Time to keep subsidizing home prices

I have to disagree with my colleague Steve Taub on this, not because my heart bleeds for jobless, underwater homeowners, but to keep foreclosures from driving home prices ever downward.

Here's the thing: What is the "natural" price that Steve wants the market to find?

I'd argue that there is none, or more precisely, that in the current environment, it will be impossible to distinguish that from a "fire sale" price. This conundrum is, in fact, the basis for the one solid argument that banks made against marking assets to market during the financial crisis, and why the Financial Accounting Standards Board was right to offer them the alternative of marking assets to model, if they could justify the projections of future cash flow from such assets on which such valuations are based.

The problem here is that just letting the market do its thing could very well lead to a downward spiral in asset prices, instead of a "natural" bottom somewhere safely north of pennies on the dollar. Remember, more than a few of those AAA mortgage securities still on banks' books are still worth only that even now.

The thing is, we've been down this road before in the early 1930s, when Herbert Hoover's treasury secretary, Andrew Mellon, opined that what was needed to fix the economy was to dump every asset in sight. Here's what Mellon recommended to Hoover: "Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate... it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."

Of course, there are those who argue that FDR made the depression worse by doing the opposite, in effect, with the New Deal. But any honest reading of the historical record shows otherwise. (Hint: Government-created jobs count.)

I'm not saying that we should mindlessly keep bailing out banks and homeowners. But what's wrong with restructuring the mortgages in bankruptcy court? Sure, the banks don't want to give bankruptcy judges the right to forgive loan principal because that would force them to write off the debt and book losses on it.

So what? Those banks that can't afford to do so are insolvent and should be dealt with through FDIC receivership. As for homeowner subsidies, yes, Fannie Mae and Freddie Mac should be restructured as public utilities and their mission limited to support the market when it's hurting, just like the SEC does the stock market through circuit breakers to prevent crashes. But contrary to what some critics say, housing subsidies were not the root cause of the crisis. That prize goes to stagnant wages, which made the subsidies (and those include low interest rates) necessary to sustain the housing bubble, and with it, consumer spending.

The whole idea of government intervention in the economy is to try to avoid or at least cushion the boom/bust cycles that characterized the late 19th and early 20th centuries, when the free market last was given the free reign that Steve so ardently seeks and that caused one depression after another.

The absence of such intervention is what ultimately led to the Crash of 1929 and the biggest depression of all (not to mention World War II), and, with said absence coming in the form of tax cuts for the rich and deregulation, what we got a taste of two years ago.

If we keep forgetting or ignoring all that and, unwittingly or not, heed Mellon's advice, not to mention that of those who, like Mellon before them, rail against government deficits and blame them for our problems, we'll get much more than a taste.

Don't take it from me. Here's Yves Smith over at Naked Capitalism yesterday on why the Fed is pushing on a string: "The underlying problem is overreliance on monetary policy, when what is needed is more aggressive measures to force resolution and restructuring of private sector debt, with stimulus to offset the downdraft of the resulting losses (note the losses really are there, but in a reverse Tinker Bell syndrome, if we all quit clapping, the economy might die). But we instead wrote large, close to blank checks to big banks, and provided them with even more backdoor subsidies, and voters have lost patience with fiscal deficits, even if we might finally be getting around to more deserving and useful targets."