Tyler Cowen agrees that housing prices need to come down. But he fears the consequences of that action:
[W]hat happens if we let them fall? Arguably many banks would once again be "under water." Enthusiasm for another set of bailouts is weak, to say the least. Our government would end up nationalizing these banks and it still would be on the hook for their debts. The blow to confidence would be a major one, especially if along the way we saw a recreation of a Lehman or Bear Stearns or A.I.G. episode.
I increasingly believe there is no easy way out of this dilemma and it is a major reason why the U.S. economy remains stuck.
Avent approaches this question from another direction:
That doesn't mean that the government should be trying to increase prices (though I think that maintaining the liquidity of the mortgage market is critical). It does mean that absent a real mechanism for dealing with homeowners in negative equity situations, falling prices will not clear the housing market. Let prices go where they will go; the problem is in the huge pile of mortgage debt that is no longer supported by home values.
This hangover is going to last a long, long time, isn't it? And we might as well face it.
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