Level with me doc

Speculative bubbles are great for the economy, and efforts to stem foreclosures, while well-intentioned, will only prolong the agony of the housing downturn.

That's the word from Slate columnist Daniel Gross, author of  "Pop! Why Bubbles Are Great for the Economy!" (Read the book if you want the whole story -- here's the Cliff Notes version from InmanBlog).

Gross says preventing foreclosures interferes with price discovery -- the "painful process" in which we figure out how much the tulips are really worth after the bubble pops. I mean houses -- did I say tulips?

Since the housing bubble popped, Gross writes: "desperate players in the market have taken a series of actions intended to delay price discovery in housing. Rather than cut prices, sellers began to throw in free cars or other inducements to buyers who paid the asking price. Brokers reduced their commissions. Builders started including all sorts of extras (fancy kitchens, pools, etc.) for no additional price. Every link in the chain sacrificed margins and profits rather than cut prices."

But the main reason home prices don't plummet overnight is that, compared to stocks, homes aren't the most "liquid" of assets. Foreclosures speed price discovery because, while it might take a homeowner 18 months to mark down the price of his house by 20 percent, "a bank will do it in 18 days," Gross says.

Home prices in some markets may need to fall 30 percent before hitting bottom, a process that is likely to take years rather than months, Gross frets. OK, with you so far, Dan. But here's where he loses me:

"In general, cleaning up quickly after popped bubbles is good for the economy, because it enables everybody to move on," Gross concludes. The last thing we want is to become mired in -- horrors! -- "a lengthy period of slow growth" like the one Japan recently emerged from.

What's strange is Gross provides a much more vivid explanation of all the reasons we might fear rapid "price discovery" in housing markets:

"Owners of existing homes are reluctant to mark down the value of their homes 20 percent overnight because, in many instances, it will wipe out their equity. Homebuilders and condo developers don't like to lower prices quickly because it makes those who bought in their development five months earlier feel like chumps. The banks don't want to concede that the houses they lent against are suddenly worth a great deal less than they were a few months ago. Investors who bought the bonds created by slicing and dicing mortgages—and then leveraged up their positions by borrowing money—get massacred when prices fall. The same holds true for bond insurers like Ambac and MBIA, which insured structured finance products created by lashing groups of mortgage-related securities together."

Hell yeah.

Last year, much of the talk of a "soft landing" for housing markets revolved around the idea that rather than falling drastically, housing prices might just stagnate for several years while incomes caught up with them.

That's no longer a possibility in markets hit hardest by speculators. But I wonder, given a choice, what's your preference: acute or chronic pain?

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