WASHINGTON – Economists and policy makers are considering new regulatory and warning mechanisms that would prevent future housing bubbles such as the U.S. bubble that burst in 2007.
Under a proposal that Rep. Bill Foster,D-Ill.,said he will introduce in the next session of Congress,minimum down payments on house purchase would rise if housing prices started to rise rapidly. In theory,this could dampen a bubble.
Foster,who is on the Financial Services Committee,proposed the idea at a discussion Monday hosted by the American Enterprise Institute for Public Policy Research on the issue of preventing the next bubble
The toll the housing bubble took on the economy was more significant than any other recent financial bubbles. Foster said the economy can survive the bursting of a stock market bubble but not a housing bubble.
“Housing was the most destructive aspect of the bubbles we saw this decade,” said Jay Brinkman,chief economist and senior vice president of research and economics at the Mortgage Bankers Association.
Foster said households lost $17.5 trillion between October 2007 and March 2009.
“This was the largest destruction of wealth in human history,” he said. “If we had just reduced the size of this bubble by a factor of two,the amount of human misery that shows up in my office every single week would have been enormously reduced.”
Foster's plan calls for a fraction of the increase in housing prices to be added to the minimum down payment set in a housing market by the Federal Reserve or some other regulatory agency.
This would create a new minimum down payment for recently appreciated assets,setting new limits on loan-to-value ratios that are a way of determining mortgages.
Capital that is based on speculation will be absorbed,and home buyers would be discouraged from purchasing houses as investments.
“If you have this counter-cyclical increase in down payments,then that will prevent flipping from being a lucrative business,” Foster said. “What's important here is that you have a mechanism,so when the markets go crazy,you squeeze them off. If you have that in place,then you can actually be more aggressive and have smaller down payments.”
Regulators could use the average housing price rise over one to five years to figure out what down payments should be. This formula would not go into effect when prices are declining because its aim is not to reduce the minimum down payment below traditional levels.
The minimum down payment variable would in effect become a feedback mechanism for home buyers in assessing their prospects for purchasing a home.
“The feedback theory is very well evolved from engineering controls theory. And there is a lot I think that can be learned there,” said Foster,who has a doctoral degree in physics and worked as a scientist for 22 years before being elected to Congress.
At the outset of a bubble,speculators feel the need to invest in anticipation of a big payday.
“Bubbles will always be with us,as will the dream of effortless wealth enhancement,” said John Makin,visiting AEI scholar and principal at Caxton Associates,a hedge-fund business. “The problem will probably persist because there are plenty of people who like bubbles.”