Harvard’s Ed Glaeser, also a Manhattan Institute senior fellow, and Wharton’s Joseph Gyourko have an excellent explanation (free registration required) of the likely futility of proposed government efforts to stop the slide in housing prices.

The profs specifically debunk the idea that the government can reduce the slide in housing prices by keeping mortgage rates artificially low. They estimate that

reducing mortgage rates to 5.25 percent [interest] through public lending … as suggested by two prominent economists last week, would imply a 69 basis point [0.69 percentage point] reduction. If the historical relationship between price and interest rates continues to hold, this fairly large credit market intervention will only manage to raise [house] price[s] by less than 3.2 percent. Such a boost would be almost imperceptible on the current extreme environment.

Glaeser and Gyourko also make the point that the real problem isn’t that prices are too low now but that they were too high — effectively unaffordable to middle-class families — a few years ago. They suggest dealing with the social costs of foreclosure-induced dislocation rather than trying to stop those foreclosures by propping up home prices.

Of course, another cost of allowing housing prices to continue to deflate is more bank and other financial-industry failures. But the faster the government explicitly admits that it won’t follow a policy of trying to prop up home prices, the faster financial institutions, investors, and the broader economy can calculcate and account for their very real losses.

Right now, there is real evidence that they have not done so. Consider: in its purchase of Wachovia, Wells Fargo is projecting 22 percent losses from a $119 billion portfolio dominated by “pick-a-pay” and other fantastical mortgages* backed by overvalued homes in the western United States. That’s up from Wachovia’s own 12 percent estimate from a few months ago, but it still may not be enough.

Government uncertainty about its attitude toward house prices could mean more bad surprises next year — when it might be better to get them over with sooner.

*Yes, that means exactly what you think, that mortgage borrowers could pick what they wanted to pay each month.

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