Everyone around knows that the housing crisis is affecting the U.S economy and in turn the World economy. We are all looking at different strategies our government is coming up with to tackle the problem and stabilize the economy.
Yesterday, when my dad asked me whether I understood what’s going wrong with the U.S. economy, I said, “Yes.” He then went on to say “Why don’t you come up with a possible solution to the problem?”
So the following is an abstract of my understanding of the problem and the most likely solution.
First, the housing cycle is a simple 3-step vicious cycle.
1. People buy houses and drive up the market.
2. Banks issue more loans and decrease the 30-year fixed interest rate.
3. Decreasing housing inventory creates demand and increases property prices.
The first step should be stimulated to positively influence the next two steps. Here lies the most amazing feature of the cycle; if this first step is not stimulated then the entire cycle is slowed down.
Generally, when more people buy houses the market improves and banks issue more loans at the lower 30-year fixed rate, which in turn allows more people to buy houses. Both these steps act together to decrease the housing inventory and create demand for housing, which increases property prices. This demand will trigger the first step and the cycle will repeat itself.
In today’s market, where property prices have been steadily dropping, people have lost their confidence and so are not investing in real estate. Others who have bought houses at higher prices are suffering foreclosures because of unemployment and the inability to pay their mortgages.
These foreclosed properties are now lying with the banks as bad debts, which pushed the banks’ balance sheets underwater. These banks have become illiquid and are not able to lend. The fear of more foreclosures, with the continuous lowering of property prices and a bad economy, are accentuating the existing overall economic problem.
Banks not lending to each other and to small businesses is triggering a huge economic crisis that’s hurting not only the U.S. economy but also the World economy.
The U.S. government is currently liquidating the banks and pleading with them to lend money in order to prevent a global recession. I feel that the steps being taken by the government will only relieve the symptoms of our dreadful economic disease and not offer a complete cure, since the government is not attacking the root cause of the disease; the lowering property prices.
Only steps taken to stabilize the property prices, which also allow them to grow, will help deal with the whole crisis.
A rise in demand, which causes a continuous rise in property prices generally, acts as a trigger to the first step of driving up demand. As this is not the scenario anymore, the government has to trigger this first step by taking some initiatives.
I suggest the government open a Parallel Funding Facility that would invest along with the buyer to guarantee the buyer’s investment and increase confidence in the system. The property has to be sold at a discounted price and the investor should be paid a minimum interest on his investment, but both these steps together would entice people to buy more properties. These investments by individuals should be allowed to be traded like bonds, to be liquidated, if the investors need it.
These steps would attract huge investments from public and these investments will liquidate the banks and other companies holding these foreclosed houses, reduce the housing inventory, create demand and help to increase prices. As prices start to increase, the buyers will pay the balance amount, initially funded by the government, to own the property. As the banks get liquidated they would allow more loans, lower the 30-year fixed rate and help build a better economy.
Through this process, our government would directly help the public and not the big banking and investment companies. This would allow the government to regain its strength and reputation, and would help us avoid the most dreaded economic collapse since the Great Depression.
