Sunday, October 30, 2011

Consequences of Deregulation for US Real Estate Market

The Destruction of American Housing

In early October 2011, Marketplace, National Public Radio's financial and economic news segment reported on a bizarre phenomenon emerging on the landscape of the US housing market.

At first glance, it would appear that the forces of supply and demand are at work. What we are really seeing are the unmitigated forces of the unregulated market recklessly creating at first far too much housing, then destroying it in a messy process in which many are needlessly made homeless and the live savings of many families are destroyed. What we should be asking is: 

Why has there been no attempt to dampen the business cycle? Why, with our massive economic, administrative, and regulatory capabilities did we not see to it that the growth of the housing market in the US proceed along lines which more closely resembled growth in fundamental value, and growth in consumption demand for housing? 

Some may see this as a story of creative destruction, along the lines of Schumpeter. Frankly, this is never how the destruction of housing (and possibly the destruction of infrastructure) should be seen. What this story is really about is the process of flat-out destruction of economic value caused by bad policy, improper management, and greed. Here are the steps:

The Process of Economic Destruction
1: This story begins during the bubble. The inflationary and unrealistic asset values in the housing market lead to an oversupply of housing being created. By definition, the bubble also absorbed savings, profits, and retained earnings in large scale from the rest of the economy. Shortsightedness and Poor Regulation

2: Record numbers of foreclosures across the US after the housing bubble ended. While various US media sources described this process as one of questionable legal legitimacy, what is clear is that American banks have broadly been unwilling to do loan modifications, or extend new loans. Instead, they have simply been in a hurry to get their hands on as many people's homes as possible. Greed

3: The simultaneous attempt to sell-off all of the foreclosed homes led to the destruction of asset value in an economic and financial sense. Broadly, this affects not only the prices of foreclosed homes, but also their ability to be sold and the property values of those who try to cling to their homes. Poor Regulation and Bad Business Practices

4:  Since homes weren't being sold and banks were not extending real estate loans, foreclosed homes sat empty. While empty, they began to deteriorate and depreciate, losing not just financial value, but more importantly, fundamental value. As the saying goes in the Real Estate industry "Homes like to be lived in" Poor Asset Management

5: After bad business practices turned people's homes across the US into vacant houses and they began to deteriorate, now they are being destroyed outright. Assets are being destroyed.

This is a cycle of the impoverishment of people, the destruction of assets, and ultimately the contraction of the economy. This is exactly the opposite of what economic policy might hope to achieve. This is also especially ominous given the negative spillover effects that foreclosures have on a community. A score of negative things from crime rates to suicides increase as foreclosures rise. In the end, it comes down to what economists call Negative Externalities.

What is even sadder about the story is that this process could have been either prevented or mitigated at any of these five stages. And yet, nothing has been done.
About the Author:
Max Berre is an economist who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.


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