The Housing Crisis Isn't A Crisis - Stand back, says Todd Zywicki, and let the markets clear

The Housing Crisis Isn't A Crisis. By Peter Robinson
Stand back, says Todd Zywicki, and let the markets clear.
Forbes, Apr 10, 2009, 12:01 AM EDT

Law professor Todd Zywicki of George Mason University is composing a book, Bankruptcy Law and Policy in the Twenty-First Century, in which Zywicki picks a couple of fascinating fights.
One involves former Fed Chairman Alan Greenspan; the other, the entire band of academics, former business executives and career bureaucrats who make up the Obama administration's economic apparat.

Zywicki's altercation with Greenspan requires a word of background.

After retiring from the Fed in 2006, Greenspan enjoyed the kind of semi-divine status that used to be reserved for Roman emperors. Then a number of economists, notably John Taylor of Stanford, began to argue that the monetary policy Greenspan pursued from 2001 to 2004, when Greenspan expanded the money supply dramatically, represented a proximate cause--maybe even the principal cause--of the housing bubble.

Last month, Greenspan descended from his plinth to defend himself. As Fed chairman, he had only lowered short-term interest rates, he argued in the Wall Street Journal, not the long-term rates on which mortgage prices are based. "No one, to my knowledge," Greenspan huffed, "employs overnight interest rates--such as the Fed Funds rate--to determine the capitalization rate of real estate."

Enter Todd Zywicki.

"What Greenspan overlooks," Zywicki says, "are adjustable-rate mortgages. ARMs are really sensitive to shorter-term interest rates."

"Look at the data going back to nineteen-eighties," Zywicki continues. "When the spread between regular mortgages and ARMs is less than about 150 basis points, people tend to take out regular mortgages. But when that spread widens, they switch to ARMs.

"What Greenspan did was artificially drive down the prices of ARMs, widening the spread. Low interest rates on ARMs enabled ordinary Americans to get bigger mortgages than they would otherwise have believed they could afford. That pushed up home prices. And that created the updraft that brought in speculators."

From loose money to cheap ARMs to rising housing prices.

"Nobody acted nefariously," Zywicki says. "Greenspan was trying to save the economy, not wreck it. But he still created a bubble."

This brings us to Zywicki's disagreement with the Obama administration. Treasury Secretary Timothy Geithner, Director of the National Economic Bureau Lawrence Summers and the other adepts in the administration all argue that the bursting of the housing bubble amounts to a national tragedy. According to President Obama himself, the "crisis" is "unraveling homeownership, the middle class and the American Dream itself."

Zywicki's reply? Nonsense.

His research has revealed three distinct types of housing markets--and only one of the three shows real signs of distress. Even then, that distress is only in a limited number of areas.

The first type of market behaves the way markets are supposed to behave, with smooth adjustments between supply and demand. When prices rose in places such as Dallas and Charlotte, builders constructed new houses. When prices softened, builders stopped. "Prices in these markets rose gradually," Zywicki says, "and now they're settling back to earth. There hasn't been any tragedy."

The second type of market, which appears in New York, Boston, San Francisco and Washington, D.C., demonstrates a long history of price volatility. "The housing stock in these markets is constrained," Zywicki says, "either by geography--San Francisco is surrounded on three sides by water, for example--or land use controls." When demand in such a market increases, prices soar. And when demand weakens, prices plummet.

"But the people who live in these markets expect big price swings," Zywicki says. "They've learned to live with them. They're holding onto their homes because they're confident prices will eventually recover. Again, there hasn't been any tragedy."

The third type of market displays both the ability to expand the supply of houses that characterizes the first type of market and the price swings that characterize the second type. "Type three markets," Zywicki says, "are concentrated in the Sun Belt. Ordinary investors seem to have calculated that a lot of people would either retire or buy second homes in these places. And when prices went up, speculators moved in. Pure bubbles developed."

In type three markets, hundreds of thousands of new homes went up. This oversupply will now keep prices low for years. "Las Vegas, Phoenix, Tampa--those are the places you'll find the tragedies," Zywicki says.

Instead of frightening people by talking about the end of the American dream, Zywicki argues, the Obama administration should offer reassurance, stressing the specific, limited nature of the foreclosure problem. "Heck," Zywicki says, "41 out of the 50 states have foreclosure rates below the national mean."

Next, the administration should think long and hard about just who it wishes to bail out and why. "If we bail out anybody, they should only be people who want to stay in their homes but can't make the payments, not people who could make the payments but want to walk," Zywicki argues. The administration should consider helping homeowners, in other words, but not speculators--"and if you put no money down and don't have any equity in your house, you're not a homeowner."

The most important step the administration could take? To resist intervening in the housing market as a whole.

"Assistance for the relatively small number of people who are facing really tragic circumstances makes sense," Zywicki says, "but if the administration tries to push overall housing prices back up, it will only be asking for trouble. We overbuilt. That's the reality. And not even Obama can change it."

In short, the administration should learn from the example of Alan Greenspan. Even when it intervenes in the economy with the very best of intentions, the government has a way of producing disastrous consequences.

Stand back, says the professor at George Mason University--stand back and let the markets clear.

Peter Robinson, a research fellow at the Hoover Institution at Stanford University and contributor to RobinsonandLong.com, writes a weekly column for Forbes.