Finally an article on letting prices fall so housing can correct itself. Also on Yahoo.

Best Way To Fix Housing Market: Let Prices Fall (Fast)
Henry Blodget | Dec 31, 08 9:51 AM
Until the housing market is “fixed,” most experts agree, the economy is screwed. So for the past year, the best and the brightest have brainstormed dozens of plans to fix the market. No plan we have seen is likely to do anything other than delay the inevitable.

“Fixing the housing market” is usually defined as:
– Stopping house prices from falling
– Stopping foreclosures

These are actually two separate problems, so it’s best to take them one by one.

Prices. The best way to stop prices from falling is to let them fall far enough to reach equilibrium, fast. They are already doing this without our help. Nationwide, prices are already down 25%, and they are falling at a rate of almost 20% per year. Even the biggest housing bears aren’t looking for a peak-to-trough fall of much more than 40%. And at the current rate, we’ll be there in another year.

Note that 40%+ price drops in Phoenix and elsewhere have already “fixed the market” in those cities. Foreclosed houses are selling like hotcakes because prices are finally attractive enough to draw in new capital. Un-foreclosed houses are NOT selling like hotcakes, but this is because their owners have yet faced up to the reality of how little they are worth (or, put differently, because they don’t yet have to sell).

But there is nothing broken about these markets. Owners who have to sell their houses will cut prices until they find buyers, and those who don’t, won’t. And given that most house prices are still above their long-term average relationship to incomes and rents, it’s no use pretending that 2007 prices were in any way normal or something we can or should immediately return to.

The vast majority of plans to “stop prices from falling” involve subsidies of one form or another (tax credits, subsidized mortgage rates, etc.) These may slow the decline, but they won’t stop it–because even the US government can’t subsidize everyone forever, at least not enough to maintain prices at above-average levels in inflation-adjusted terms with the current inventory glut. And subsidizing/encouraging debt-bingeing and homeownership is what got us until this mess in this first place.

The fastest and most effective way to stop prices from falling is to let them fall until they’ve reached equilibrium. And then start rebuilding wealth, equity, and economic growth from there.

Foreclosures. Lots of Americans are going to lose their houses in the next few years regardless of what we do. In some cases, this is because they bought houses they couldn’t afford. In some cases, it’s because they lost their jobs. In some cases, it’s because they have too much debt. In some cases, it’s because of predatory mortgage lenders and any number of other reasons. Keeping the number of foreclosures as small as possible is certainly a worthy goal, for communities, families, and the rest of the housing market. But not if it temporarily and artificially keeps people in houses they can’t afford (this will just delay the inevitable).

Importantly, foreclosures are not caused by falling house prices. Foreclosures are caused by owners’ inability to make debt payments. House prices could drop to zero, and as long as homeowners are able to keep meeting payments, there needn’t be a single foreclosure.

The best way to stop foreclosures, therefore, is to get people out of houses they can’t afford and into houses they CAN afford (whether by renting or buying). The collapse of prices actually helps this process, because it makes houses more affordable for those who aren’t yet homeowners or who are willing to trade down (and can sell their existing houses or declare bankruptcy and start again). And so, obviously, does economic growth, which is only likely to be strong again once house prices have stopped falling.

The Obama Administration will likely roll out some sort of mortgage restructuring plan that will enable some homeowners–some–to stay in houses they can’t afford with ARMs and other mortgages that reset at much higher rates. This will help save some houses, but it won’t fix the foreclosure problem–in part because more and more folks are now losing their jobs and income. And this brings us back to the house-price issue again. (No reason to buy or build now if you think prices will be cheaper tomorrow).

Bottom Line

Businesses and consumers won’t open up their wallets again until they are persuaded that things have stopped getting worse. That will NOT be when foreclosures stop. It will be when house prices stop falling. And the fastest way to get there is to let them fall.