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Any bright spots in the economy?

Answer Desk's John Schoen fielded readers' questions in a live chat on Wednesday, Feb. 17. Here are some of his answers about the housing crisis and the economic recovery.

Answer Desk's John Schoen fielded readers' questions in a live chat Wednesday about the housing crisis and the economic recovery. Read below for some of their questions and his answers.

Bruce: What are the bright spots in the economy?

The economic numbers are certainly moving in the right direction. Both housing starts and industrial production are up from last month. Other data show a slow but steady improvement from the depths of the recession.

But housing and production, for example, are still far below where they were when the recession began in December 2007. The Federal Reserve’s index for industrial production – tied to a benchmark set to the level of production in 2002 - didn’t hit 100 until December. Last month’s reading was 101.1. That means that industrial production is just now climbing back to where it was eight years ago.

So until these numbers get back to where we were before the recession began, growth won't feel like recovery. Especially to the 8 million people who lost their jobs to the recession.

Stephen: I think people will begin to respond [to the recession] as I have. I refinanced my 15-year note to a 30-year one to cut my payment in half, and have invited my sister and her husband to move in with us to cut our two household expenses in half. As long as we can hang onto our jobs, we should weather the storm.

No doubt a lot of people are hunkered down. And that will certainly help them "weather the storm." But the storm won't be over until the housing market begins a convincing, sustained recovery. Here's why:

There are a couple of reasons housing is so vital. In any down cycle, housing often leads the rest of the economy out of a recession. In a recession, home sales fall, but demand continues to grow with as the population expands. So when the recovery begins, that pent-up demand helps give the housing industry a nice boost, increasing sales of building supplies and putting construction workers back to work.

There’s a second boost that comes from sales of all the things that people need when they buy a new home: furniture, kitchen appliances, TVs, etc. Increased sales of those products puts people back to work (though many of those jobs are now overseas) and generates profits for the companies that sell and distribute those products locally. All of that increased activity has a cumulative effect: more sales generate more jobs, which give people money to buy more stuff, which gets the rest of the wheels turning. Consumer spending still makes up two-thirds of U.S. GDP.

Tim: What do you see as the biggest obstacle and opportunity for the economy. And how can our government help either way?

Housing is certainly one of the big obstacles, for the reasons cited above. The government is already playing a big role - now that it has taken over the agencies that finance housing: Fannie Mae and Freddie Mac. The best thing the government could do now would be to clear the books of those two entities of bad loans - write them down and take the loss - to get housing finance started again.

Restarting the housing market is especially critical because this housing recession has cut much more deeply into the economy than any in memory. That’s because the value of homes has fallen so far since the peak. There are many reasons for this: housing appraisers cutting corners and inflating prices; mortgage brokers getting paid to write loans whether or not the money was paid back; Wall Street bankers selling bonds backed by those mortgages without taking on the risk they wouldn’t get paid back, etc.

Stephen: Do you sense that another wave of foreclosures this year will add a glut of homes onto the real estate market, keeping housing prices depressed and slowing new construction?

Unfortunately, that seems to be where we're headed. Beginning last fall, many lenders instituted a hold on foreclosure while they tried to modify loans and keep people in their homes. As those "moratoriums" expire later this year, the risk is that a back load of foreclosed homes comes on the market. Some lenders I've spoken with call this "the 180-day bubble."

The approach taken by the government and the lending industry has been to try to modify loans – lowering payments and stretching out the payoff date – to try to make the mortgage affordable. It just isn’t working. We’re on the third program and all of the tweaking in the world won't fix it.

Of the millions of homeowners who were supposed to get help, maybe 100,000 have gotten permanent relief. The result is that we’re “kicking the can down the road” – just delaying the inevitable day when the house has to be sold at the market price and the lender, investor or homeowner – or all three – gets hit with another loss.

Pushing the problem into the future also just postpones the day when the housing market stages a convincing recovery. If millions of mortgages are unsustainable, and those homes have to be sold at distressed prices, the price of everyone else’s house will keep falling until the market is cleared of all that excess supply.

Jennifer: Do you see the extension/expansion of the home-buyers' tax credit as beneficial? Or do you see it as artificially propping up the housing market and creating small bubbles?

The tax credit certainly helped - home sales perked up last fall as people went shopping in time to get the credit. But the credit doesn't address the fundamental problems of the housing market. Until those are addressed, it's likely that we're just seeing sales moved up in time that would have happened anyway.

Josh: How do we tackle the issue of moral hazard in the future, as related to the housing market?

My personal view is that the experience of the last three years has provided a better antidote to "moral hazard" than any government program or new law. Anyone who has lived through a home foreclosure has gotten about the harshest lesson imaginable on the dangers of getting overextended.

I also happen to think that the primary cause of the collapse was not people deliberately loading up on debt with the idea that they would never pay it back. There is just too much evidence of predatory lending - and a complete dismissal of lending risk by mortgage brokers, lenders' investors, etc.

I would be more concerned with the issue of moral hazard as it relates to bankers. To prevent this from happening again, we need to make sure that the people who put up all the money to buy these overprice houses bear the consequences of ignoring risk.

But with the TARP bailout - and the Fed's unprecedented efforts to hold rates at zero (where banks can't lose money), the banking industry has no reason not to go on a rogue lending spree again.

Mark: What is your best- and worst-case scenarios as far as a timeline for the housing market to return to normal?

The best case is that we keep gradually coming out of the worst housing recession in a lifetime. Prices have come down considerably and the "affordability" of homes has improved substantially. This case assumes that most of the fraudulent appraising and predatory lending has been washed out of the system. And that the Fed can keep mortgage rates low for the next several years.

The worst case is that foreclosures continue to rise this year, mortgage rates go up after the Fed stops its $1.25 trillion program of buying mortgage bonds in April, unemployment keeps people from qualifying for new mortgages to buy a home and the market gets hit with another wave of "pay option" adjustable mortgages that push more homeowners over the edge.

Those are the extremes. I don't have a crystal ball to tell you which one will happen.