Put $35 Billion On That Horse With the Broken Leg

Tim Cavanaugh | September 29, 2009

All and sundry report on a new Obama Administration proposal to provide $35 billion in emergency funds to state and local housing agencies in order to subsidize new mortgages. The money -- $20 billion in purchases of bonds issued by state housing finance authorities (HFAs), and $15 billion in as-needed followup funding for the HFAs -- is designed to get states back on track to subsizing more than 100,000 mortgages per year. Most HFAs have closed their doors to new borrowers since the credit unwind began.

Question for Keynesians: Why does government intervention in the market always have to be countercyclical in intent?

From a strictly political view, it makes sense to fight the tape anytime there's a downturn: The administration is under intense pressure to buoy real estate prices and demonstrate that efforts like the $75 billion Housing Affordable Modification Program are succeeding. Supporting real estate is a political winner because there is a vast lobby in favor of higher prices and a small, powerless lobby against. As Calculated Risk notes here, real estate prices, unlike unemployment, have performed more strongly than projected in the so-called Bank Stress Test, so there is some evidence for the hope that government efforts will prevent another steep decline in housing prices -- though for reasons discussed here, these efforts are in fact very likely to fail.

But in terms of managing an economy, a strictly countercyclical policy is a boxer with only one arm. The government could, for example, engage in the pro-cyclical policy of providing compensation to lenders and/or borrowers who get the foreclosure process over with quickly. This would introduce a large stock of affordable housing into the market and help the people (lower and middle-income first-time buyers) whom this $35 billion is designed to help. And by encouraging the sale of a lower-priced home, rather than subsidizing the mortgage on a higher-priced home, it would help those folks without pressuring them to take on more debt. Again, it seems pro-cyclical intervention is more merciful than counter-cyclical.

All this assumes that government intervention in the economy is legitimate, so all libertarian caveats and to-be-sures apply. But as the underappreciated economist George Michael told us, if you're gonna do it, do it right-right. If you believe Keynesian policies make economic as well as political sense (and my understanding is that Keynesians do believe this), what's the justification for always attacking in the same direction?

Comments

|9.29.09 @ 6:14PM|#

All this assumes that government intervention in the economy is legitimate...


Ludwig von Mises already demonstrated the assumption is wrong, by describing the Calculation Problem.

Also, Hayek demonstrated the same thing as the Fatal Conceit.

Rich|9.29.09 @ 6:16PM|#

The firms plan to buy the assets at bargain prices in hopes that they will turn profitable over time.

There's that h-word again.

Attorney|9.29.09 @ 6:18PM|#

What episode is that?

|9.29.09 @ 6:21PM|#

"The Cloud Minders." You know, the one where Spock tried to pick up that chick whose dad ran everything.

Attorney|9.29.09 @ 6:26PM|#

Thank you! I can sleep sound tonight.

Some Guy|9.29.09 @ 6:36PM|#

Put another $35 Billion On That Horse With the Broken Leg

Fixed.

|9.29.09 @ 6:54PM|#

The government could, for example, engage in the pro-cyclical policy of providing compensation to lenders and/or borrowers who get the foreclosure process over with quickly. This would introduce a large stock of affordable housing into the market and help the people (lower and middle-income first-time buyers) whom this $35 billion is designed to help.

Sure they could do that...but then how will all the lenders be insulated from taking loses on their bad loans? And what will all the municipalities who are relying on the property taxes that are based on pre-popped-bubble assessments/valuations do?

The reason why the government wants to try and keep housing values high is two-fold.

1. Too many banks/hedge funds/investors will lose too much money if foreclosures are allowed and property values adjust downward to where it's actually affordable for families (owners who are really underwater have less incentive to keep paying their mortgage). Too many important people will lose too much money and that just can't happen.

2. Local property tax revenues will get decimated and the municipalities will either have to raise the tax rate to make up for the lower assessment values or they will have to make do with less money (something no government entity ever wants to do)

Joe M|9.29.09 @ 7:10PM|#

efforts like the $75 billion Housing Affordable Modification Program

Oh, you mean HAMPr?

Some Guy|9.29.09 @ 7:41PM|#

This would introduce a large stock of affordable housing into the market and help the people (lower and middle-income first-time buyers) whom this $35 billion is designed to help.

I hope you don't seriously believe that helping lower and middle-income first-time buyers was the intent of their plan to keep house prices inflated.

I'd sooner believe that Obama is a robot sent back in time by Trig Palin in 2050. At least you could argue that.

MattXIV|9.29.09 @ 7:52PM|#

My understanding of the theory behind it is that temporary downward shocks to aggregate demand become self-reenforcing - within the assumptions of the model, the stimulus should move aggregate demand back to the equilibrium level before aggregate supply adjusts downward thus preventing a recession while AD returns to it's pre-recession value.

The model makes sense to the extent the underlying assumptions of price stickiness and the decline in production being due to a temporary shock in AD hold. In the case of a step change in AD rather than a shock, even by the assumptions of Keynesian short run models, stimulus will not restore the old equilibrium. I'm not sure what the canonical Keynesian view of what happens when you throw stimulus at a step change is - my understanding of the model leads me to believe that AD stimulus in the face of a step change will temporarily keep consumption levels at above the new equlibrium levels at the cost of cannibalizing the capital stock if aggressive enough and ever greater amounts of AD stimulus will be required to maintain the level since AS is gradually moving in the other direction due to capital stock depletion. In terms of specific mechanisms, it'd expect things like deferring preventative maintenance of equipment and depleting inventories to provide the resources for higher instantaneous levels of consumption.

Stimulus outside of a recession should work the same as stimulus after a step change in a Keynesian model, which I think kind of answers Tim's question.

What I'd like to ask is why they believe that this recession is a shock rather than a step change and if they don't think it's a shock, what do they expect stimulus to accomplish? The reduction of personal net assets due to declining house prices seems like it would be a step change in AD (or if you view the entire housing bubble as big, long positive AD shock, a return to equilibrium), not a negative shock.

I'm quite amenable to correction in this matter, because I have a nagging felling that I may not actually be making sense when I talk about Keynesian models, but I also have that same feeling about the Keynesian models themselves...

JB|9.29.09 @ 8:05PM|#

More money for people that shouldn't be buying houses!

At this point the rallying cry is: abort the stupid. That includes lots of government employees, Democrats, Republicans, et al. A lot like a certain scene in a certain great piece of literature that suffocates the fuckers in a train tunnel.

You call it murder. I call it a medical procedure.

Tim Cavanaugh|9.29.09 @ 9:58PM|#

Rent/own-ratio fetishists (you know who you are) will be interested in this new evidence (courtesy of OC Register's Jon Lansner by way of Calculated Risk) that another giant real estate dump is painfully working its way down the dehydrated colon of our nation:

Rents are down here, there and everywhere.

I can't speak for everywhere, but I can tell you in Hollywood there are vacancy signs and first-and-last-month-free offers all over.

|9.29.09 @ 11:58PM|#

What episode is that?

One of the worse final season ones.

Ebeneezer Scrooge|9.30.09 @ 4:16AM|#

ChicagoTom,

The reason why the government wants to try and keep housing values high is two-fold.

I think you're right.

My question is, do these idiots really think they can keep real estate prices up where they are without cutting inflation loose for a few years?

Given that rational options will never get on the table, a few years of inflation might be the least painful way of clearing out the housing market.


So here's another question. Did we really over-build, to the point that there's a lot more houses out there than people to live in them? Or are people not buying just because nobody knows what houses are really worth yet and they're hoping prices will fall further?

Or is it that people are just obstinate bastards like Keynes said, and you have to coax or beat their "faith" back into them?

|9.30.09 @ 10:10AM|#

My understanding of the theory behind it is that temporary downward shocks to aggregate demand become self-reenforcing - within the assumptions of the model, the stimulus should move aggregate demand back to the equilibrium level

Whoa, hold it right there. These seems to assume there is some Platonic equilibrium that exists independently of a match between actual demand and actual supply.

before aggregate supply adjusts downward thus preventing a recession while AD returns to it's pre-recession value.

And this assumes that the "pre-recession value" was sustainable in the long run, such that artificial supports for (over)-supply will be temporary and not result in permanent supports and stranded capital.

robc|9.30.09 @ 10:40AM|#

Just looked up some Case-Shiller Index numbers. July of 2009 (just released) is at 143.05, which is August 2003 housing price levels.

The last 2 months (May to July of 2009) actually went up, which is the first uptick since the peak in May of 2006.

All numbers from the composite-20, the composite-10 goes back further, but why use 10 cities instead of 20, unless you are trying to compare to 1987?

Tim Cavanaugh|9.30.09 @ 11:27AM|#

So here's another question. Did we really over-build, to the point that there's a lot more houses out there than people to live in them? Or are people not buying just because nobody knows what houses are really worth yet and they're hoping prices will fall further?

Some areas may be overbuilt (cough, Florida, cough), but if you extract places like the Detroit neighborhoods where land is close to free, then the answer is no. Once the asking price reaches a certain point, you get a swarm of buyers. It's happening in Southern California, in New Jersey, in the D.C. Beltway, in Texas, etc.

But in all those places it's still happening rarely, because the only way you can get to an attractive asking price is to let the bank foreclose and put it out with aggressive price. And all the public policy is designed to prevent that from happening.

But make no mistake: Propping up real estate values is not a victimless crime. There is a demonstrated demand for houses at a good price, even now. Those prospective buyers are getting massively dicked around by a policy that is openly and proudly based on denial of reality.

JB|9.30.09 @ 11:37AM|#

I can't speak for everywhere, but I can tell you in Hollywood there are vacancy signs and first-and-last-month-free offers all over.

I wouldn't want to live there either; half of Hollywood has come out and said it's ok to rape whomever you want.

Tim Cavanaugh|9.30.09 @ 11:55AM|#

Only if you're an award-winning director, ya hater!

|9.30.09 @ 1:08PM|#

Even so, Tim. I wouldn't want to live in fear that an award-winning director was going to pound me in the ass.

Ebeneezer Scrooge|9.30.09 @ 1:29PM|#

Tim,

About what I suspected.

test|9.30.09 @ 5:30PM|#

test