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Univ. of Kentucky College of Law

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Sunday, September 5, 2010

What, If Anything, Do We Do Now?

Home values continue to drop.  The market for existing stock is at a standstill, and tens of thousands of new foreclosures have yet to enter it anyway.  More and more homeowners -- including boringly responsible ones, like yours truly -- find themselves underwater, owing more on their mortgage loans than the house is worth. Homebuilders?  With no homes to build, they're unemployed.  Between the unemployed and the underwater, there's no one to buy homes even at current prices.

The Obama administration didn't create this disaster, it inherited it from the economic anti-Midas that was the Bush admninistration.  But the Obama administration has been unable to repair it.  The home-buyer tax credit that expired months ago had no long-term positive impact.  It was supposed provide enough stimulus so that, combined with other parts of the stimulus package, the economy would grow, making further market stimulus unnecessary.   It didn't work, and there's no reason to think another tax credit is (a) possible, given the enormous budget deficit, or (b) advisable, since the last one didn't work anyway.

George with raven

So now what, if anything, do we do?  That's the question posed by this article in the New York Times.   The simplest, most painful, most politically deadly, and most advisable thing to do may be this: nothing.  Theoretically, eventually the market has to bottom out: eventually prices have to hit a point so low that people begin buying.

But, and this a HUGE but: as home values continue to fall, more and more homeowners will be underwater.  More and more are likely to default, unless they ignore their own economic self-interest. 

Let's say some hypothetical homeowner's -- let's call him, say, Mark Edwards -- home is worth $100K less than he paid for it 3 years ago  Now he could buy a very similar house next door for $100K less than he owes on this one.  His child is approaching college age, and he needs to find a way to pay for tuition.  So: does he (a) continue to make payments on a house that's worth much less than he's paying for it, and tell his child he can't afford to pay her tuition, or (b) default, buy the house next door, and send his child to college?  

If you think that many people would choose (b), then consider the consequence of doing nothing to try to stop the fall in home values: more defaults and foreclosures, and therefore more discounted housing stock entering the market, driving home values down further.  The spiral will get worse -- possibly much worse.  In fact, three years later, Edwards might be motivated to default on the house next door, too (maybe even to buy back the first house at less than he paid for the second). 

So, yes, eventually home values will hit bottom, but bottom is a long, long way down, and getting there will be more than just painful; it will require a fundamental readjustment in our economic expectations.  And God help any politician who proposes THAT. So if we can't face the pain of doing nothing, then we have to try to do something.  But what?  And at what cost? 

Mark A. Edwards

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