Tuesday, August 31, 2010

Ethical Questions in Housing Market Support

A Fortune story in CNNMoney.com, “Housing quagmire: Is it time to remove relief?” raises the usual questions about the wisdom of supporting the housing market, along with interesting new questions. If the housing market is, as many economists believe, 10 to 20 percent above a sustainable price level, is it ethical to provide special encouragement for people to buy houses now?

The few who are buying homes now might likely be overpaying for them.

Then, after prices fall, these borrowers and their banks might fall into the exact same problems that are causing so many foreclosures and bank failures already. A quote in the story from Dean Baker:

“We’re just putting more people in the trap,” Baker says of government policies that basically encourage people to buy or stay in homes beyond their budget. “I don’t feel good that we’re finding more suckers.”

There is no question that housing market support has some short-term benefits for communities and the banking system. Having more occupied houses means fewer unoccupied houses for criminals to exploit, and that’s good for communities. At least 50 banks that might have failed this year won’t go under till next year because of the short-term effects of propping up the housing market.

But if these benefits are coming at the expense of more bank failures in the future, and more consumers lured into the financial trap of an underwater mortgage, is it really ethical to continue the programs that create them? It is a difficult question to answer because we don’t know the exact proportions of these effects relative to each other, and no one can say the exact degree to which the value of any given house will decline from here.

A point to consider, however, is that it is financially natural for the value of a house to decline over time. People who have taken advantage of the appreciation of the value of their homes have had the advantage of demographics, but in normal times, houses depreciate. Things wear out and break down. The insulation or security that seemed adequate when the house was built is inadequate decades later. Most houses built in the last century will be demolished or rebuilt at some point in this century — their value will diminish to zero, or near zero.

And this is without even considering the possibility that the cost of building a house could decline because of technological advances. We tend to discount that possibility because it has never happened in our lifetimes. But it will surely happen someday, probably within the next 30 years, and when new houses are less expensive to build, this reduces the market value of all houses. If the economy or the financial system is built on the assumption that technology will never reduce the cost of a house, then it is just setting itself up for an unpleasant collapse at some unknown time in the future.