The first reason is the curse of the bubble. A price bubble occurs when the price of some kind of asset goes up for a prolonged period of time based on speculation rather than underlying supply and demand. Price bubbles defy the naysayers by proving them wrong. In the process skeptics are turned into believers and join the stampede. In the process, everyone comes to trust that the bubble asset can never lose value and is inherently safe. ("Safe as houses?")
Bubbles often result from easy credit for the asset in question, or from some kind of government endorsement. For instance, the 1920s stock market bubble resulted from aggressive margin lending by banks. The 1990s bubble resulted in many ways from the rise of 401(k) plans, which gave people a tax incentive to buy stocks.
The housing bubble had both: a reckless and aggressive lending environment, plus countless government programs to encourage homeownership and real-estate development. I will discuss these later. For now, I just want to demonstrate we're dealing with a classic bubble phenomenon.
Just as the bubble drives prices up to utterly "irrational" levels, they then fall to equally irrational levels after it breaks. Just as people are conditioned to buy the bubble asset on dips on the way up, they then learn to sell it on any kind of rally after it's broken. While home prices don't "rally" like stocks, as soon as the market firms up, loads of houses will be listed for sale by people who have been waiting for a better market.
George Packer, a reporter for New Yorker magazine, recently appeared on the radio program On Point to discuss an article he'd written about subdivisions near Tampa, FL:
"The slums of the future are visible in some of the driveways and houses in some of these places...
Lehigh Acres was a very good and successful working class and lower middle class development
So far a handful of cities like New York and Washington have implemented free-market reforms. Because they have lots of kids and lots of schools in one place, it's a perfect environment for competition between schools. Even if it's not the model for the future, cities are going to close the education gap with suburbia, which will attract families and give them fewer reasons to chose a life at the end of a cul-de-sac. This will be a direct threat to the attractiveness and relative value of the suburban life.
Racial exclusion: People in suburbs never liked to admit it, but they benefited from a de facto system of apartheid. Many of them were liberals who supported the Civil Rights Movement. When they sought "a better life" on Long Island or in Westchester in the 1960s or 70s, they implicitly diverted resources and jobs from blacks who had recently migrated to the old industrial centers. The flow of educated white people away from cities channeled more money and purchasing power into suburban real estate. Now that line of distinction is fading as many middle-class families move to cities while suburbs attract more minorities with relatively low levels of education and income. The money is no longer moving in just one direction, which will be a negative for suburban home prices.
Mortgage lending: For years, Washington pushed home loans. The Federal Housing Administation was founded in 1934 to guarantee mortgages, followed by Fannie Mae in 1938. These companies got banks to make 30 year loans, when previously they would only lend for periods of about five years. Their goal was to expand lending, but they were too successful. (The federal government also enforced racial segregation using the FHA until 1968.)
Home loans peaked at a ridiculous level not very long ago. Now much of the U.S. banking system is insolvent as a result and the economy faces what could prove to be something like another Great Depression. The chart above says it all. (It's interesting that by trying to make something like homeownership "normal," the government has destroyed it. There's a lot to think about in that, especially for proponents of nationalized healthcare.)
Crime: As property values fall and homes become empty, crime will inevitably spread. Insurance rates will rise, cars will get broken into and people will move away. This is what happened in countless inner cities across the country, and now it's starting to happen in suburbia.
For decades, the factors above supported the value of suburban real estate relative to urban. Now they're all reversing and cities are going to enjoy a renewal after decades of decline.
Given that suburbia benefited from this systemic pattern for more than 50 years , it's seems reasonable to expect the process to go in reverse for at least 10-20 years.
One more thing: The USA is going to attract fewer immigrants in the future as the economy generates fewer jobs. Population growth will slow, also reducing demand for houses.
As suburban areas and houses decay, they will bring down everyone's net worth and cause large geographical parts of the country to become slums. (Suburbs cover many more square miles than did the old inner cities.)
I see three immediate courses of action the government should pursue to manage this problem:
1-Organize a concerted effort to halt foreclosures. Foreclosures are devastating to home prices. It's a bizarre irony that local authorities are using their own laws to screw over their own citizens and taxpayers. Given that foreclosures are legal proceedings carried out by a local sheriff, I don't see why governors, the Federal Reserve and FDIC can't somehow reach an agreement to stop home seizures. Now that the government is taking ownership of the banks and their vast holdings of "toxic mortgages," does it make any sense to foreclose on anyone? There have been isolated instances of local officials halting foreclosures, so it can be done.
(I see this as a truly exceptional event, and should be done under a program with a clear expiration date. Under "normal" circumstances with a functioning resale market, foreclosures are fine. In a situation like we have now, they hurt borrower and lender alike.)
2-Dismantle houses: Do a national study of the worst-affected areas and hire unemployed construction workers to dismantle entire subdivisions. Leave the roads, sewers and maybe slab foundations. If they could uproot entire neighborhoods to build the Cross Bronx Expressway, they can do it in the suburbs too.
This would help reduce house inventories. More importantly, it would prevent suburbs from turning into dilapidated, crime-ridden slums that will haunt the country for years to come.
It might sound like this isn't a productive use of human labor, but it's common for companis to spend billions of dollars in "restructuring charges" to exit a bad business. Freeing oneself from a debilitating legacy is an investment in the future. The company winds up with lower costs and can focus on more profitable activities. In the long run, it's often a good thing for a company's stock price.
The same logic should apply to fixing housing. If something's a problem that's only going to haunt you, it's best to take your lumps and move on. Otherwise, you live in crisis for years. It's a bit like cutting off an infected limb to prevent dying of blood poisoning. We have seen slums take shape before. It's a process we understand and need to prevent.3-Encourage investors to take over houses. For 70-80 years the government has encouraged home-ownership. That means owner-occupancy.
Generally, when the government wants to "encourage" something, it means the activity in question is economically unfeasible. I say that if homeownership wasn't already a common thing, there was probably a good reason for it. (I think some of that is now becoming obvious. A certain percentage of the population is simply not suited for owning and caring for a structure costing $200-400k, or more.)
We should make a new legal system so that investors can buy houses and convert the current owners into tenants. There could be some kind of rule about allowing the tenant to live their guaranteed for 5-10 years, or perpetuity, etc. The homeowner might lose their downpayment and the bank would probably have to take a haircut, but it would reestablish an economically viable ownership model.
Mickey Levy of Bank of America, cited above, called for a new tax credit for home purchases, saying it will put a floor under home prices. I think this is essentially right in theory, but still misses the point I am making. Many people shouldn't own homes. We need to stop thinking that home ownership is an a priori, unquestioned good thing. People have rented residences for millenia (like in ancient Rome) because it often makes more sense. We need to cast aside the notion that home ownership is always the right thing.
Many aspects of the lending rules and other laws also discriminate against landlords. We need to rethink all of this.
One more idea, which is geared to the financial side: We need to encourage private investors to get back into the market for mortgage-backed securities. I think the government should outline a new series of standards for the bonds and buy them at a certain spreads. This will make private investors more willing to purchase them. There could also be tax benefits to buying distressed assets.
If the government gave people a complete tax holiday for buying these assets, it might seem like a big tax giveaway. (After all, many of these yield 20-30%.) But, they are currently on the books of banks, which are suffering huge losses. Those banks are now costing the taxpayers money already, so they will never pay tax on the income. So, in my view, making them tax-free instruments would cost the government nothing. And, it would help get them off bank balance sheets.