Dotzour’s 4 stage plan to fix America’s housing problem

by Steve Crossland, REALTOR in Austin TX on December 22, 2008 · 5 comments

Texas AM economist Mark Doutzer Dotzour has a new video outlining his 4 stage plan to fix America’s housing problems. Regular readers know Dotzour is my favorite economist on these issues, not to mention a funny speaker if you ever get to see him in person.

He breaks it down like this; at its essence, the housing crisis at present is a supply and demand problem. There are too many empty homes and not enough demand. He proposes:
1) Curtail the supply, especially new home construction.
2) Slow foreclosures.
3) Increase demand, particularly by incintivizing qualified investors.
4) Lower interest rates (this has already started to happen)

You can watch the video at this link. It’s about 7 minutes long. Or you can read the transcript below.

Bold Government Can Solve America’s Housing Crisis
by Mark Dotzour, Chief Economist, Director of Research
Real Estate Center at Texas A&M University

America’s housing market problem is fairly simple. Somewhere between one and two million vacant
homes need tenants.

In some communities, vacant homes are not being cared for, deteriorating the quality of the
surrounding neighborhoods. This is causing further price declines, which lead to more foreclosures. The
fact is supply is running far ahead of demand. What has to happen for the national housing market to
stop falling?

We need to decrease supply and increase demand. This can be done in four stages.

Stage One
First, we must curtail the supply of new homes in the market. Virtually everyone agrees that falling
home prices are at the center of the current economic and financial crisis in our country. Why are new
homes still being built in cities where prices are collapsing and foreclosures are skyrocketing? Even in
places like Detroit and Sacramento where foreclosures are at the highest levels, thousands of new
homes are still being built.

In the first nine months of 2008, 2,825 new home building permits have been issued in Sacramento and
1,528 in Detroit. When new homes are built in challenged markets and sold with massive price
concessions, prices for all homes in the community trend downward.

Stage 2
Second, we have to slow the supply of homes coming back into the market through foreclosure. To this
point, government efforts to do this have not worked. It appears the FDIC plan used to mitigate losses
at IndyMac Bank offers a workable solution. FDIC Chair Sheila Bair is emerging as the new thought
leader in this arena.

Simply “helping people stay in their homes” has disturbing repercussions. If you are 90 days delinquent
in your mortgage and the government reduces the principal amount of your mortgage and lowers your
mortgage payments significantly, what incentive do you have to get back on track? Only the stigma of
bankruptcy and foreclosure will limit that trend.

If one homeowner in your neighborhood gets lower principal and lower payments, wouldn’t the other
five owners on your block want the same thing? And the fact that the government is willing to consider
“freezing interest rates on mortgages” and “cramming down principal” is not going unnoticed by bond
investors.

Suppose you invested your grandmother’s savings in mortgages that were expected to pay her 2 percent for two years and then 6 percent for the next eight years. One day you read in the newspaper that Congress is considering freezing the interest rate at 2 percent. Then you note that the chairman of the Federal Reserve is encouraging banks to write down principal balances on mortgages. Now grandma will be lucky to get 2 percent for the life of her bond and then $700 in principal back. Will you and grandma want to buy any more of these bonds?

Stage 3
Third, we have to increase demand for houses, and we have to do it quickly. What are we waiting for?
How long do American homeowners have to be punished before the government will step in and help
stave off a larger catastrophe as house prices continue falling? How can the government do that?
Simple. It needs to give investors an incentive to purchase vacant homes and rent them to tenants.
With solid mortgage underwriting standards, investors can buy these homes. There must be adequate
down payment so the investor has a big incentive to keep the house. This can be done by lowering the
depreciation schedule for investors who buy foreclosed houses to around five to seven years. If we
really want to solve the problem quickly, offer these investors zero percent capital gains tax if they hold
the properties for more than five years.

Tax policy is frequently used by the federal government to modify behavior in America. A similar tax
incentive was given to all businesses after Y2K to buy computers and software because of an acute lack of demand.

By getting these vacant homes into the hands of private American citizen owners, people will have an
incentive to keep the lawns mowed and the windows from being boarded up. This will help staunch the
decrease in neighborhood values resulting from lack of upkeep.

Stage 4
Fourth, mortgage rates are way too high. Over the past ten years, the 30-year mortgage rate has been priced somewhere around 1.5 percent higher than the ten-year Treasury rate. The ten-year treasury rate has been around 3.7 percent in recent weeks. This means that under normal circumstances everyone in America should be able to get a 30-year mortgage for about 5.2 percent.

Unfortunately, mortgage rates have been much higher than that. Why? In my opinion it’s due to a
complete lack of confidence in the financial integrity of Fannie Mae and Freddie Mac.

The government has now nationalized these two institutions. Why not go ahead and make the
government guarantee on “FRANNIE” bonds explicit? Just tell the world that, for the foreseeable future,
FRANNIE mortgage bonds are guaranteed by the full faith and credit of the U.S. government. This would drop mortgage rates substantially and let all Americans refinance their homes at a very low rate.

On Nov. 20, the ten-year treasury rate dropped to 3 percent. This should create an opportunity for all
Americans to refinance with a 30-year mortgage around 4.5 percent. Everyone knows that the federal
government “implicitly” was behind FRANNIE bonds. Now that they have been nationalized, make the
guarantee explicit.

Summary
No matter how complex this situation appears to be, it can be reduced to supply and demand. In the
housing market, we’ve got too much supply and inadequate demand. We need public policies that
address these fundamental wounds in the U.S. economy. Simply printing money is a temporary
bandage that merely delays the inevitable.

{ 5 comments… read them below or add one }

1 Aaron December 22, 2008 at 12:26 pm

Following through with these stages would seem to lock America in the current fiscal doldrums for an interminable future. Housing prices will be locked at artificially high prices, no one will be able to afford to become homeowners, because of government intervention, and we will become even more of nation of haves (investors) and have nots (renters).

Sounds economic principles in a capitalistic society depends on responsibility. The bond holders may have simply made bad investments and should be responsible when those investments do not pay out.

Real estate investors should not expect the rest of society to subsidize their profits, through zero capital gains tax, any more than the individual homeowners who bought in over their head. Both groups should be responsible for the risks they have taken on.

The best course of action (in my humble opinion) is to speed up the housing correction, so that the responsible investors can again make intelligent investments in the economy.

My counter plan:
1) New housing starts will fix themselves in the near future. If there is no market then they will stop building. It is as simple as that.

2) Speed up foreclosures. Get as many people out of the houses so the free market can more quickly return these houses to the proper values.

3) Treat investors the same as everyone else. No more sweetheart deals. Those are the policies that got us in this situation in the first place.

4) Raise interest rates. If bond investors (e.g. your grandma) can not expect a decent return on their investments because the Federal Reserve is giving money away, then no one will invest. We have too long been a debt society, we need to become a responsible investor society. High interest rates encourage saving, and discourage living off credit cards.

If you implement these 4 stages, then you will see one thing happen. Housing prices will drop dramatically. Then, remarkably enough, average people will be able to afford them again. If they have good credit, then the banks will loan them money, and this will encourage responsible behavior. Yes, current investors (both real estate and bonds) will be hurt by this price decline, but that will be a temporary pain, and there will be an important lesson learned about investing in bubble markets, which everyone did not apparently learn the last time in 2000.

2 tony December 22, 2008 at 4:05 pm

Government intervention is not the answer. Let consumers decide where they want to buy. Falling housing prices are good for consumers.

3 David Jones December 23, 2008 at 7:54 am

His name is Dotzour, not Doutzer. If you are going to quote the man, at least get his name right. Good grief.

4 Steve Crossland December 23, 2008 at 8:53 am

David, thanks for pointing our my error. Corrections made.
Steve

5 Martin January 5, 2009 at 1:57 pm

This guy doesn’t have a clue. He was probably saying that there was no housing bubble 2 years ago.

The problem isn’t that housing prices are dropping. It’s that they rose out of proportion with incomes.

Housing starts have been dropping by themselves. They are at a decade low.

Demand increases with price declines. That’s the supply-demand curve.

Interest rates will stay low as long as we’re in a deflationary environment.

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