Who can be the ultimate housing buyers?

Market Watch
RWIN KELLNER
The missing link
Commentary: Home lender of last resort must become buyer of last resort
By Irwin Kellner, MarketWatch
Last update: 6:53 p.m. EST Dec. 8, 2008

PORT WASHINGTON, NY. (MarketWatch) -- In an effort to jump-start lending, the government has become the lender of last resort. Now to stabilize the economy, Washington must also become the buyer of last resort.

All over the country, the politicians, pundits and the press have finally figured out what readers of this column have known for nearly a year: Housing is dragging down the economy. See Jan. 29 column on why stimulus package wasn't the right solution

And it's more than simply the decline in homebuilding that's plaguing us, although this alone would be serious enough. Rather, it's the fact that the supply of homes on the market far exceeds the demand for them at current prices.

As a consequence, prices have been falling for a couple of years, bringing the median home price down by some 18% from its all-time high. In some markets like South Florida, prices are down as much as 50%.

Add falling prices to the mix and you can see why we are in a recession. A home is the typical household's biggest asset, so whenever it declines it affects people's wealth, thus their ability and willingness to spend.

Since many families had been relying on the increase in the value of their home as a substitute for saving, today's decline has an even more serious effect than in previous housing cycles.
However, the main problem emanating from the housing slump is the freeze in the financial markets. This, of course, is a by-product of the fact that so many mortgages were turned into securities whose values are now in question because of the decline in home prices.

It seems obvious, then, that the key to ending this recession and thawing out the frozen markets is to stabilize home prices. To do this, it is necessary to pump up the demand for homes, reduce their supply or both.

Boosting demand will be difficult. People are afraid of losing their jobs, the banks have tightened their lending standards and no one's willing to buy these days unless they are sure that prices have hit bottom.

Besides, prices are still too high, relative to household incomes. So while 30-year fixed mortgage rates have come down to a bit over 5.5% and the Treasury is planning to bring them down to as low as 4.52%, the lowest since the early 1960s, it won't be enough to get most buyers off the dime.

Thus supplies must be reduced to meet demand. To do this would mean that median prices would have to come down even further, around another 8% by my calculations.

In effectuating this, the government is not the problem, for a change, but the solution.

As I recommended in March, the government should create an agency (call it the Home Owners Loan Corporation), capitalize it with a few billion dollars, and have it offer to buy all houses for sale either by sellers or through foreclosures for a price not exceeding 2.9 times median household incomes in each market.

This is the ratio that prevailed during most of the 1980s, when the housing market was strong and healthy. Obviously, not every house will go for the median price; mansions will sell for more, shanties for less.

The HOLC probably won't have to actually buy many houses; just offering to buy will set a floor for prices. Those homes that it does purchase can be rented until the market improves, and then sold at what should be higher prices.

Once a floor is clearly established, buyers will buy, sellers will sell (knowing that this is the best deal they will get), bankers will lend --and, most important, value of mortgage-backed securities will materialize. This is the sine qua non for thawing out the financial markets.

Meanwhile, current mortgage holders can renegotiate a lower fixed rate and stretch out repayment of principal to help them keep their homes.

Some foreclosures will be inevitable -- but most of these people probably should not have gotten a mortgage in the first place.

Irwin Kellner is chief economist for MarketWatch, and is Distinguished Scholar of Economics at Dowling College in Oakdale, N.Y.