Harvard economics professor Martin Feldstein, who made himself famous by predicting in 1993 that Clinton tax increases would not raise any revenue, strikes out big time in his proposal for the housing market in Thursday’s NYT. He tells readers:
1) House prices are continuing to fall because of the wave of foreclosures;
2) Consumers are not spending because they are losing housing wealth;
3) A major reason unemployment is high is that underwater homeowners can’t move to places with jobs;
In response, he proposes a plan that could bail out banks from underwater mortgages while leaving millions of homeowners as near indentured servants.
Let’s deal with each of these points in turn.
First, house prices are falling for the same reason that the price of Pets.com stock plummeted in 2000. The housing bubble has not fully deflated. If Feldstein bothered to check the data he would know that real house prices are still about 8-10 percent above their long-term trend. Consistent with over-valued prices we see that there is still a near record vacancy rate in housing (topped only by the levels hit in 2010).
In other words, the main reason for house prices to decline is simply excess supply. There are certainly areas where foreclosures have blighted communities and thereby caused prices to fall further, but this is not the main story of house price decline.
Second, consumers actually are still spending at an above normal rate. The savings rate out of disposable income is still just 5 percent. This is above the near zero rate at the peak of the housing bubble, but it is well below the 8 percent average of the pre-bubble years. It is strange that Mr. Feldstein appears to be unaware of the lower than normal savings rate (and higher than normal consumption), since he has done a great deal of work on precisely this topic, and his original claim to fame was a paper showing that Social Security lowers household savings.
We should actually anticipate that savings will increase further when the bubble has fully deflated, and according to Feldstein’s past writings, this would be a good thing. It is striking that he now seems to view saving as bad.
Feldstein’s third claim is simply not supporting by any evidence. There have been several studies that examined the extent to which being being underwater has prevented job losers from moving to new jobs (including one study by John Schmitt and Kris Warner). They all have found little or no effect. People are prepared to leave their homes, or two-earner couples separate so that one earner can move to a job. This is simply not a major cause of unemployment.
So Feldstein has no real basis for his claims about the disastrous impact that the housing market is having on the economy. However, his policy solution is a disaster. He proposes to have the government pick up half of the loss on seriously underwater mortgages. In exchange, if the homeowner consents, the lender can track them to the ends of the earth for their remaining debt.
There are two really really big problems with the Feldstein plan. First, it is completely voluntary for lenders. This means that they will not take up the deal with people whom they think are likely candidates to repay their mortgage. There are many underwater homeowners who are struggling to pay their bills. Feldstein’s plan offers them nothing. The bank knows that they will pay, so they will not put their mortgage in the program.
However, there will be more questionable loans that will go into the program. Some of these people may be able to make their payments after the principal write-down. They will then get to live in their home until they move and in all probability never accumulate a dime in equity (but the bank got half of its loss picked up by the government).
Others will take the deal and then find themselves still unable to pay their mortgage — remember we still have 9.1 percent unemployment and most people in Washington don’t seem to give a damn. Under the Feldstein plan the debt will now become a recourse loan, which means that the bank can hound foreclosed homeowners until the day they die for any portion of the mortgage that is not repaid by the sale of the house.
So there you have it, a solution for a non-problem that gives banks tens of billions of dollars for bad mortgages and makes foreclosed homeowners debtors for life. What could be better than that?