private sector, if the LTV exceeds 80 percent. Yet 90 day delinquencies there remain under 50 basis points. All home lenders in Canada are subject to strong regulatory oversight.

My favorite Art Goldberger quote

I saw a paper today on heritability and savings. It made me think of my econometrics teacher, Art Goldberger, who once wrote:

Professor Hans Eysenck was so moved by the twin study that he immedi- ately announced to Hodgkinson that it "really tells the [Royal] Commis- sion [on the Distribution of Income and Wealth] that they might as well pack up" (The Times, 13 May 1977). (A powerful intellect was at work. In the same vein, if it were shown that a large proportion of the variance in eyesight were due to genetic causes, then the Royal Commission on the Distribution of Eyeglasses might as well pack up. And if it were shown that most of the variation in rainfall is due to natural causes, then the Royal Commission on the Distribution of Umbrellas could pack up too.)

From "Heritability," Economica, 1979, 46, 327-47.

Do low rates make house prices more volatile?

Over at the FT blog, Cardiff Garcia has a nice summary of three papers that attempt to explain the run-up in house prices before 2007. It particularly approves of the work of my friend and co-author Susan Wachter and Andrew Levitan, who argue that a supply-side credit bubble produced the housing bubble.

As I read the piece, though, I couldn't help but think that while it is unlikely that low interest rates would explain prices, they might explain volatility. When nominal interest rates are low, a small change in price expectations can lead to a large change in prices.

Consider the Gordon Growth model, where Value = dividend/(i-g), where in this case the dividend is the value of living in a house, i is the interest rate and g is the expected growth rate of the dividend. Let everything be real (i.e., not nominal) Consider two worlds: 2 percent real interest rate world and a 4 percent world. Now let expectations about growth vary from negative one percent to positive one percent. In the two percent world, the upside scenario produces three times the value of the downside scenario. In the four percent world, the upside produces 67 percent greater value than the downside. Hence small changes in expectations have a much larger impact in a low interest rate environment than a high interest rate environment. It may be hard to pick this up because expectations are so difficult to measure.

Just a thought.