- The Washington Times - Tuesday, November 22, 2011


The nation’s economic distress and its housing woes are inextricably linked. The bursting of the housing bubble was one part - but only one part - of the 2008 financial crisis. As the economy continues to struggle to regain altitude and airspeed, the distress in housing is evident. Nearly 15 million mortgages are underwater (28.6 percent of all homeowners with a mortgage, according to Internet realty firm Zillow.com) with the aggregate negative equity hole in the vicinity of $700 billion.

What will fix the housing market? First and foremost, it will require more rapid economic growth. Faster growth will generate job and income growth, which will, in turn, alleviate the labor market and income losses that are the dominant cause of default and foreclosure. Improved growth also will translate the demographic demand for housing into real purchases of new and existing homes. As is well known, millions of young Americans have returned to their parents’ abodes - and neither generation likes it. Better economic opportunity would yield young adults confident enough to form households and purchase homes - and likely nearly double the current pace of housing starts.

Faster growth is the key and will require a new, disciplined policy approach that does not allow social engineering, a green agenda, union activism or class warfare to trump the need for a vibrant private sector. It would include real entitlement reform that would preserve the social safety net for the next generation and avoid an impending U.S. debt crisis. It would include pro-growth tax reform toward lower marginal rates and a broader base that improves U.S. competitiveness, enhances incentives for saving, investment and innovation, and eliminates the return to financial engineering. It would include a renewed commitment to multilateral trade agreements, both for their inherent virtues and as the only practical way to force China onto a level global playing field. It also would include reformed, efficient infrastructure strategies for transportation, energy and communications.

It also would ignore the competing narrative developing about housing recovery and economic growth. That narrative follows these lines: (a) Underwater mortgages are the driving force behind foreclosures and housing-market distress; (b) principal reduction - notably the negotiations between mortgage servicers and the state attorneys general - is, accordingly, the best route to housing-market recovery; and (c) housing-market recovery is the necessary prerequisite for broader economic growth.

This line of reasoning is embedded in recent writings by New York Times columnist Joe Nocera and Reuters blogger Felix Salmon.

The argument gets off on the wrong foot by misdiagnosing the source of foreclosures. My reading of the evidence on foreclosures is that “strategic default” - tossing the keys on the kitchen counter and walking away when underwater - is not the driving force in foreclosures. It does happen, but in a minority of cases. Instead, the most important factor is the cash-flow position of the family. If the cash keeps coming in and the mortgage payments don’t change, fine. If there is a sharp reset in mortgage payments, problems arise. If one or both earners face job loss or wage cuts, problems arise. Getting the foreclosure diagnosis wrong leads one to underestimate the importance of faster growth.

Worse, even if strategic defaults were driving the foreclosure mess, the focus on attorneys general negotiating principal reductions is completely misplaced. Most public reports place the size of the possible reductions in the range of $20 billion to $25 billion. As noted above, the size of the negative equity hole in underwater mortgages is slightly south of $1 trillion. Principal reductions of $25 billion do nothing. That aside, a settlement at least would bring some much-needed certainty to one of the factors forestalling the inevitable and necessary housing adjustment.

Finally, the counternarrative argues that until you fix the housing market, you cannot get faster economic growth. This tempts policymakers into continued, counterproductive meddling in housing and mortgage markets.

Narratives can have a powerful impact on policy. The emerging housing-market narrative is misleading and runs the risk of distorting the needed policy mix. Economic growth and the housing market both will benefit from a ruthless focus on the former and less activism in the latter.

Douglas Holtz-Eakin, former director of the Congressional Budget Office, is president of the American Action Forum.



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