How to Fix the Housing Market

Washington says it wants to help homeowners, but so far it hasn't. Here's what might actually work

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Vincent Laforet

Las Vegas has borne the brunt of the housing crash, with plummeting home values and a spike in foreclosures.

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At the same time, some houses are still overvalued. Economists disagree by how much, and the answer changes from region to region. Houses in Cleveland are undoubtedly cheap. They could use some new home buyers there. But if we're still not in the ballpark of normality overall--and certain market watchers think we might see prices drop an additional 10% to 15% nationally before this thing is over--then spending billions to spur on buyers won't be a magical fix. "To prop up prices above fundamentally justified levels is throwing good money after bad," says Joe Gyourko, professor of real estate and finance at the University of Pennsylvania's Wharton School. Overboosting homeownership helped get us into this mess, after all.

In some ways, proposals to stimulate the housing market aren't really aimed at bringing in new buyers. Extending tax credits to people selling one home to buy another and letting homeowners use cheap mortgages to refinance won't get rid of excess housing inventory. These policies are meant to do something else: stimulate the economy by delivering money to homeowners. "We could tell everyone you can get a credit card at a rate of 6%, and that would put money in people's pockets too," says Dean Baker, a co-director of the Center for Economic and Policy Research. Call this a housing-mediated stimulus--but don't call it a housing-market fix.

Figure Out Who Should Be Saved

The other core issue is that too many people can no longer afford their mortgage. Maybe they took out an adjustable-rate loan that has reset higher, or they lost a job in the slowing economy. If we could stop the cycle of defaults and foreclosures, the thinking goes, we could prevent deeply discounted, bank-sold homes from flooding the market, keep losses from further impairing mortgage-backed securities and preserve property values. That's how we wind up with ideas like paying mortgage servicers to make loans more affordable and changing the bankruptcy code to allow judges to reduce the amount borrowers owe their mortgage company.

Are there people who bit off more than they could chew and will never be able to afford their homes? Yes. "We need to recognize the goal is not to keep everyone in their houses for as long as possible," says Edward Glaeser, professor of economics at Harvard University.

But there are also plenty of people who might be able to keep their homes with a lower interest rate or a longer loan period. In many cases, this is in the best economic interest of the mortgage holder, since up to half of a house's value can be lost in foreclosure. And yet often--especially when the loan has been chopped up and dispersed to investors around the globe with a third-party servicer in charge of collecting payments--that's not happening. "Servicers don't have the right incentives," says Christopher Mayer, professor of real estate at Columbia University's Business School. Cutting them a check in return for a modification of the loan, or trumpeting their legal authority to do so, is meant to prime the mortgage-rewriting pump, as is letting bankruptcy judges revise mortgages.

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