Deflation in the housing market

William Gross:

It seems to me that the U.S. economy requires a new orthodoxy, a redirection from consumption toward the stabilization of the housing market and an emphasis on infrastructure. America's economy is faltering because of an exhaustion of free-market capitalism that has mutated in recent years to something resembling a pyramid scheme. Our levered, derivative-based financial system, seemingly so ascendant after the dot-com madness that preceded it, has met its match with the subprime lending and poorly structured, opaque mortgage-backed securities of today's marketplace.

The result has been a dangerous deflation in America's most important asset class -- housing. Preventing home prices from declining even further is job No. 1 for monetary and fiscal authorities. So far, only Fed Chairman Ben Bernanke seems to appreciate the necessity for timely, creative solutions. The Fed has cut interest rates twice in eight days, by one-half of a percentage point yesterday and by three-quarters of a percentage point at an unscheduled meeting last week, and implemented a revised discount window framework in the form of its newly created Term Auction Facility. This "TAF" is designed to lower risk spreads in the high-quality end of the credit markets, and so far it is succeeding. Yet monetary policy has its limits. It cannot make bad assets turn good, nor can it be expected to lower mortgage rates to a level necessary to engender the buying power that would clear the tracts of unoccupied homes and place a floor under the deflating prices feared by American homeowners.

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Take a breath Gross.

There were similar declines in value of housing in the late 80's after Congress change the tax code. The price of homes in Houston dropped because of the oil bust. Remember $10 a barrel oil? This drove down the price of homes in growth areas of Houston. Prices were also depressed in the Clear Lake area of Houston after the Challenger explosion slowed the space program.

When I bought my home in the Clear Lake area of Houston the seller had to bring a check to the closing to pay off his mortgage because my purchase price was less than he owed. Ten years later the house was sold at the asking price in less than a week.

Markets fluctuate in value all the time and attempts to prop up the price are doomed to failure. So far foreclosures are around one percent of the mortgaged homes. The down markets always create opportunities and in this case it is creating more affordable homes. And, BTW, Houston is not experiencing nearly the decline in value for its home as some other areas where homes were over valued.