How much? No one really knows. There is no national housing market. Prices and family incomes vary by state, city and neighborhood. Prices rose faster in some areas (Los Angeles, Miami, Phoenix) than in others (Dallas, Detroit, Minneapolis). Some economists now expect an average national decline of about 20 percent. The Federal Reserve estimates that owner-occupied real estate is worth almost $21 trillion. A 20 percent reduction implies losses of about $4 trillion.

The largest part would be paper losses for homeowners: values that rose spectacularly will now fall less spectacularly, back to roughly 2004 levels. That's still 30 percent or so higher than in 2000. But hundreds of billions of dollars of other losses are already being suffered by builders (from the lower value of land and home inventories), mortgage lenders (from defaulting loans), speculators and homeowners (from lost homes). Mark Zandi of Moody's Economy.com estimates that mortgage defaults this year will exceed 2 million, up from 893,000 in 2006.

To be sure, all this weakens the economy. No one relishes evicting hundreds of thousands of families from their homes. Eroding real estate values make many consumers less willing to borrow and spend. Some economists fear a vicious downward spiral of home prices. More foreclosures depress prices, increasing foreclosures as people abandon houses on which the mortgage exceeds the value. Losses to banks and other lenders rise, and they curb lending further. Particularly vulnerable would be Fannie Mae and Freddie Mac, the two government-sponsored housing lenders. (Their vulnerability emphasizes the need for Congress to pass legislation strengthening regulation of Fannie and Freddie.)

Up to a point there's a case for providing relief to some mortgage borrowers. In many cases everyone would gain if lenders and borrowers renegotiated loan terms to reduce monthly payments. Losses to both would be less than if their homes went into foreclosure and were sold. The Treasury has organized voluntary efforts. Some measures being considered by Congress might help (for example: overhauling the Federal Housing Administration). But other proposals—particularly empowering bankruptcy judges to reduce mortgages unilaterally—would perversely hurt the housing market by raising the cost of mortgage credit. Lenders would increase interest rates or down payments to compensate for the risk that a court might modify or nullify their loans.

The understandable impulse to minimize foreclosures should not be a pretext to prop up the housing market by rescuing too many strapped homeowners. Though cruel, foreclosures and falling home values have the virtue of bringing prices to a level where housing can escape its present stagnation. Helping today's homeowners makes little sense if it penalizes tomorrow's homeowners. An unstoppable free fall of prices seems unlikely. Slumping home construction and sales have left much pent-up demand. What will release that demand are affordable prices.

© 2008