Solutions to the nation's housing bubble still up in the air

So far, President-elect Barack Obama has not said exactly what he wants to do about the nation's housing market bust.

Economist Joseph Gyourko sympathizes with Mr. Obama's reluctance to spell out a solution. "You look at the size of the problem and it takes your breath away," says the professor of real estate and finance at the Wharton School, University of Pennsylvania, Philadelphia.

The United States has some 80 million houses. Owners of about 10 percent of them are in some sort of financial distress. With the economy still tumbling, the number of endangered home owners might rise to 10 million, Mr. Gyourko predicts.

Maybe by late January or February, Obama will have put together a proposed remedy for the multitrillion dollar housing crisis, he suspects.

The basic problem is that the housing price bubble that inflated over recent decades has popped and continues to deflate. As a whole, American homes are still overpriced by $8 trillion, calculates Dean Baker, codirector of the Center for Economic and Policy Research in Washington. He wants that bubble to deflate faster in parts of the country where too many houses have been built.

In bubble markets, Mr. Baker argues, the supply of housing hugely exceeds demand at current prices. The way to restore stability is to have prices return to levels consistent with demand conditions. Propping up prices now in bubble-inflated markets, primarily those on the West Coast, Florida, and the East Coast north of Washington, D.C., would just pass along housing losses to a new contingent of home buyers down the road when the economy rises and interest rates rise again, he holds.

Both Baker and Gyourko disapprove of a reported Treasury Department plan to revitalize the housing market by using the financial might of Fannie Mae and Freddie Mac, now essentially government owned, to encourage banks to issue traditional, 30-year fixed-rate mortgages at interest rates as low as 4.5 percent. That plan could be "very expensive" for the government – perhaps $7 billion to $15 billion in losses – if the recession deepens and more people lose their jobs and default on their mortgages, says Gyourko. Those losses would eventually fall on taxpayers.

Instead, Baker suggests the powerful government-sponsored enterprises (Fannie Mae, Freddie Mac, and Ginnie Mae) refuse to buy mortgages on homes with inflated prices. That would quickly push down prices to "trend level," and perhaps by diverting mortgage money to nonbubble areas, such as the Midwest, prevent a broad spiral of price declines.

This could be called "tough love," letting homeowners more quickly recognize their actual financial situation, Baker reckons. He sees prices in bubble areas dropping another 20 to 30 percent.

The latest news on the housing market has not been encouraging. During the third quarter, a record 1.35 million homes were in process of foreclosure, up 76 percent from a year earlier. The percentage of homeowners delinquent on mortgage payments rose to 7 percent, up from 5.6 percent a year ago.

Mortgage-loan delinquency (ratio of borrowers 60 or more days past due) has risen approximately 54 percent from the same quarter of 2007, estimates TransUnion.com. And the ratio will continue to rise through 2009, states Keith Carson, a consultant with the firm.

In October, house prices on average across the nation declined 1.7 percent from September and were down 12.9 percent from a year ago, calculates Integrated Asset Services, a Denver firm engaged in default management and residential valuation. On the Pacific coast, prices have slumped 20 percent.

The housing crisis offers an opportunity to rethink federal housing policies, maintains Gyourko. He and a Harvard University economist, Edward Glaeser, criticize those policies in "Rethinking Federal Housing Policy: How to Make Housing Plentiful and Affordable," a new book for the American Enterprise Institute, a Washington think tank.

Federal subsidies that encourage people to buy homes, such as the tax deduction on mortgage interest, helped make housing more affordable for the poor and the middle class. That's a "laudable goal," says Gyourko, but it hasn't worked well, pointing to the current crisis.

The two economists would also like to see the elimination of federal subsidies to build low-income housing. Instead, that money should be used to fund more Section 8 housing vouchers. These vouchers currently help the poor to afford to rent or buy homes and perhaps move to more economically vibrant areas.

Further, the two urge gradually lowering the cap for mortgage deductions, now set at $1 million, to $300,000 in areas where zoning and other restrictions discourage new housing. The revenues thereby raised should be channeled back to those areas to subsidize new housing construction and thereby lean against restrictive zoning laws.

Homeowners facing foreclosure should be given the right to rent their homes at the market rate for perhaps 10 to 20 years, suggests Baker. If the rent amount falls below the monthly mortgage payment on the home, the lender would absorb the loss, he says. Homes would remain occupied, however, preventing neighborhood deterioration.

Such ideas show that Obama has some choices on a housing policy. Unfortunately, none are easy or cheap.