This week, the new director of the Federal Housing Finance Agency, Melvin L. Watt, announced that Fannie Mae and Freddie Mac, government agencies who purchase mortgage debt, will cease their retreat from the market, which in plain speak means that housing loans will be more available to middle and lower class Americans. This is good, right? It puts people in homes, helps the economy—it’s win-win—a smart play by Watt and the administration.
Wrong. It’s breathtakingly stupid. And it represents yet another example of how little policy elites—especially within the Obama administration—understand about what’s wrong with our economy or how to fix it.
To start with, making mortgages available to more Americans, while in the short term good for the real estate market—and therefore good for the economy—will only exacerbate the already growing housing bubble. Here in the Portland area, for instance, housing prices have already grown almost 24% between the market low in February 2012 and the most recent measure in February 2014.
Now that’d be great if those prices were rising because of a genuine increase in wages, but as has been well documented by any number of economists recently, they’re not: middle and lower class workers’ wages are stagnant. Indeed, the vast majority of Americans are not likely to see their wages rise anytime soon, because dynamics within the economy (for example, the transition from middle class, blue-collar union jobs to low paying, white collar, service-industry jobs) have fundamentally changed; possibly for good.
Because wages haven’t risen, the ability of most Americans to buy housing is no greater now than it was two years ago; likewise, because wages are unlikely to rise anytime soon, those who buy mortgages now probably won’t be able to recoup their investment. The problem, in other words, is that the recent rise of housing prices ISN’T tied to an increase in real value, but rather, perceived value. But wait you say, isn’t perception a reflection of reality?
To answer that question, let’s review some basic economics: price is determined, mathematically, at the intersection of supply and demand—how much suppliers are willing to sell at the price that consumers are willing to buy their good and/or service. Now it’s true that the demand for housing has gone up, which means that suppliers (property owners) are willing to sell more at the higher price, but in this case, demand has not gone up because of a sustainable reason, like, oh I don’t know, an increase in wages.
No, the reason that demand has gone up is because no matter how dumb, popular ideas are hard to kill. Dumb idea exhibits: A) housing is a great investment, and B) real estate values will always go up. Never mind that a huge number of people lost their asses in the market crash of 2008, including the millions who had their mortgages foreclosed on—a whole lot of people still believe that real estate’s a great investment, and all the mortgage brokers, real estate agents, and boys on Wall Street are happy to tell them what they want to hear. But remember, demand has gone up for a reason that has nothing to do with increased buying power OR a real increase in the value of any one particular home; rather, it’s risen solely on the false perception that real estate is a great investment, and that if one only waits a few years, their house is sure to appreciate in value. In fact, neither is true.
That’s right: real estate is not a particularly good investment. Over the long term, it’s basically is a zero sum investment: meaning that after property taxes and the cost of upkeep, over periods of more than 10-15 years, housing prices rise, on average, at the rate of inflation—if that. Sure, those who buy and sell at the right time and/or place, can make a killing—but that’s true with almost any investment. In our current situation, what’s worse is that without some sort of mechanism that causes the wages of average Americans to rise, those now buying houses are going to end up paying mortgages higher than the real, long-term value of their homes. Once the market realizes this, we’re going to see another crash—probably not as bad as 2008—but bad enough to have a significant negative effect on the economy.
It’s important to state, at this point, that Fannie and Freddie did not cause the Great Recession, as conservatives allege; they were merely following the trend already set by private lending institutions and the big banks on Wall Street. Ultimately, the crash was particularly bad because so much of our economy rested on the assumption that mortgage backed bonds were fantastic, triple-A rated investments, which had a lot more to do with our financial system of pensions, 401Ks, insurance investments, etc., than anything else.
However, any action by the government (or the private market for that matter) that encourages ordinary Americans—who already have the deck stacked against them—to go into debt in order to invest in something that is likely to LOSE VALUE, is terrible policy.
To enlarge the scope, the housing industry is not what’s wrong with our economy. Rather, it’s the lack of demand caused primarily by two factors: 1) low and stagnant wages, which I, and others, have written about extensively, and 2) the relatively high cost of living.
Low wages hardly need explaining: people can’t spend money they don’t have, and we know, based on the evidence right before our eyes, that businesses and the wealthy DON’T reinvest any gains they might reap from having low wages into creating jobs. Indeed, why would they? No one can afford to buy up the increase in supply—the demand isn’t there. So instead, they put their money offshore, or invest it in other companies, becoming in effect, de facto financial institutions.
The high cost of living certainly has something to do with housing prices, but making mortgages easier to get in the short term is going to drive prices UP, not down, which has a ripple-effect of making rents more expensive, furthering the squeeze on those in the middle and lower class. Unfortunately, there won’t be much relief in the long term either: once the market realizes its mistake, property owners are more likely to sit on their investments rather than take a loss by selling them, which means that renters are still going to be on the hook for most, if not all, of the mortgage payments. Furthermore, the drag on the economy caused by another burst of the real estate bubble would no doubt hurt the employment market, impacting low and middle income workers more than their more well qualified and educated counterparts.
The reality is that until our government gets its collective head out of its ass and does something to lower the cost of living AND raise wages for lower and middle income workers, our economy isn’t going to get much better—and housing prices won’t continue to rise like they are now. Just watch.