Reason Foundation

http://reason.org
http://reason.org/news/show/politicians-must-ignore-urge-t

Reason Foundation

Los Angeles Business Journal

Politicians Must Ignore Urge to "Do Something" About Housing Woes

Officials can do little but ride out housing market crash

Samuel Staley
April 15, 2008

Angelenos must feel like Alice peering through the looking glass. A little more than a year ago, home prices were soaring, and for many middle-class families, homeownership was little more than a pipe dream. Now, the Los Angeles housing market is mired in a recession unparalleled since the Great Depression.

Unfortunately, state and local policymakers have little choice but to ride out the storm. Any attempt to "rescue" homeowners, Realtors or builders will wreak even more havoc on the housing market and economy.

The depth of the housing crisis is hard to dismiss. The California Association of Realtors reports that housing sales in the Los Angeles region are down 42 percent compared to February 2007 and home prices have fallen 20 percent. In Ventura County and the High Desert, prices have dropped even further. And in the San Fernando Valley, foreclosures nearly outnumber home sales, according to a study by California State University, Northridge.

Of course, the housing market meltdown isn't unique to Southern California. The National Association of Realtors reports national home prices fell for six straight months, the first time that has happened since they began recording sales data. The impact of all this on the economy has politicians scrambling to bail out lenders and homeowners. Sen. Hillary Clinton has even called for a moratorium on foreclosures and freezing interest rates in existing mortgages to stop the bleeding. But these feel-good programs will make L.A.'s problems worse, not better.

Speculative bubble

Unlike the Midwest and Northeast, where housing market woes are rooted in weak and stagnant economies, much of the housing mess in California is the result of a speculative bubble and a severe imbalance between housing supply and demand.

L.A.'s housing problems stem from the long recognized inability to meet rising demand. L.A.'s Department of Housing reports that the city needs to produce 8,600 new housing units per year just to meet current demand. From 1999 to 2003, the city added just 4,800 units a year.

This market imbalance goosed housing prices; it was a seller's market. During the housing boom, the median L.A. home price soared to nearly $600,000 in 2006 according to the U.S. Census Bureau. But these prices were simply unsustainable, and set the stage for today's devastating crash.

How do we know?

Using conventional rules of thumb, a typical household can "afford" a home valued between three and four times its annual income. So, a typical household would need to earn between $150,000 and $200,000 a year to afford the median house in Los Angeles, depending on the size of their down payment.

But, L.A.'s median household income is just $51,315. In other words, the typical L.A. household can afford a home valued between $150,000 and $200,000, about one third of the median price of a typical home here.

Despite that gap, the housing market stayed robust because many households took advantage of the inflated value of their homes, sold them and used the equity as a down payment on new, higher priced homes.

Others took advantage of creative lending products, including zero down payment requirements and adjustable rate mortgages, to take on housing debt they really couldn't afford long-term. By 2006, more than a half a million L.A. households, 44 percent of all households, were funneling 35 percent or more of their monthly income toward home upkeep and their mortgages.

Unfortunately, the only practical way out of this morass is to wait.

Local and state politicians need to fight their impulses to "do something." The best thing, as painful as it may be, is to let the local housing market rationalize itself and bring prices back in line with the reality of what L.A. households can afford. This likely means even further declines in home prices while banks and other financial institutions scramble to readjust their portfolios to reflect lower home prices.

Limited supply was the biggest factor driving up home prices in California, but many investors were also playing the L.A. real estate game in the same way they'd play the stock market or blackjack tables in Las Vegas. They bet that they could take an interest-only loan, flip the house, and win big. Well, some lost that bet. The government shouldn't be in the business of bailing these gamblers out.

After years of skyrocketing housing prices, many first-time homebuyers and middle-class families could actually benefit from this market correction if it brings L.A.'s housing prices back in line with the region's incomes. Then the working families long priced out of the Los Angeles housing market may finally get a shot at owning a home.


Samuel Staley is Research Fellow


Print This