Housing Stimulus Fails

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On Tuesday, Case-Shiller released their monthly housing price index. Surprise, it fell by 4.2% in the first quarter of 2011. I’ve been predicting a decline of about 6% over the course of 2011 (might need to adjust that).  Of course, this should come as no surprise. We’ve spent the last couple of years trying to re-create the bubble, with little success.

While there’s been a home-buyer tax credit, the largest stimulus has been extremely cheap credit on the part of the Federal Reserve. The problem with all these subsidies is they ignore the fact that eventually the housing market will come back to fundamentals. And those fundamentals are demographics and income. You cannot over long periods of time sustain house price increases without increases in incomes. Loose credit only gets you so far. Prices have already fallen enough to pretty much wipe out the entire value of the home-buyer tax credit.

Even worse than putting off the inevitable correction, subsidies that maintain prices above construction costs result in additional supply being added to an already glutted market.  While housing starts are near historic lows – they are still positive.  And worse, they are higher in the very markets in which we don’t want more building.  That permitting activity is twice as high in Phoenix as in San Diego, despite being of similar size, illustrates the perverse incentives of trying to re-inflate the bubble via demand subsides.  In supply-constrained markets you simply maintain prices at unaffordable levels – San Diego is still 54% above its 2000 price level – while in easy-to-build markets you add to the glut – prices in Phoenix are now back to 2000 levels. 

House prices were always going to find their “true” bottom. The question was simply: did we want to get there right away, or drag out the process? Washington chose the course of dragging out the process, at considerable cost.  I believe dragging out the process has only further spooked potential buyers.  Any buyer today has to suspect that further price declines are possible.  We need to get to the point where the only direction is up.  We aren’t there yet.  Policymakers continue to ignore the basics of supply and demand.  Unfortunately the rest of us pay the price for their doing so.

See this Cato essay for more on the problems with the federal government meddling in housing finance.