One Real Source of Uncertainty: Housing Policy

Policy uncertainty is back in the news, with the Romney campaign’s recent release of an economic paper positing policy uncertainty as one of the key factors holding back a strong recovery.

Policy uncertainty has long been a favored explanation for the recession among Republicans. For instance, John Taylor, a Stanford professor and prominent Republican, wrote in the Wall Street Journal this May that “In my view, unpredictable economic policy…is the main cause of persistent high unemployment and our feeble recovery from the recession.”

In the white paper Taylor, along with other big-name Republican economists, drafted for the Romney campaign, the authors cite the Index of Economic Policy Uncertainty. The index is a metric devised by economists from Stanford and the University of Chicago to estimate the impact of uncertainty about policy on the economy.  

The index compiles figures on expiring tax provisions, differences between economic forecasts, and news about business uncertainty. The idea is that the higher any or all three of those indicators, the more uncertainty businesses face, and the lower growth will be.  

Of course, Democrats have an alternative view of what’s prolonging the crisis: weak demand. As the Roosevelt Institute’s Mike Konczal writes, the Index of Economic Policy Uncertainty involves some circular logic – it treats news about uncertainty as uncertainty itself – and wouldn’t distinguish between regulatory uncertainty and uncertainty about demand. The alternative explanation, as laid out by Lawrence Mishel of the liberal Economic Policy Institute, is that the lack of consumer demand for goods and services far outweighs the impact of any uncertainty about regulation.  

Clearly, the idea that a large number of expiring tax provisions and the unclear direction of federal policy are to blame for the state of the economy is a controversial one. It’s easy to imagine that the approaching fiscal cliff and implementation are causing businesses to hold off on major investments, but it’s less obvious that such concerns are the primary reason the economy isn’t returning to its pre-crisis trend.

The index doesn’t address, though, two major sources of policy uncertainty that almost everyone, including those who think the economy’s problems are on the demand side, would agree are significantly impeding growth.

The first is housing policy uncertainty. Of course, the collapse of the housing bubble was a central cause of the recession. Since the bubble burst, housing policy has been hesitant when not contradictory. Neil Barofsky, the former Special Inspector General for TARP, writes that it was clear by late 2009 that the signature effort to boost the housing market, a mortgage modification plan called HAMP with $50 billion in available funding, would be a failure. Yet the administration has neither fully abandoned the effort nor tried to do it the right way. Only this past month, a similar plan to offer debt relief to homeowners through Fannie Mae and Freddie Mac was rebuffed by an independent regulator. For those who are counting, that’s three-plus years of uncertainty about the assistance that would be given to homeowners. As Barofsky writes,

It may be a fair debate whether we should have gone with the “all in” approach that I and others have advocated or the “do nothing and let the market find its natural bottom” approach advocated by many conservatives. There should, though, be little question that the chosen policy – a “foam the runway” approach that assisted the banks and only a fraction of the homeowners that could have benefited – has been a failure and has left us stuck in economic mediocrity. 

Nor are homeowner assistance efforts the only source of uncertainty in the housing sector. E21’s Christopher Papagianis argues that “there is perhaps no other major industry that faces more micro-policy uncertainty than housing today,” because of pending regulations regarding servicing and underwriting.

Federal Reserve chair Ben Bernanke has pinned the slow recovery on lingering problems in housing markets. It should go without saying that depressed housing prices (median home equity fell over 40 percent during the crash), lowered sales, 2-plus million unemployed construction workers, and elevated foreclosures are holding back consumer spending. As Wall Street economists have noted, a lack of housing investment, along with cutbacks in state and local spending, is one of the hallmarks of this recession, as can be seen in this chart: 

Until those problems are resolved one way or another, the recovery will be on hold.

Nevertheless, housing policy is a distant second compared to the number-one source of uncertainty. More on that in a subsequent post.