Originally Posted by sugarkang
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.
The real problem is household balance sheets. House prices are falling and since people owe a great deal to their bank on their house this hurts, a lot. So the solution is to make the overall debt smaller you can do this in two ways:
1. Government transfers the debt from households to public. For example we could have a fiscal stimulus where the government mailed everyone a $5,000 check.
2. Inflation. This happens if Fed starts to ease and do so vigorously.
Of course one could envision a combination of 1 and 2 where government sells its debt directly to the Fed to pay for the helicopter drop
. But sadly that is not something I expect to happen ...