Bond fund manager Bill Gross of the giant fund family PIMCO writes in his recent commentary
Make no mistake, the current conundrum that must be solved is: how to make the price of 120 million U.S. barns stop going down in price and then to make them go up again. That, however, is easier said than done. One of the wisest men I know has this serious but admittedly impractical solution: have the government buy one million new/unoccupied homes, blow them up, and then start all over again. Absent that, he’s not quite sure what to do, nor am I, with the exception of the next paragraph’s proposal.
It’s not entirely clear how serious Gross is but, taking him seriously for the moment, this is rather similar to programs actually carried out during the Great Depression to buy up agricultural products (such as pigs) and destroy them. The thinking at that time was that low prices caused the depression by lowering the purchasing power of sellers; so that, if prices of agricultural products could be raised, then the purchasing power of farmers would increase, they could buy more of other goods, and that would lift the economy out of its slump.
The flaw in this thinking is shown Say’s law: supply of one kind of thing constitutes demand for other kinds of things. Reducing the supply of some goods, i.e. pigs, or homes, reduces the demand for other goods. For this reason, there can never be a general oversupply problem.
However, there can be insufficient demand for existing supply of a particular good to support a selling price above the cost of production because the good was produced out of proportion to demand for that thing in particular. This is the case we are facing right now with housing. Contrary to Gross, falling home prices are part of the solution, not part of the problem. The problem is not low home prices as such. The problem is that home prices were inflated out of proportion to real (i.e. funded) consumer demand by a combination of credit expansion, the activity of the GSE in purchasing home mortages, lower lending standards, and bogus ratings on securitized loans.
These factors resulted in more homes being produced than were really demanded by consumers, at the cost of fewer of other types of goods being produced. While it’s true that the these homes were built because of artificial demand, now that they exist, they are certainly worth something to someone, and destroying them would only us even poorer than we would otherwise be when we get done paying for this mess.