Chicken/Egg

From Free Exchange:

As Mr Glaeser notes, slow household growth puts off housing market recovery, which prolongs the period during which residential investment and construction aren't contributing very much to output. And that's true. But I think it's also probably worth recognising this as a source of shadow demand. Shadow housing supply, recall, refers to housing units held by banks and homeowners who'd like to sell their properties but who are waiting for better market conditions. It is supposed that any brief uptick in housing could quickly lead to renewed decline as shadow supply hits the market.

But it's also likely that there is shadow demand in the system. I suspect that as economic conditions improve, twentysomethings living at home will quickly look to move out and start their own households. This, in turn, will support housing demand, housing prices, and housing construction, buoying the initial uptick.

To put this another way, everything comes back to unemployment. If you get steady job growth, many housing concerns (though not all) will begin to take care of themselves. Unfortunately, America has still had only one month of payroll growth since the onset of recession.

Free Exchange has it backwards. Calculated Risk has referred to research showing that recoveries (i.e. job growth) are generally prompted by upturns in residential investment. This rebound in residential investment can't happen until the massive inventory overhang is eliminated. At the current rate of turnover in the housing market, we shouldn't expect this to happen in the near future; S&P estimated today that it will take 3 years to clear the shadow inventory of bank-owned properties.

There are several forces slowing the process of churning through the excess inventory. Every program that "extends and pretends" - such as the federal push for loan modifications or banks holding on to properties in default to avoid taking losses - will only delay the eventual recovery. In addition, the various programs aimed at supporting house prices are similarly counterproductive as they will only decrease the volume of home sales. House prices usually overshoot their historical valuation metrics when they fall and this is exactly what we need in order to see a meaningful recovery during Obama's first term. Unfortunately, it seems like this Administration is opting for the "extend and pretend" philosophy rather than taking the pain now and recovering faster.