Preventing a Recurrence
of Widespread Home Foreclosures

Edward J. Dodson

[A response (3 March, 2008) to a commentary by Lawrence Summers
on the Economists' Forum of the Financial Times, 25 February, 2008]

America needs a way to stem foreclosures By Lawrence Summers The American economic outlook remains highly uncertain. But macroeconomic policy is now properly aligned, as the economy will benefit over the next several quarters from fiscal and monetary stimulus. To the extent conditions warrant and inflation risks permit, monetary and fiscal policy are appropriately poised to provide further stimulus. Policy towards America's failing housing sector is in a far less satisfactory state. All honest analysts accept that policies adopted so far, such as the "teaser freezer" limits on resetting mortgage interest rates and increased federal support for mortgage lending, have had only a marginal impact on what may be the most serious crisis in housing finance since the Depression. ... [Go to the Economists' Forum link above to read the full commentary by Prof. Summers]

March 3, 2008

Once again, we are as a society debating what public policy measures are appropriate to mitigate the negative consequences of other public policies. In this case, the policies are those that create expectations of huge gains out of investment in or ownership of residential real estate.

Economists could play a much more constructive role by describing the market forces at play with greater specificity. I say this as someone who has spent decades trying to put together affordable housing initiatives that would counter the effects of contradictory existing public policies. I have found in my discussions with bank economists, for example, that too few possess a good understanding of the operation of land markets, even though land markets impose heavy costs on those who produce goods and services, including housing.

The irony is that land markets are not that difficult to understand. With rare exceptions (e.g., buildings having some historic character) housing does not increase in market value. A house must be constantly maintained and its main systems actually replaced to match the resale value of new construction.

The component of 'housing' that is subject to speculation is land. A major reason for the periodic escalation in mortgage loan defaults and foreclosures is that the GSEs and FHA have consistently increased mortgage loan limits to accommodate rising land prices. When combined with lower down payment requirements, more flexible creditworthiness standards and a stable or declining interest rate environment, a higher percentage of mortgagors are certain to be vulnerable to even modest shocks to their personal financial circumstances.

If economists want to help solve the problem of widespread mortgage foreclosures, my suggestion is that you get behind policies that will tame land markets - starting with restructuring of the property tax so that property improvements are eventually exempted and land values are more fully captured as a primary source of public revenue.

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Martin Wolf: I very much liked Mr Dodson's comment here. It parallels arguments I have been making for some time for shifting to land-value taxation in the UK, where the combination of tight planning controls with modest taxation of land, has generated enormous appreciations in the price of land. My very rough estimate is that the real price of land has risen something like four-fold in London over the past decade. Quite apart from the economic effects, this has generated a massive intergenerational shift in wealth, from the young to the old, which I regard as highly undesirable.