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Is Housing Too Important An Industry To Trust To The Free Market?

By Brian Brady

Commercial Real Estate Agent with Matthews Capital Markets NMLS 2415712

July 01, 2011 11:03 AM

Two analysts I follow have diverging opinions about residential housing finance.

PIMCO's Scott Simon, who predicted the housing collapse back in 2006, thinks the government backstops in housing should operate more like a utility (a government-sanctioned monopoly).:

For most adults today, the government has been involved either explicitly or implicitly in the backing of home loans for as long as we can remember. In our opinion, the pre-financial crisis selling of nongovernment-guaranteed mortgages was essentially an experiment. It was this private-market experiment that we further believe did not work as intended, and at one point threatened the entire global financial system.

If we ended government support in all forms, mortgage rates could rise significantly, because home loan investors would need to be compensated for greater credit risk, and loan availability could decline. Higher rates and less mortgage availability would put downward pressure on home values, with potentially negative consequences for the market and also for the economy as a result of wealth destruction and consumer confidence declining. banker

Simon adopts a collectivist approach, with the presumption that home ownership is a "public good", a right if you will. His argument presumes that housing prices must be artifically inflated, in spite of economic forces, so as to avoid a "run on housing". I think Simon ignores the fact that properties have income-producing value which offer a natural economic floor to prices. Simon's view isn't surprising when you consider the fact that he is a Wall-Street welfare queen (securities investor who prefers that profits be privatized while losses be socialized across the taxpaying public).

Alternatively, Reason Foundation's Anthony Randazzo is a true capitalist. He believes private businesses, in competition, should share in both the risks and rewards of investment. Randazzo makes an excellent argument against government-guaranteed housing loans, in this Wall Street Journal article.. The obvious argument is that it hasn't worked thus far but Randazzo goes deeper:

Guarantees degrade underwriting standards over time. Historically, a primary justification for guarantees has been to increase the availability of finance to politically important groups with higher credit risks. It is inevitable that this will continue to happen, requiring the government to lower underwriting standards, and resulting in more risky mortgages.

Government guarantees always underprice risk. All federal guarantees underprice risk in order to provide a subsidy for lending. That is their purpose. And taxpayers will be exposed to losses in the future, as those risks materialize.

This shouldn't be ignored. Politics hijacks government programs and mortgages become a way to buy votes. It is not unthinkable to imagine a day when union members get subsidized rates because they have "more secure jobs", This would be an excellent way to expand the labor movement and thus, secure the loyalty of a dedicated voting bloc. Conversely, expanded guarantees for miltary members, or defense-related industry workers, provides an economic incentive to grow those industries (and secure their votes) as well. Both political parties have their "favored children" and both have a history of using government mortgage programs to curry favor with them.

Guarantees inflate housing prices by distorting the allocation of capital investments. The artificially increased capital flow will make mortgages cheaper, boosting demand for housing and pushing up prices, ultimately creating another bubble.

This is the most dangerous unintended consequence of government subsidies. Two examples, unrelated to housing, are health care and education. Since the inception of Medicare, health care costs have risen by 2.5 to 3 times the inflation rate, to the point where the only solution to a government-engineered industry was a complete government takeover of the industry (which willl distort costs even more). In education, the expansion of Pell Grants and student loan guarantees created so much "monopoly money", that education costs rose at twice the annual inflation rate. The solution to that government engineering was a complete takeover of the education finance industry. dmv

Maybe Randazzo is wrong and Simon is correct. Perhaps housing IS too important an industry to trust to the free market. In that case, housing can be rationed by the needs of the population rather than economic forces. Certain people are probably more important than others to the State. Their value to the State's agenda could be rewarded with subsidies while others, who don't contribute to the State's agenda, can just pay more.

We're in the middle of a vortex right now. I think that lower housing prices are the most egalitarian affordable housing program available because it sufficiently matches supply and demand but, then again, I'm not a member of a favored political class. I still cling to the notion that competition is the best way to organize society.

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Retired Notworking

Tallahassee, FL

There are intelligent people and reasoning on both sides of every issue and you have presented some good arguments. I prefer freedoms and am not impressed with government's success at managing the country, so the less government control, the better.