Sunday, March 4, 2012

Housing and the Economy -- Which is the Chicken and Which is the Egg?

For those who ask why I continue to forecast declining U.S. housing prices, here is the core of the issue. U.S. housing will not likely recover until the U.S. economy improves...but the economy will not improve until the housing market recovers. It is a classic chicken and egg problem.

Getting out of this vicious circle is difficult. Recovery of the economy depends on spending by middle-class consumers, which represent almost 70% of the US Gross Domestic Product. But spending by those consumers has been stalled by declining housing prices. 

Some suggest modifying the personal bankruptcy code. This is a good idea but its proponents tried to include such revisions as part of the Dodd-Frank financial legislation of July 2010--and failed. Other ideas have also been floating, including the suggestion that government agencies own part of people's houses in exchange for forgiveness of debt. This also seems a little far-fetched.

In the meantime, our current tax policies favor the top 10% of the population (including myself) and leave the rest to suffer declining real wages, increasing expenses for oil and food and health care, and rising costs of a college education. The current strategy of allowing inflation back into the economy (so that borrowers will have an easier time in repaying their debts) is surely not one likely to succeed.

In the author’s view, what is needed is: (1) a fundamental restructuring of the personal tax code to simplify and lower taxes (which always increases tax revenues by eliminating the loopholes), (2) reform of the business environment to make it easy for small businesses to operate and grow, (3) a national education policy to increase the college-educated population to 50% (from just over 20%) of all adults and (4) a viable long-term strategy to reduce total government debt (including state and local government obligations) from the current level of 120% of Gross Domestic Product.

Along the way, we also need to bring our telecommunications policies in line with international practice and increase effective competition among the carriers. In financial services, we are only half-way through the reforms needed to avoid another financial crisis similar to September 2008. Improving consumer protection in financial services and raising financial literacy will eventually be critical but for the moment, regulating financial instruments such as credit derivatives is far more pressing. Stopping banks from using tax-payer funds to finance speculative investments, as former Federal Reserve Chairman Paul Volcker has proposed, is at the top of the agenda but remains difficult to put in place.

Big agenda, eh?

Of this, so far the administration has announced efforts to: (1) reduce corporate taxes, (2) make it easier to borrow for college, (3) develop a bipartisan plan for government debt reduction, (4) strengthen consumer protection in lightly regulated financial services, such as payday lending and debt collection, and (5) adopt the Volcker rule on banks' use of depositor funds. It is a start but not enough to get the economy moving--or solve the housing dilemma--or give the middle-class a chance to realize the American dream once again. 

But at least, we don't have to figure out which is the chicken and which is the egg.
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