Bailout Hinges on Stable Housing Prices

New York, NY, Oct. 6, 2008--Experts say the most important thing that needs to happen before the $700 billion bailout even has a chance of working: Home prices must stop falling. That would send a signal to banks that the worst has passed and it's safe to start doling out money again.

The problem is the lending freeze has made getting a mortgage loan tough for everyone except those with sterling credit. That means it will take several months or longer to pare down the glut of houses built when times were good -- and those that have come on the market because of soaring foreclosures -- before home prices start appreciating.

Housing is a critical component to the U.S. economy and by extension the availability of credit. Roughly one in eight U.S. jobs depends on housing directly or indirectly -- from construction workers to bank loan officers to big brokers on Wall Street. A turnaround in housing prices would boost confidence in the wider economy and, experts hope, goad banks into lending again.

"Housing traditionally does lead the economy through a recovery. I think it's going to be critical for a sustained recovery in this cycle, too," said Gary Thayer, senior economist at Wachovia Securities.

Sung Won Sohn, an economics professor at California State University, Channel Islands said the near certainty of a recession makes it too risky for the thousands of small and medium-sized banks across the country to lend.

"Banks know the economy is getting worse, so ... they will keep being cautious," said Sohn, a former banking executive.

Still, the government hopes that by scooping up billions of dollars in bad mortgage debt and other toxic assets, banks eventually can clean up their shaky balance sheets, crack open the vaults and send money washing through the system again.

The rescue plan also raises the federally insured deposit limit from $100,000 to $250,000, a move that could boost banks' reserves and further grease the lending wheels.

Rep. Barney Frank, D-Mass., the Financial Services Committee chairman and a key negotiator over the past weeks, said the measure was just the beginning of a much larger task Congress will tackle next year: overhauling housing policy and financial regulation in a legislative effort comparable to the New Deal.

Several other hurdles could trip up the bailout plan. For starters, even when the Treasury starts buying bad assets, some banks may hoard the cash they receive in return until they see how the plan pans out. That has the potential to make the lending logjam worse, said Vincent R. Reinhart, former director of the Federal Reserve's monetary affairs division.

It also creates a vicious cycle: No trust means no lending; tight credit means it's harder to buy a home; the more difficult it is to buy or sell a home, the further home prices will fall; and the further prices drop, the more foreclosures there will be.

U.S. home prices -- down 20 percent from their peak in July 2006 -- still have further to fall, and must hit bottom before demand picks up. The long-awaited bottom in prices could be a year or more away.

But Jim Gillespie, chief executive of Coldwell Banker Real Estate, said he hopes that lower prices, combined with the government's actions will jump-start stagnant demand. The federal bailout plan, he said, "will give people reassurance that mortgage money is available."

Jobs are another big concern. The stranglehold on credit has choked companies big and small that depend on regular inflows of borrowed money to pay employees and stay afloat.