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Housing Clouds Economic Recovery

Author: Roya Wolverson
August 25, 2010

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A plunge in U.S. home sales and uncertainty over the Obama administration's housing policy plans are fueling fears about another looming recession. Sales of previously owned homes fell 27.2 percent in July, the lowest level in over a decade, followed by a sharp drop in new U.S. home sales, leading economists to predict a further decline in housing prices (WSJ), which stabilized last year. Such declines, coupled with high unemployment and slow hiring, could further depress consumer spending, key to short-term recovery (WashPost). The development also raises questions about how to reform the government's role in the housing market, particularly its relationship to mortgage lenders Fannie Mae and Freddie Mac, whose near-collapse are considered partially to blame for the housing bubble and subsequent financial crisis.

Continued glum U.S. economic news bodes poorly for the global recovery. With Europe and the United States facing the threat of deflation, the value of the Japanese yen has risen sharply against their currencies (MarketWatch). Fears about European sovereign debt persist, with news that rating agency Standard & Poor's downgraded Ireland's long-term credit rating and Spain's economy continued contracting last year.

U.S. housing has typically led the country out of recessions, but continued low mortgage rates have failed to offset the decline in home prices, since homeowners and buyers remain constrained by high unemployment, consumer debt, and rising foreclosures (Bloomberg).

The Federal Reserve attempted to bolster market confidence with a recent pledge to keep interest rates near zero and maintain its $2.05 trillion stash of mortgage debt, a controversial move both within the central bank (WSJ) and among economists. But whether the Fed can create public confidence by tweaking monetary policy remains unclear. The Fed has already spent two years flooding banks with liquidity to spur growth. That has prompted some critics to argue that the reason corporations are sitting on cash rather than hiring has more to do with uncertainty surrounding new financial regulations and healthcare reform.

Crisis Guide: The Global Economy

Adding to the uncertainty is the Obama administration's proposal due early next year on rebuilding the national mortgage market and reforming Fannie Mae and Freddie Mac (TheHill). Fannie and Freddie, along with the U.S. Federal Housing administration, are responsible for some 95 percent of the country's mortgages today (WashPost), up from 30 to 50 percent before 1990.

Bill Gross, who runs the world's biggest bond firm, Pimco, has argued for complete nationalization of the mortgage market (WashPost) to help boost the overall economy. But many congressional Republicans say Fannie and Freddie, along with other housing subsidies, should be eliminated to fix the market distortions that created the housing bubble. "Setting as a goal the maintenance of high levels of investment in housing has obvious political appeal, but it's junk economics for a nation that wants to innovate and grow," argues this recent Wall Street Journal editorial.

Additional Analysis:

American Enterprise Institute Fellow Peter Wallison says recent remarks by U.S. Treasury Secretary Timothy Geithner suggest the government is trying to "disguise its responsibility" for the demise of Fannie and Freddie by blaming the problem on the businesses' pursuit of short-term profits rather than flawed government housing policy.

Harvard economics professor Kenneth Rogoff says there is too much discussion on what U.S. and European governments can do to stimulate demand through budget deficits and monetary policy. "These are key issues in the short term," he says, "but, as every economist knows, long-run economic growth is determined mainly by improving productivity."

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