Sunday, June 29, 2008

Economics and the Regulation of the Housing Market

One of the more difficult aspects of understanding economics is the fact that in many cases it takes a long time for the full affects of economic policies to work themselves through the economy. As a consequence of this it can be difficult for people to identify cause and effect.

This allows those responsible for the economic policies to avoid blame because what they started…and continued…began a long time ago and it is difficult for people to specifically identify these policy makers as the culprits for what is currently taking place. In my estimation, one has to go back six or seven years to find the beginnings of the monetary and fiscal policies that have resulted in the present dilemma. One has to go back even further than that to find the beginnings of the United States energy policy that we are finally having to pay the price for.

And, since it is much easier to place the blame on something that people are doing now rather than on what people did a while ago, our leaders can point their finger at speculators, at dishonest real estate brokers and lenders, and at foreigners as the perpetrators of our current problems. Furthermore, if our leaders can shift the blame to these villains then they can escape from dealing with the hard problem of correcting the economic policies that really did create the situation. (See the piece by Paul Krugman in the June 27 New York Times, “Fuels on the Hill”,

The ultimate problem that results from a situation like this is that policy makers usually end up facing a real dilemma. Let’s pretend we are the Chairman of the Board of Governors of the Federal Reserve System. What is the dilemma we are in, if we are the Chairman of the Board? The value of the dollar has been declining for over six years. People are saying that the fall in value has helped to fuel the increases in the price of commodities worldwide, especially that of oil. They are also saying that this decline in value has resulted in a flood of United States wealth flowing into other countries…to the Middle East, to China, to Russia, to India, to Brazil…and this is going to come back to bite us. And, now, other central banks around the world are considering raising their interest rates which will only exacerbate the situation. We should raise our target interest rate to help strengthen the value of the dollar…or at least protect it from declining more.

But, if we raise interest rates that will only cause further economic distress and dislocation here in the United States and our financial institutions are not that strong…some forecasters are saying that some banks are going to have to write off another $65.0 billion in assets. Unemployment is increasing…home foreclosures continue to rise and housing prices continue to fall…the auto industry is in the tank…and so on and so on…

This is the problem of mismanagement…of getting away from fundamentals…of letting ideology dominate reality. Bad management results in situations in which there are no good or easy choices available. Something is going to have to be done about the value of the dollar…but what price are we going to have to pay to strengthen the value of the dollar? We can continue to postpone the day of reckoning…but the longer we postpone that day…the larger the cost will be!

Another rule in economics is that the day of reckoning does ultimately arrive!

One of the short run responses to the current situation is to change regulations…to create programs that alleviate the problems created by the economic distress being experienced. An example of this is the effort to produce a housing bill that will help people who face the possibility of losing their home…and most or all of their wealth. People want to help those in dire straits. There is no question that this is a worthy cause. However, are legislators want “results”!

Short run solutions always focus on “results”. One can understand that politicians want programs that create “results” so that can justify the expenditure of large amounts of money. Individual personal problems are a great help to politicians in generating a rationale for the legislation they want to enact. And, individual personal success stories are a great help to politicians who are explaining to voters why they should be re-elected. But, programs that are based upon the achievement of “results” hardly even come close to achieving what is needed or what is hoped for. “Results” are based on idealistic goals and objectives and seldom have any relationship to the reality of the situation.

Furthermore, “results” based legislation sets up rules and procedures that people can take advantage of. The writers of the Housing Bill seem to be aware of this and are concerned about how the bill will be administrated. Still, “results” orientated programs are taken advantage of because there always seems to be many individuals that find ways to circumvent the rules and procedures to their own benefit.

One final point on this issue relates to the organization that is going to administer the new Housing Bill. The designated institution in this case…the Federal Housing Administration. This is an institution that already has many problems and has rightly been criticized for its weaknesses. The others to be involved? Fanny Mae…and Freddie Mac. Oh, boy…where is FEMA when you need it?

There is another issue to consider in the creation of legislation and additional regulatory oversight. This is the issue of time. One of the big problems that regulators have in today’s environment is that things change so rapidly. Let’s just look at the housing market that the congressional leadership is attempting to help. Earlier this year it was estimated that the number of homeowners having financial troubles with respect to paying their mortgages was around 2.6 million. The figure is currently said to be around 3.0 million. Within the next year or so analysts are forecasting that another one to two million will be added to this total. And the Housing Bill…it is aimed to help around 400,000. The response to this shortfall? Legislators say that more housing bills will have to be enacted.

The other side to this is that legislation and regulation always tends to fight the last war. That is, legislators are responding to the behavior of individuals and the market instruments they believe got us into the current situation. My experience leads me to believe that while the legislators are responding to these historical issues there are already some people, somewhere in the markets thinking about what can be done in the future. Legislation and regulation will not be created to deal with these “new things” until sometime after they have been introduced and seem to need some kind of oversight.

Leaders in the United States have some hard decisions to face. The question is whether or not they will deal with them in the near term, or, will they, in whatever way that they can, postpone the hard decisions to some undefined time period in the future. What is sad to me is that the leaders seem to be postponing the hard decisions once again. This is why I believe that there is a growing discussion around the world about the credibility of those guiding the country at this time. Can you imagine China questioning the credibility of our economic policy makers?


Realty Rider said...

We are off late witnessing Indian realty prices touching the sky. Learning to know what precedes property price increases can be challenging for any investor. There are some well-recognized factors that drive the market. I have discussed few of them below:
1. Demand & Supply- Population change is the key driver of demand. When an area becomes popular more people want to live there. Given there are fewer dwellings than interested parties, prices increase and vice-versa. The other driver is availability of land.
2. Affordability and availability of money-Affordability is the relationship between housing prices, interest rates and wages. It's the cost to the owner or investor to retain and enjoy a property. When prices, interest rates and wages reach a ceiling in a particular area, residents often realise they can have a better lifestyle elsewhere.
3. Infrastructure-Infrastructure is always a major driver for price growth when it increases the attractiveness and amenities of an area. The benefits of infrastructure are generally recognized after the changes.
4. The resources boom-The demand for skilled and unskilled workers is increasing day by day.And with an increase in their salary scale, these workers seek to improve their lifestyle by buying bigger and better homes, or maybe an investment property or two.Put a number of these drivers together and you have an extremely good understanding of what's going to drive price growth. Having identified these areas, careful homework may reveal good cash-flow returns as well.For more view-

Bryan said...

Regarding the issue with Realty Pricing I do not believe there is any relationship to Supply and Demand in the U.S. The issue is current economic situations do not lend themselves to the majority of the buying public feeling they can risk moving. While there are individuals that can afford to invest in properties, and now is a good time for them to do so, middle-class Americans can not do so. The homes they purchased within the last 5 years are now valued below what the market will bear for them. As such, the equity they have, if any, is not sufficient to take advantage of the lower prices for perhaps an upgrade in neighborhood or home. The situation in India and other developing nations certainly are mirror images of times past in the U.S.A. However, without adequate focus by the governing bodies, and the soon to be newly elected President, must be upon areas of policy correction as Dr. Mason has suggested. This will be no easy task certainly, however, without deep and sweeping change the current economic situation will have such long lasting affect that the "good old days" will be only a faded memory.