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Implications for the economy

After reaching the more than 1. 7 million new units started in 2005, single-family housing starts in February 2008 fell to a seasonally adjusted annual rate of 707,000 units, less than half the level of production two years earlier. On a year-over-year basis, the decline in starts was 40. 4 percent. 4 Sales of new homes fell precipitously over the same period. After reaching 1,283,000 units in 2005, they fell in February 2008 to a seasonally adjusted annual rate of 590,000, less than half the level of 2005 and down 29. 8 percent from February 2007.

For existing homes, sales peaked in 2005 at 7,076,000 units, fell to 6. 4 million in 2006, and by February 2008 had fallen to a seasonally adjusted annual rate of 5 million, nearly 30 percent below the peak levels of sales during 2005. After two years of declining activity in the housing market, many are hopeful that the bottom has been reached and that the market will soon revive, but this seems unlikely. The subprime default and foreclosure problems first emerged at a time when the economy was healthy, most borrowers were employed, and housing values were stable or rising.

In 2008, home prices and sales

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are falling, some borrowers may soon confront unemployment, tightened credit standards will exclude many from homeownership, and the number of subprime mortgages resetting to higher payments will be greater than the number that reset in 2006 and 2007. Consequently, the homeownership rate is likely to fall from its record levels near 69 percent to something closer to the long-term historic norm of 64 percent. This trend in turn implies a greater number of lost homes coming onto the market at a time when sales are depressed.

Under the circumstances, government policies should focus on cost-effective ways to facilitate the transition to a sustainable housing market of fewer homeowners and/or lower home prices, as opposed to a costly exercise to prop up the inflated an unsustainable market that characterized 2004 to 2006. In response to the threat of a financial market panic that could contribute to a severe recession, as well as to the growing number of borrowers who might soon lose their homes, both Congress and the Administration began to take a number of steps to address the problems.

Regrettably, they all involved expansion of existing federal programs and the creation of many new ones, often at very substantial cost to the taxpayer. Notwithstanding the constituent and lobbyist pressure to do something costly and do it quickly, the history of government intervention in housing markets and the economy has not been one of notable success. Many of the proposals now on the table hold the promise of carrying on that tradition and doing so, as noted, at great cost to the taxpayer. More Regulation.

Many in Congress and the Administration are calling for more regulation, yet a much more intensive system of federal regulations of the industry in the past contributed to the catastrophic collapse of the savings and loan industry in the late 1980s and early 1990s. Thanks to a burdensome system of intense federal regulations, the S&L industry—then the most important source of mortgage credit—was technically insolvent because the market value of its mortgage loan portfolio was less than the value of the deposits financing it.

Although Congress belatedly responded by reducing the regulatory burden it had earlier imposed on the industry, that effort was too late, and by the end of the 1980s, the S&L industry was teetering on the brink of collapse. And collapse it did. In the late 1980s, more than 1,000 S&Ls became insolvent and filed for bankruptcy. By 1995, there were only 1,645 S&Ls in operation compared to 3,234 in 1986, and the industry’s share of the mortgage market fell from 44 percent in 1970 to 21 percent by 1990.

Because the value of the insolvent S&Ls’ assets was less than that of their deposits, the Federal Savings and Loan Insurance Corporation (FSLIC) had to cover the loss between what the assets were worth and what was owed to the federally insured depositors. The losses quickly exceeded the reserves of the FSLIC (which was subsequently merged into the Federal Deposit Insurance Corporation), and the final cost of the debacle to the taxpayers totaled approximately $130 billion.

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