The U.S. Census Bureau reported yesterday housing starts – the number of privately owned new housing units for which construction began -- rose 4 percent in November, a seemingly cheery development until you put the news in perspective.
The rise in housing starts retraces just part of the sharp decline seen over October, and more strikingly, starts are running at about only one-fourth of the pace seen at the height of the housing boom. Although the housing sector has often led the economy out of downturns in the past, it is very unlikely to do so in this episode given the still-significant degree of oversupply in the market. The vacancy rate for owner-occupied housing, at 2.5 percent, remains a full percentage point above the pre-crisis norm.
In addition to the softness in construction, a big concern for the housing market is the possible future path of home prices. For the most part, it appeared home prices stabilized after their plunge between mid-2006 and early 2009. But recent readings from a variety of sources, including a release by Corelogic Thursday, point to modest declines in prices in recent months. This is a somewhat troubling trend for home prices, and one that could possibly get worse before it gets better.
A key consideration is that we are likely to see many more defaults and foreclosures over the next year or two, as I argued in a presentation last week. A subsequent flooding of the market with distressed properties could put considerable further downward pressure on prices, reducing housing wealth broadly and providing a reason for homeowners to make cuts to their spending. Even if not the most likely outcome, this scenario warrants concern given that the substantial earlier decline in housing wealth was a fundamental force behind the depth of the recession and the lackluster recovery to date.
What can the government do to address this situation? To the extent that the high level of mortgage distress reflects borrowers’ lack of cash to make their mortgage payments, the various government programs aimed at modifying payments should help (as should programs that support cash flow like emergency unemployment benefits). But, a bigger challenge is the substantial part of the distress that reflects the large share of households that are “underwater” with their mortgages—recent estimates put the figure at more than a fifth of mortgage borrowers nationally, and half or more in the worst-hit states.
Further policy initiatives to spur principal write-downs on these loans could help remedy the situation with underwater borrowers, but might also have critical disadvantages. Any effort to force lenders to make such write-downs could hurt the still-fragile banking system and also raise the cost of mortgage borrowing both now and in the future. Using government funds to subsidize write-downs could ease the burden on lenders, but would be costly for taxpayers and raise important fairness issues. The better solution may be to instead accept that the situation is unsustainable for many of these households and put money and energy toward policies that ease the transition for these families and their communities as well as policies that mitigate the disruption to housing markets.
Karen Dynan is vice president and co-director of the Economic Studies program and the Robert S. Kerr Senior Fellow at the Brookings Institution.
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