July 2, 2012

Housing, the American Dream, and the Economy

In order to induce them to buy, play the American Dream, and contribute retirals monies for the old, prices of homes, and the quantum of debt they have to take to buy them, need to be in line with the incomes of young people.
My latest column on Nolanchart is about the fundamentals that made the First World Economies (Click on the image to navigate to that article)

Out of all the broken threads - affordable education, buyable housing, and ratio of well earning young people to retiress - Housing is the one that is, by far, the most difficult problem to solve even on paper. Yet it is most intimately connected with engaging the young in the pursuit of the Dream.
In order to induce them to buy, play the American Dream, and contribute retirals monies for the old, prices of homes need to be in line with the incomes of young people, so they are not overwhelmed by the mountain of debt that they would undertake to buy the home.
Yet, if home prices are allowed to correct, many more people will come underwater, and might dump their homes - because their buying, at the price level they bought at, was informed by speculation that they will make a gain on their home, that it will not depreciate like a car.

This author is of the reckoning that the Home Prices issue needs to be tackled in two parts:

Underwater Homeowners

There needs to be a scheme for underwater homeowners to do a virtual foreclose and buy back1 their homes, without loss of credit rating, with a fresh, modest downpayment (say, 10% of new assessed price each) contributed by the buyer and the adjusting bank.
The bank and the homeowner work out and agree upon the new market price for the house. The owner puts in 10% of the new price and the bank foregoes another 10%. So now, the loan outstanding on the buyer stands effectively reset at 80% of the new market price. This is a workable scheme provided the buyer can show ability to pay the new fixed monthly mortgage.

Homeowners To Be

As we noted, the prices of homes need to be allowed to correct to come in line with the incomes the young are making. The current, crazy high prices imply that the down payments will take many years to save up. In the bubble days, there were zero-down sort of schemes that exist no more. Now, one has to pay 20% of the value of the house assessed by the bank, which could be 10% lower than what the buyer is purchasing it for! So, the guy has to pay out of pocket 10% of the purchase + 20% of 90% = 28% of a price too high as down payment. Surely, a non starter. When it was zero down, that was another matter.
But there's more to worry about for a young homeowner to be than just downpayment.

After making payments for 5 years or 10 or 15, if a home buyer defaults on his payments due to financial difficulties, and the price of the home is below his loan outstanding at that point, he basically loses the house altogether. THAT is a great disincentive to buy, especailly if the price is too high.

Without the hypnosis unto a housing bubble, or blind faith in it's forever uptrend, better home ownership schemes2 need to be devised.


Housing is a critical sector, and the bedrock, of the American Economy. But it does not imply that the salvation of the latter lies in the former's inflation - that model failed. I believe, at this point, the opposite is true - that is, Salvation of the American Economy lies, among other things, in a managed deflation of housing prices. Else, the American Dream will lose it's appeal to the young, that actually it is the continued engagement of the young in the American Dream that is the true bedrock of the American Economic model.

There are no easy, or pareto-optimal!, solutions. But, as I draw in 1 and 2 together: It IS possible to allow home prices to correct while arresting any precipitous price fall by clearing inventory via innovative home ownership schemes, and also practically adjust for a few more existing homeowners slipping underwater.

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