Obama's economic policy has been justly criticized for the lack of transparency, regulations and accountability in dealing with Wall Street and its accomplices. But the flip side of this has been almost total neglect of the main street side of the equation--inadequate attention to foreclosures, loss of home equity value, and employment deficits that belie the purported "good news" of economic recovery. A couple of recent papers from Dean Baker at the Center for Economic Policy Research (on co-authored, one solo) help to bring the relatively neglected side of the situation into focus. Together, these two papers indicate potentially substantial benefits to be gained from vigorous federal action.
"CBO Projects More Severe Downturn" (pdf) looks at at the August CBO's Update of its Budget and Economic Outlook, and discusses its implications. The 5-page report features the following chart illustrating the magnitude of economic loss we face:
Of course, the lost output is to the whole economy, while the health care cost is restricted to the federal budget. But the federal taxes on the lost income, plus reduced federal costs because of such activity pretty much indicate that if we did not face that magnitude of lost economic activity, that alone would produce enough federal revenue to pay for the $1 trillion in health care spending.
The last paragraph of the report concludes:
These new projections from CBO suggest that the downturn will be far more severe and prolonged than in its projections from January. The projection of a more severe downturn should draw considerable attention from the Obama administration and Congress. It implies a much more dire situation than the one envisioned when the stimulus package was crafted in February. Presumably, the President and Congress will want to adjust their policy in light of the new information in this report.
By comparing home prices to rents, as suggested by basic economic theory, this paper finds that while most of the nation's metropolitan housing bubbles have deflated and many markets never had one to contend with, there is the possibility of a persistent housing slump in the years ahead. An appropriate response to this problem involves:
1) Stimulating the fundamental demand for housing through acting to lower unemployment and raise wages;
2) Recognizing a leading role for rental housing in federal foreclosure mitigation and
neighborhood stabilization policy, including allowing foreclosed homeowners to remain in
their homes as renters; and
3) Adequately funding the National Housing Trust Fund to capitalize on current low prices,
ensure long-term affordability in a recovery, absorb excess housing, and stimulate
employment.
CBO substantially increased their projections of unemployment from their January Economic Outlook. It is now projecting that unemployment in 2010 will average 10.2 percent. The unemployment rate is projected to decline gradually towards the 4.8 percent level that CBO considers the long-term sustainable rate. The unemployment rate for 2012, when President Obama will presumably be running for re-election, is projected to be 7.7 percent. CBO does not project that the unemployment rate will return to its long-term level until 2014, as shown in Figure 1 below.
The area between the two curves represents the excess unemployment, or lost productive capacity in the years ahead. The loss in output shown in the chart above the fold was calculated using
Okun's law, a rule of thumb that a 1% increase in unemployment implies a 2% drop in GDP.
In terms of actual need, there should be a clear case here for another round of stimulus spending, particularly spending that is employment intensive. But we do not live in a rational world.
Turning to the second report, the map below shows the variations in the local housing markets. Red circles indicate negative equity over the coming 5-year period, blue circles indicate positive equity, size of circles is proportional to equity expected:
The normal long-run relationship of housing price to rents is 15-1. The table below shows markets generally, but unevenly, returning to historical norms:
The basic logic of the analysis in this paper is explained in this passage:
The Prospects for Accumulating Equity
Building housing wealth is a possible advantage of homeownership and is often used to justify higher monthly costs. Therefore, in addition to looking at current costs, the relative merit of owning or renting a home is examined by projecting the equity a new home buyer can expect to accumulate after the purchase. It is also possible that a home will become a growing liability, a clear concern in the current market.
Another long-standing rule of thumb in the home-buying process has been that once the costs of purchase and resale are accounted for, it takes five years for a first-time homebuyer to begin accruing equity in a home. Our calculations (see Appendix Table 2) indicate that new homeowners in 21 markets, particularly the 13 bubble markets, will not have positive equity by 2013 if the home is purchased in the current market. Only three of these markets, however, are predicted to have larger losses in equity relative to last year (Providence-New Bedford-Fall River, RI-MA; Washington-Arlington-Alexandria, DC-VA-MD-WV; and Worcester, MA). In the remaining 18 markets, homebuyers this year can expect to see less loss of value than homebuyers last year. Yet, even accounting for the improving equity outlook over the next four years, renting continues to be a more attractive option for homeowners in these markets.
Meanwhile, in non-bubble markets, homeowners can have a more optimistic outlook for accumulating equity. A first-time homebuyer in 79 out of 87 markets can expect to accrue equity in four years. In five markets, where we projected that a household purchasing a modestly-priced house last year would fail to accumulate equity within four years, a household purchasing the same home at today's prices is now projected to have equity by 2013.
The report includes a number of example cities, showing the difference in prospects when using a uniform projection vs. a projection based on local market recovery projections. It's clear from this analysis that the strength of local economic recovery is an important factor in determining whether local housing markets will recover sooner, rather than later.
Among its conclusions, the paper states:
This analysis indicates that in a growing number of metropolitan housing markets, the costs of homeownership are falling back into their historical relationship with rents. As this occurs, it seems likely that housing values have or will soon reach bottom and stabilize. This analysis also illustrates, however, that in order to expect this market stabilization to occur and to be able to achieve increases in affordability (a potential upside from a declining real estate market), the broader economy must also recover. In essence, we should be wary of a false bottom to the housing market and with this in mind, not wait to see if a reversal in home prices is sufficient to pull up the rest of the economy.
Since prices appear to be bottoming out, the most sustainable housing market recovery will come from making certain the floor under prices does not falter. This is done most directly by stimulating demand for housing through increasing employment and incomes. This will lead to the creation of new households and the reformation of independent households to absorb excess housing, be it for rental or ownership. At this point in the downturn, trying to stimulate the economy by incentivizing existing home purchases through homebuyers' tax credits is at best putting the cart before the horse and at worst rearranging the deck chairs on the Titanic, to use the clichés.
In many communities, existing homeowners will continue to be underwater, owing more on their home than it is worth, for some time to come. Negative equity and high loan-to-value ratios in general are logically and empirically the best predictor of foreclosures we have. While in some instances this may be corrected by existing refinancing efforts, given the lack of success thus far, the size of the problem, and the potential for stagnation or even further decline in the economy, coupled with the fact that many markets clearly remain inflated, policies should be enacted that emphasize the avoidance of displacement as well as foreclosure.
When foreclosure cannot be avoided, homeowners should be given an option to remain in their homes as tenants at a fair market rent, for a substantial period of time (e.g. five to ten years) to preserve community continuity and stability, as well as minimize the disruption to the market caused by vacant and abandoned buildings. The Right to Rent would provide homeowners facing foreclosures in hard-hit areas an important degree of housing security and stability in the neighborhoods as a whole.8
This is what rational policy discourse sounds like, when it is not over-run by people shouting at the top of their lungs that the government has cooties. Imagine if we made policy based on this kind of analysis.
We used to do things that way, once upon a time. It's up to us to get us back to that way of doing things again.
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