Steve Rhodes / http://www.flickr.com/photos/ari/

It has been more than three years since the housing bubble began to deflate. During this time, nationwide house prices have fallen by close to 30 percent, after adjusting for inflation. Millions of people have lost their homes and tens of millions of homeowners are now underwater, owing more than the value of their home. In addition, the destruction of more than $6 trillion in housing wealth has curtailed consumption and thrown the economy into the worst downturn since the Great Depression. Unfortunately, it seems that few people in policy positions have learned much from this disaster or have thought seriously about how housing policy should be reshaped going forward.

Homeownership Is Not Always Best

The first and most obvious lesson that should come out of this disaster is that it is not always best for people to be homeowners. This is true as a general proposition, but it is especially the case when the housing market is in a bubble, as it has been since the beginning of the decade.

Homeownership can often be a way for families to get good stable housing as well as an effective vehicle for them to accumulate wealth. However, this is not true everywhere and always. Specifically, owning a home is not likely to be a wise investment for families in unstable work or family situations.
There are large transaction costs associated with buying and selling a home. The round-trip cost on the purchase and sale of a house averages close to 10 percent of the purchase price. This would typically be the equivalent of about a year and a half worth of rent. If a family can only stay in a home for two to three years, these transaction costs can effectively boost their cost of housing by more than 50 percent, compared with what they would have paid to rent a comparable unit.

If a family does not expect to be able to stay in a home for at least five years, then they are likely to lose by being owners rather than renters. Those who do not have stable family or employment situations will typically be much better off renting than owning. It was irresponsible that many people in policy positions urged homeownership on families who did not expect to stay in their homes for a substantial period of time. It was especially irresponsible that they urged homeownership for these families in a context where house prices were clearly out of line with long-term trends. The bubble made it virtually certain that new homebuyers would lose money on their houses.

Having failed to recognize the bubble and warn against it, most people in the policy community are still not seriously addressing the fallout from this crisis. Specifically, we are facing a situation in which foreclosures are taking place at a rate of more than 150,000 a month, a pace that is likely to continue at least through 2010 and possibly well into 2011.

The most widely proposed response to this situation has been to urge lenders to arrange loan modifications, with some assistance from the federal government. While the modification programs have helped some homeowners, less than 15 percent of those facing foreclosure have even entered the loan modification process. Many of those who enter the process will not succeed in getting a modification. And many homeowners who do get a modification will subsequently default a second time, and thereby end up losing their home anyway. In such cases, the modification process will have only succeeded in delaying the loss of a home by six months or a year. On the current path, it is unlikely that more than 10 percent of the homeowners facing foreclosure will have successful modifications, meaning that 90 percent of the families in this situation will lose their homes.

Modification can also be costly to taxpayers. Many of the proposals involve the government giving servicers thousands of dollars per loan modified, plus guarantees that could lead to payments in the tens of thousands of dollars. Since some of these homeowners would have been able to stay in their home even without assistance, and some will end up losing their home even with assistance, these programs end up having a high cost for each foreclosure prevented. To a large extent, the banks, not the homeowners, are the main beneficiaries of these programs, as they collect far more on these mortgages than would otherwise be the case. This gap is especially clear in the cases where the homeowner ends up redefaulting. In that situation the sole beneficiary of the program is the lender.