Should we just let house prices fall?

Low home prices are great for buyers, great for mobility, and great for the economy because we’d all have more money to save or spend on things beyond mortgage interest.

The transition from high prices to affordable prices has been horrendously painful, but necessary. Simply put, we have to go through it to get through it and come out on the other side.

So far, politicians have tried to preserve the status quo of high debt, high home prices, and lots of government involvement, because they think it’s what we want. They think it’s what will get them re-elected.

Today, they may be right. But patience is wearing thin.

Consider The Politics of High House Prices

Maybe that’s how all of this will end. Maybe, eventually, enough of us will get mad enough and tired enough and simply demand that the charade ends so that we can get on with out lives. Eventually protests could turn to riots as social acrimony spreads and perhaps at some point our politicians may get it:

It’s not high home prices that will get them re-elected, it’s that light-at-the-end-of-the-tunnel – the mass optimism that things will get better.

And right now, that light is pretty dim.

Only hours after I wrote that, Tom Petruno wrote in the Los Angeles Times Time to Let House Prices Fall?

Reports this week on home purchases in July were beyond dismal. Sales of existing homes tumbled 27% from June and 25% from a year earlier. New-home sales slumped to an annualized rate of just 276,000 units, down 32% from July 2009 and the lowest since at least the early 1960s.

Some of the fall-off undoubtedly reflected the spring expiration of the latest federal housing gimmick — tax credits of $8,000 for first-time buyers who met certain income requirements, and $6,500 for repeat buyers.

But it can’t be a coincidence that the summer plunge in housing demand occurred as faith in the year-old economic recovery continued to wane.

“It’s not a housing issue anymore — it’s an overall economic issue,” said David Crowe, chief economist for the National Assn. of Home Builders.

Historically, housing has led the way in recoveries. “But this is a case where housing is going to follow the economy, not lead it,” Crowe said.

Absolutely. When the tech-bubble burst, the housing boom pulled us out of the recession. It put people back to work and created wealth.

No matter how much money Uncle Sam throws at it, housing won’t pull us out of recession this time around.

Dean Baker, co-director of the Center for Economic Policy and Research in Washington, believes home prices still are overvalued by 15% to 20% in many areas.

For government to stand in the way of a further price decline is unfair to the next generation of buyers, he said. “The people who get hurt the most are those who are overpaying for houses today,” he said.

Robert Shiller, co-creator of the S&P/Case-Shiller price indexes, said that although he doesn’t forecast prices, “I think the scenario of declining home prices for years to come is underemphasized by people.”

That’s an argument for allowing the housing market to hit bottom sooner, so that a genuine recovery also can begin sooner.

The risk is that another downward spiral in home prices would feed a deflationary mind-set, meaning the sense that prices for all sorts of goods, services and assets can only go lower. That could cause many consumers to severely rein in spending, leading to another recession, or worse.

But a new decline in home values also could force the banking system, and the government, to finally deal realistically with a root cause of the economy’s woes: the gigantic debt load consumers took on over the last two decades.

This is exactly how the government is confusing the cure with the disease. Excessive debt is the root disease, and yet the only “solutions” they’ve come up with so far are encouraging us to borrow more money.

If the problem is debt, then the real solution must be the destruction of debt. That means foreclosures, bankruptcies, and lower home prices.

Regarding all of the stimulus and bailouts:

All of these ideas, however, are bailouts of one sort or another. “There is no ‘fair’ answer here,” Green concedes.

Well, there is one: Leave housing to market forces, let prices fall until buyers are motivated to come in, and hope that the economy can stand one final cathartic wave to clear the excesses of the bubble.

That one final, cathartic wave would be awfully painful. But, we would get through it. And, once we’ve hit bottom, there’s no where to go but up!