Thursday, August 25, 2011

Instead of Reading Fiction, Obama Should Be Educating Himself on Economics

I guess I missed this story yesterday in the NY Times which talked about a couple of plans the Obama administration has to "strengthen the housing market."  The two main proposals the administration is considering are:

1.  Make it easier for homeowners to refinance at today's low rates.
2.  Possibly convert the large swathes of empty foreclosed houses into rental properties, the idea being that there will be less pricing pressure in real estate markets due to less supply.

Both ideas show exactly how oblivious the Obama administration is in terms of economics as both will have major negative effects downstream and will be unlikely to actually stimulate anything.  On the refinancing, the only people unable to refinance their home right now are the bad credit risks and those underwater, or close to it, in their mortgage.  Since even with a government program, those that are underwater will probably still not be able to get refinanced (who is going to underwrite a 30 year mortgage for $300,000 on a house worth $250,000?) you are left helping those with bad credit.  And even with those, there  will have to be some minimum level of income in order for them to refinance so you are left helping just a small swath of the population, which will do nothing for housing prices or the economy in general.  But what it will do is spook mortgage bond investors who will view any program like this as an additional risk they are taking.  For mortgage bond investors, refinanced mortgages are a bad thing as they limit the amount of money they collect from the mortgages they invested in.  By changing the risk-return dynamics of the bonds, the government will, in effect, lower the value of these bonds which will hurt all those banks we just bailed out a couple of years ago as they are still loaded to the gills in mortgage debt.

The other possible proposal is equally braindead.  Yes, taking foreclosed properties off the market will take off some immediate selling pressure.  However, putting these homes on the rental market will lower rents across the board, which will negatively impact the residential market negatively in two ways.  First, those deciding whether to rent or own will more likely decide to rent, which will take some of the buying pressure off the market.  Second, those that buy homes in order to rent them out will have less of a return on their investment, so they might decide either not to invest at all or will be willing to pay a lot less.  Basically, by reducing supply, this plan would also reduce demand.  As even a Keynesian can figure out, much of the benefits of this program will therefore be canceled out by the unintended by very predictable consequences.

Essentially, both proposals are worthless.  Yes, on the margin a few people might be able to refinance and a few might be able to get a little more for their home but due to the downstream consequences the benefit to the economy will be meager at best and detrimental at worst.

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