Op-Ed

Inflating the Bubble?: This Isn’t Your Parents’ Mortgage Market

Jason Furman

The following is in response to “Why Weren’t Last Year’s Unemployed Worth Helping? ” by Steven E. Landsburg in the Los Angeles Times.

Steve,

I wanted to come back to a point you alluded to in your first post. You argue that the stimulus package will only delay the necessary adjustments in the economy. Elsewhere you argued more fully that the “new stimulus package only delays that process by propping up dying industries for a while and postponing the day of reckoning.” Presumably chief among these industries would be real estate.

Let me first say that I agree: Policymakers should not try to prop up individual industries. Real estate clearly was overpriced and too much was built; it would be impossible and undesirable to postpone the needed adjustments. More broadly, I oppose trade restraints, regulatory rules and financial support for specific industries or regions for precisely the same reasons you do.

But the problems that started in housing markets in a handful of states are now spreading across the country and across a variety of sectors in the economy. The fiscal stimulus plan is designed to prevent or minimize this broader slowdown. It does not include substantial sums to bail out the housing industry or create jobs in particular industries or states. Instead, it provides essentially neutral incentives for consumer spending or business investment. The stimulus bill represents an implicit admission by policymakers that they cannot predict from where the new jobs will come; they are leaving that to the decentralized decisions of millions of consumers and businesses. (As an aside, this is one advantage of fiscal stimulus over relying on the Federal Reserve alone, because the Fed’s interest rate cuts operate more through specific sectors, notably housing.)

But would preventing the unemployment rate from rising dramatically stop the economy from adjusting, weak industries from dying and successful new industries from emerging? The experience of recent history suggests not. From the middle of 1992 through 2000, the economy enjoyed a sustained economic expansion, falling unemployment rates and a net gain of more than 20 million jobs. But this net gain concealed the enormous transformations occurring in the economy: Over that period, the economy created 274 million new private sector jobs and lost 252 million old private sector jobs. The manufacturing sector’s job share fell, but new jobs simultaneously rose to take their place. And no recession was required.

Having said all that, let me end with one caveat about housing. There are a few modest but potentially helpful steps that could benefit both lenders and borrowers in the housing market with little or no harm to taxpayers or other third parties. In this era of securitization, a person’s mortgage is sliced and diced and sold all over the world. That can lead to coordination problems, resulting in defaults and foreclosures that cause unnecessary harm to both homeowners and lenders. One type of beneficial step to avoid this Solomon-type slicing the baby in half was the voluntary interest rate freeze coordinated by U.S. Treasury Secretary Henry Paulson but implemented on an entirely voluntary basis by the private sector.

The recently passed House stimulus bill also allows Fannie Mae and Freddie Mac to temporarily hold larger mortgages in higher-priced areas, a step that will help prevent some markets from freezing up. Eventually, these higher limits should be allowed to expire or be extended only in exchange for tighter regulation of Fannie and Freddie. Another promising step along these lines is allowing the Federal Housing Administration to insure somewhat larger loans; this would be even better if it were combined with some of the FHA reforms that are supported by both the Bush administration and Rep. Barney Frank (D-Mass.), which would make the FHA more effective in preventing avoidable foreclosures.

I do not believe that we should allow the economy to slip into a serious downturn in the hopes that a systemic crisis will help foster the needed adjustment in housing. While propping up housing should not be our central goal, I certainly would be happy if helping the overall economy — with a few low- or no-cost measures for the housing sector — provided some relief for struggling homeowners who can eventually afford to stay in their homes.

Jason

Will the economy get a much-needed boost from a stilmulus package? In a week long Los Angeles Times ‘Dust Up’ series, Jason Furman, a Brookings scholar and an advisor to President Clinton, and author-economist Steven E. Landsburg discuss the U.S. economy and the recently announced stimulus package.

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