J. Bradford DeLong: August 21, 2009
It Would Be Good to Nationalize Housing Finance J. Bradford DeLong University of California at Berkeley and NBER delong@econ.berkeley.edu August 21, 2009
Let me start by outlining how the 2000s were supposed to work— according to Alan Greenspan. The late 1990s had seen a large technology-led boom that had employed extra millions of Americans and provided a forced draft that intensified the fire of economic growth. It was accompanied by “irrational exuberance” in the venture capital and stock markets, as investors began to think not just that technological progress in information technology was rapid but that it would be easy for the companies they invested in to turn that technological progress into profits. The first half was true—technological progress in America’s Silicon Valley is still progressing at an extraordinary rate: I just got a spam email offering to sell me a four gigabyte USB flash disk for storage for $9.25. In 1987 I paid $900 dollars for an Iomega ten megabyte hard disk–a hundred times the money for one-two hundred fiftieth the space, a factor of 25,000 in cost-per-bit. The second half was false—it’s very hard to pay a lot of dividends to your investors if you are selling four gigabyte USB flash disk for storage for $9.25. In the early 2000s investors began to realize that technological progress was easy relative to making profits in a competitive market, and high-tech stock prices collapsed, and the American high-tech industry began to shed workers as firms closed.
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J. Bradford DeLong: August 21, 2009
Alan Greenspan decided to deal with this situation by lowering interest rates. The enormous flood of savings from Asia seeking investments in America had started, so low interest rates could be sustained—demand for funds would not outrun supply. And low interest rates meant that lots of long-run durable investments would be profitable: you could, after all, borrow the money to produce or to buy them at low interest rates. And the biggest long-run durable investment as a share of the economy that the American economy makes is housing. So Greenspan thought that he could keep employment near-full by generating a housing boom, so that as employment in high tech (and related occupations) fell employment in construction (and related occupations) would rise. Did Greenspan worry about what would happen if the housing boom also succumbed to irrational exuberance? Yes. Did he worry very much? No. After all, when the high-tech stock market and venture capital bubbles had collapsed the systemwide consequences for the economy were small. Lots of overenthusiastic investors lost their money—but they were rich and they were grownups and the Federal Reserve doesn’t exist to keep rich people from risking their money in silly ways. Lots of engineers lost their jobs—but they had been well-paid during the boom, and would not have had nearly as good jobs (or perhaps any jobs at all) but for the boom. And American consumers got a lot of cheap computers and a lot of extra fiberoptic cables over which to make our phone calls. The winners were American consumers and (during the boom) American workers. The losers were relatively rich American investors. On net, a plus. Greenspan expected something similar to come out of the housing boom. If it did turn into a bubble, then the winners would be (a) homeowners who got to buy houses on good terms by borrowing at low interest rates and (b) renters who after the boom came to an end would find a plentiful supply of houses on the market and be able to bargain for big houses at cheap rents. The losers would be irrationally exuberant investors who had lent their money when it was cheap to borrow or bought extensive properties when prices were high. Once again—Greenspan thought—the workers firms closed. boom as as a whole, even with the likely magnitude of irrational exuberance
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J. Bradford DeLong: August 21, 2009
and overspeculation, would be a net plus. But it did not happen that way. The housing bust was big enough that, Ed Leamer calculates, we are now back to having not a plentiful supply of houses but rather a supply of houses that is in line with trend—and we are still underbuilding, which he says is “laying the foundations for the next housing mania.” Yet because the bust triggered a financial crisis and the financial crisis triggered a recession the market is not sending the construction industry the price signals of rising home values that trigger the recovery of the housing sector. Because of the recession, people are doubling up. And a great many houses are not where they should be—four bedrooms with swimming pools east of San Bernardino, Ed says, when what America really needs is multifamily units in the north of Orange County. And Ed is right. Thus there is a strong case for government intervention in housing finance to try to get the construction sector back to where it really, in a wellfunctioning market system, ought to be but where the magnitude of the recession is making sure that it is not. Ed points to California’s 10% or $10,000 tax credit for new homebuyers for the next six months, to the federal government’s 10% or $8,000 tax credit for relatively poor new homebuyers for the next four months, and “hopes that that is enough.” I don’t think it will be. I think that we should face the fact that home mortgage finance is broken, that the risk tolerance of the private financial system is impaired, that we will not get the flow of finance to potential homebuyers through private banks working again anytime soon. And we need to. So I think—I have thought for a year and a half now—that it is time to bite the bullet. The federal government has already nationalized the two great mortgage lenders Fannie Mae and Freddie Mac. It should stop treating them like private companies and start treating them like arms of the Treasury. They should set an interest rate spread above the 30-year Treasury rat—1.5%, 2%, whatever is appropriate—and then go out into boom the market as a whole, buyingeven up every with single the likely mortgage magnitude fromof itsirrational bank or whoever exuberance
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J. Bradford DeLong: August 21, 2009
currently holds it and transform it into a standard constant-amortization thirty-year fixed-rate mortgage at that rate. The government may well lose money on the deal. But a lot of homeowners who cannot pay their current mortgage and are about to be foreclosed on could pay thirty-year mortgages at Treasury +2%. And a lot of construction companies would be willing to start building the multifamily units in northern Orange County that we need if they knew that potential apartment buyers could get financing from the government on such terms. And the government might, after all, make money on the deal. Then, after the crisis is over, we can think about how to reprivatize the mortgage finance portion of the financial sector.
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