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Thursday, February 19, 2009

Stabilization through Government Interference = Pseudo Price Controls and Market Disequilibrium

Everyone agrees that the housing bubble bursting lead directly to the current crisis. There is, however, a lot of disagreement about how it happened and furthermore what to do about it. The current policy contends that real estate must be stabilized at all costs because as long as real estate continues to fall the economy will continue to crumble. That school of thought will be put into practice and we can all pray and hope that it will be proven correct.

Yet, there is another school of thought that will be around only in theory. It is a school of thought that I belong to and while I hope I am wrong, it would also mean leaving all basic economic principles behind. The reason that real estate continues to fall is three fold. First, it went up far too fast and far too much. It needs to fall because it is overvalued. Second, mortgage guidelines have changed and fewere people are eligible to buy. Third, the boom created a significant group of borrowers that had no business being in property and until they are removed there is no price stabilization.

I am from the school of thought that real estate will only stabilize once we find equilibrium with these three significant factors. Furthermore, I am from the school of thought that believes that no amount of government intervention to stabilize the housing market will actually stabilize it until these three factors are dealt with by the market itself. In fact, all government intervention does is prolong the real estate decline and contribute to pseudo price controls and market disequilibrium.

To put it simply, real estate prices are falling because there are more sellers than buyers. Simple supply and demand theory tells everyone that prices will continue to fall until there buyers and sellers are equal. The government can do all sorts of things to artificially create some sort of stability in real estate. They can drive down mortgage rates in order attract more buyers. They can also create all sorts of dramatic programs that will keep at risk borrowers in their homes rather than having them get foreclosed.

Now, all of these actions will have some stabilizing effect but it is unlikely that they will stabilize, and whatever the effect it will be temporary. Sure, the government can drive down rates and bring new borrowers into the market. Yet, in the long term, such schemes are inflationary and ultimately they will drive up rates in the long term. Whatever short term stabilizing effect it will have ultimately, rates will return up and probably even higher, and so, in the long term, there will still be fewer buyer than sellers.

As for saving troubled borrowers, this is even more devastating. All of these borrowers will likely never again qualify for a mortgage on the open market. As such, unless the government is prepared to give these folks mortgages for life, they will at some point need to be removed from the market. As such, all of thes measures will only stabilize the market until the sell. Yet, in the meantime, they will continue to contribute to a disequilibrium in the market. They shouldn't have been in the real estate market to begin with. Their continued presence in real estate only creates a disequilibrium between supply and demand. The sooner they are removed the sooner we reach equilibrium. The only way to remove them is to remove them from the mortgages they can't afford. Giving them mortgages they can afford, but don't deserve, only keeps them in homes the market long ago determined they shouldn't have. Once they start selling, we will again see a decline in real estate because they aren't going to buy, but rent. As such, all this government intervention only perpetuates the lack of stability in real estate.

1 comment:

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