Go read Benjamin Wallace-Wells’ Washington Monthly article on the current housing bubble. Even more than the Economist’s survey on the topic, the piece explains the bubble, the likely economic fallout and the political dimensions in clear, readable terms.
As one of the overheated housing markets, Boston should pay special attention - currently the average home price 5.9 times the average income. As Wallace-Wells notes of the high price-income ratios,
To some extent, there are sound and basic economic reasons for this anomaly: supply and demand. Salaries in these areas have been going up faster than in the nation as a whole. The other is supply: These metro areas are “built out,” with zoning ordinances that limit the ability of developers to add new homes. But at some point, incomes simply can’t sustain the prices. That point has now been reached. In California, a middle-class family with two earners each making $50,000 a year now owns, on average, an $830,000 home. In the late 80s, the last time these eight states saw price-to-income ratios this high, the real estate market collapsed.
It’s too late simply to hope that a crash won’t come; trends that aren’t sustainable won’t be sustained. What’s going on? If Wallace-Wells’ analysis is accurate - and I encourage you to read his argument - the bubble is halfway between the stock bubble and the savings-and-loan collapse of the late 80s. Like with the former, prices and expectations got pushed up by irrational exuberance, by the lack of credible independent analysts and by an unfortunate situation in which no one found it in their interest to cast doubt or short the market. Yet the housing prices also reflect a breakdown in the checks the banking system had on lending.
Once banks knew they could automatically hand off the mortgages they wrote to Fannie and Freddie with basically no risk, the old incentive system dissolved. “Banks and other mortgage lenders are not watching home prices carefully because they rarely hold onto the mortgage paper they create–they just sell it upstream to mortgage investors,” John R. Talbott, a housing researcher at UCLA’s Anderson School of Business, has argued. “It is a dangerous situation indeed when neither home buyers nor the institutions that finance them are concerned with the ultimate price being paid for the housing asset.”
So like the S&L crisis, a fundamental lack of moral hazard has crept into the system. Only instead of high stakes speculation on the part of underregulated savings and loans, we have an underregulated secondary mortgage market that takes away the caution.
One of the ironic things is that one of the beneficiaries of the lack of moral hazard has been more democratic homeownership. As Wallace-Wells notes, the old mortgage finance regime “was a little stingy, and meant some people on the low end of the income scale couldn’t buy a home and many others got less home than they might have wanted, but the system usually kept prices in check.”
Perhaps this is why the housing bubble got to where it is and is so entrenched. It’s no accident that Fannie Mae and Freddie Mac advertise themselves with gauzy TV spots showing families owning their first home. On top of the dismantling of banking and finance regulation, we added an unflappable ideology of homeownership for all. Unfortunately, the law of unintended consequences looks poised to stike.
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