Today's Opinions, Tomorrow's Reality 

Time For a New Leaf

By David G. Young

Washington, DC, February 28, 2012 --  

Raising home prices isn't the answer to boost America's sluggish growth.

After a fourth straight month of declines in U.S. home prices, worries are growing that the housing market is dragging down America's economic recovery. In figures released today, the S&P Case-Schiller national index showed a decline in home sale values of 4 percent over the past year.1

The debate on what to do to solve this problem led to a row between the Federal Reserve and Congress in recent months. The Federal Reserve published a whitepaper in January and followed it up by a February speech to the National Association of Homebuilders by Chairman Ben Bernanke advocating aid to the housing market.2 This didn't rest well with legislators, including Senator Orrin Hatch (R-UT) who sent a letter to the Fed Chairman demanding he refrain from lobbying.3

Indeed, despite the views of the most interventionist Fed Chairman in history, there is ample evidence that the continued decline in home prices is nothing but unfinished business from the collapse of the housing bubble. Compared with rents, home prices remain elevated compared to where they were 25 years ago4,5 (see graph.)

These data are based on a comparison between the Case-Schiller 10 city index and the Bureau of Labor Statistics' Owner's Equivalent Rent of Residences index. When both are fixed at their value in January 1987, U.S. home prices would have to fall by another 11 percent to bring them in line with rents.

There is an important limitation to this comparison -- first, the home price data going back to 1987 only include 10 major U.S. cities, where the data for rents is based on a broader set of urban centers. This difference in sample cities certainly exaggerates the overvaluation of homes because bigger cities have generally become safer and more attractive places to live in the last 25 years, and thus command relatively higher prices than they did a quarter century ago.

Yet even with this caveat in mind, the data certainly show that American home prices are not low by historic standards -- they are merely returning to normal.

Yet to macroeconomists like Bernanke, even a return to normal is deemed unacceptable, when it conflicts with the Fed's mission of supporting economic growth. But the last decade's source of growth was fleeting and unsustainable. It was based on an irrational rise in home prices and a rise consumption fueled by home equity loans and other forms of debt. It was but a sugar high that was quickly followed by a calorie crash.

Americans now finds themselves in a period of what economists call deleveraging. After years of living high on the hog while taking on new debt, they now have to reduce their standard of living in order to pay off these debts. As a result, an economy still geared toward consumer spending just can't grow as fast as it used to. This won't change until the nature of the economy changes. It's time to turn over a new leaf.

The answer to America's sluggish economic growth has nothing to do with boosting housing markets and consumer spending. Instead, America must pursue economic growth based on selling things that other people in the world want.

The good news is that despite a large trade deficit, exports have grown by 14 percent in real terms since the start of the financial crisis, while imports have remained relatively flat6 (see graph.) This proves that Americans make plenty of products that are desired the world over, if they can just hunker down and get to making them: cars, airplanes, food, movies, music, software and electronics.

If Americans continue to deleverage as they should, imports and housing prices will remain relatively flat while the trade deficit slowly shrinks. No, economic growth and consumer spending won't be as strong as they were five years ago. But for now, they absolutely should not be. Until America's economy returns to a sound footing, happy days will not and should not be here again.

Related Web Columns:

Smarter Than a Spendthrift, August 11, 2009

Persistent Problems, Painful Solutions, Feburary 10, 2009

Stagnation's New Decade, September 16, 2008


1. Standard & Poor's, All Three Home Price Composites End 2011 at New Lows According to the S&P/Case-Shiller Home Price Indice February 28, 2012

2. NPR, Bernanke: No 'Silver Bullet' For Housing Market, February 10, 2012

3. Orrin Hatch, Press Release: Hatch Warns Bernanke of Fed Treading too Far Into Fiscal Policy, January 10, 2012

4. Standard & Poor's, Case Schiller 10 City Index, February 2012

5. Bureau of Labor Statistics, Owner's Equivalent Rent of Residences, Not Seasonally Adjusted, February 2012

6. U.S. Census Bureau, Seasonally Adjusted Real Exports, Imports, and Balance Of Goods, Petroleum and Non-Petroleum End-Use Commodity Category Totals, 2005 Chain-weighted Dollars, February 2012