Originally Posted by Parallax
How far do the prices have to fall? When is it too much depreciation? Or is there anything like that at all? This view is most widely known as real business cycle theory which has been greatly discredited by ... reality.
Glenn Loury and Ross Levine discuss this briefly in the latest diavlog. Home prices are being propped up by Fannie and Freddie. There are a number of proposals that have been put on the table of which mortgage workouts are one; Ross says that none of the ones he's come across are particularly palatable.
Make no mistake about it. The primary problem of demand is what I've said. House prices are too high. This isn't crank theory; it's Krugman. The reason we don't allow for prices to just drop to equilibrium is that demand would be even worse. This last part is plausible, but I'm skeptical. Either way, no one's going to do anything about it, so expect the problem to go on for another 4 years.