Fed study says home price drop 'necessary'
Yahoo News/AFP
July 7, 2008

WASHINGTON (AFP) - Large-scale government intervention in the US housing crisis would be counterproductive and prevent a "necessary" correction in home prices, according to a Federal Reserve study released Monday.

The study by economist William Emmons of the St. Louis Fed concluded that "government interventions directly in housing or mortgage markets are not necessarily the best policy responses."

"By allowing markets to sort themselves out quickly, a foundation for sustainable homeownership and responsible mortgage lending can be re-established," the regional branch of the central bank said.

The report said home prices in many parts of the country may fall from their peak levels in 2006 or 2007 by the largest amount in several decades, but that "from an economic standpoint this decline of overvalued properties is necessary."

"If house prices are allowed to remain artificially high, homebuilders will make the eventual correction even worse by supplying more unneeded houses and driving prices down even further," the report said.

The economist noted that the phenomenon of home foreclosure is an "unpleasant, but essential aspect of the mortgage market."

"In order to ensure the mortgage market functions effectively, the lender must have the ability to seize the borrower's property as collateral," the report said.

"Without the possibility of foreclosure, mortgage rates would be more on par with those of credit cards," said Emmons.

"It is important to keep in mind that there will be those individuals who are truly harmed by the crisis," said Emmons.

"The financial distress to borrowers and communities caused by foreclosure should be addressed directly," he said, with a stronger "social safety net."

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