The Case for Housing Help

The unprecedented crash in home values threatens the entire economy, and it's not over.

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The head of General Motors in the Fifties famously said that "what was good for our country was good for General Motors and vice versa." Today, with homes the largest asset on America's family balance sheet, amounting to about $21 trillion, what's good for housing is what's good for America.

Or very bad for America.

The unprecedented crash in home values, the first since the Great Depression, threatens the entire economy, and it's not over. Home equities are predicted to drop 10 to 12 percent in each of the next two years, reducing value further by the staggering total of $4 trillion to $6 trillion.

The bubble in the housing market that has now burst is causing a daisy chain of damage in America's financial system. The increased defaults in subprime mortgages began to depress mortgage-linked securities last summer, and soon the contagion spread to all sorts of products in the financial world as confidence went into free fall, along with housing prices. This has made it difficult to stabilize the financial markets.

Banks have reacted to their losses on mortgage-backed securities by pulling back mortgage loans, as well as other loans, intensifying the credit crunch and further compounding the economic downturn. The Fed's attempts to halt this negative spiral by cutting interest rates have been largely upset through rising interest rate spreads, i.e., the growing gap between mortgage loan rates and the federal funds rate. The result: Mortgage rates today are higher than when the Fed resorted to emergency rate cuts in January. And because of tighter standards, many types of people who were able to borrow two years ago cannot today, at any interest rate.

No bottom. There is probably no way to stop house prices from falling, but the current crisis won't end until buyers think prices have hit bottom. Only then can we hope to clear the excess supply from the market.

What's critical to recognize is that house prices had begun to fall even before the recession began and without the shock of higher interest rates. This is conclusive evidence that a speculative bubble was in place. It was fueled by excess credit creation and lax lending standards. The estimated losses exceeding $1 trillion are not fanciful when you realize how many of the mortgages that originated in the past several years came with little or zero down payments. Borrowers putting a 10 or 20 percent down payment on their homes are almost mythological figures today.

The stark possibility now is that 15 million homes will have mortgages that exceed their value. We are talking about almost 30 percent of the nation's 51 million households ending up with negative equity, which means the owners have an incentive to walk away from their mortgages. Today, 8.8 million homeowners have a clear financial incentive to abandon their homes. The housing binge is ending with a hangover.

If millions of Americans do walk away from their homes or are forced out by involuntary foreclosures, the effect on the value of whole neighborhoods may be catastrophic. Abandonment increases decay and crime and accelerates further reductions in home values. What a challenge it is to American daily life and American politics! The economy is back at the heart of our politics, and so is fear.

Political policy contributed to where we are. Can it get us out of the mess? Politicians had long wanted to raise homeownership through subsidies, tax breaks, and dedicated agencies, such as Fannie Mae and Freddie Mac. When George W. Bush became president, he challenged lenders and others to create over 5 million new minority homeowners by the end of the decade. In 2003, he created a program that would offer money to the poor so they could secure a first mortgage. Many lenders stopped requiring sizable down payments from people who couldn't afford them. They often did the deals without documentation of family income and net worth. These "no docs" homes amounted to almost 44 percent of subprime borrowers in 2006 alone. But they weren't the only borrowers who were encouraged to take the over-the-top mortgage money. Included were people with higher incomes who wanted to speculate on housing and many homeowners who refinanced to cash out their equity stake, thus assuming more mortgage debt than they could afford. In a word, the nation gorged itself on accelerating home prices.