Sunday, August 12, 2007

Let the Foreclosures Begin!

Many politicians are complaining about the rising wave of foreclosures, and insisting that government needs to step in and stem the crisis. Thankfully, President Bush has decided to do so such thing. Why not, you ask? Well, it simply isn't the government's place in a free-market system to insulate individuals from risk; such a practice simply encourages greater risk-taking and creates ever-greater bubbles until the protector is no longer able to be a hero.

Housing prices must correct! I hope to be financially in a position to benefit from a substantial correction down the road, but this isn't simply about the value investor in me who's hoping in asset price corrections to give me goods at bargain prices. We have frequently heard complaints that housing in most big cities is unaffordable. The Housing Affordability Index put out by the National Association of Realtors declined from a high of 133.2 in 1998 to 113.9 in March 2007, thanks to the housing boom. But even that understates the problem because it considers home prices across the US - the median price, for example, is $215,300 - good luck finding a home for that price in almost any decent-sized American city.

A real estate correction then is appropriate, and may be desirable in the long-term. Despite all the huey, one could argue that indeed price appreciation in excess of wages is rather undesirable, and if anything, government should consider tweaking tax policy to dissuade rampant speculation, including measures such as limiting the number of times you can flip a house before you lose capital tax gains.

This is hardly a popular position. We tend to get really excited when stocks or houses skyrocket in price, even if it means that the early buyers are being rewarded, while younger entrants are forced to pony up. But unlike stocks, housing affects livability, and government support of speculative efforts would be rather undesirable.

A side note You may have read that the Fed Reserve has been using something called repo agreements to purchase mortgage securities. Lest you think of it as a bail-out, here's a clarification I needed, from John Hussman of Hussman Funds:
Contrary to the apparent belief of investors, the Fed did not shift its policy, nor did it “bail out” the mortgage-backed securities market by “buying” them from banks. What actually happened is that the Federal Funds rate shot to about 6% on Friday morning, and the FOMC brought it down to its target rate by entering into 3-day repurchase agreements . The banks sold securities to the Fed on Friday, and are obligated to buy them back from the Fed on Monday at the sale price, plus interest. Such open market operations are designed to ease the immediate demand for liquidity, and to give the banks and dealers more time to find buyers in the open market for the securities they are trying to liquidate.

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