The impending recession began at home. The credit market is uncertain because the mortgage market is uncertain and the mortgage market is uncertain because home values are uncertain. The stock market is falling because consumer confidence is falling and consumer confidence is falling because home values are falling. Naturally, politicians want to make sure home values stay where they belong.

The question is: Where do they belong? For the past decade, home values have risen as never before, propping up consumer confidence, the stock market, and nearly every other economic indicator. Rather than doubting this rise, pundits rushed to explain it with various theories about the impending retirement of the Baby Boomers, the expansion of the "knowledge economy," and the migration of the "creative class". Eventually, the price of the average American home rose to the point that the average American family couldn't afford it. There's no way that can end well.

This leads to the next question: How did home prices get so high in the first place? In most cases, they inflated as a speculative bubble fueled by cheap credit. As the cost of borrowing money declined, consumers could buy increasingly expensive houses without spending any more money per month. Naturally, this drove up prices. As prices rose, first-time buyers could no longer afford the traditional 20 percent down payment, so they took out mortgages that didn't require it. As prices rose even more, people started feeling confident — overconfident — and started borrowing money from their home equity to spend accordingly.

This raises yet another question: Why do politicians think that housing prices can stay even close to where they are? By any historical measure, housing is overvalued — perhaps by as much as 30 percent, according to some estimates. There are various ways to stabilize the inevitable decline or cushion its impact, such as preventing some foreclosures. But people simply can't spend more money on housing unless they can make or borrow more money — the first isn't happening and the second is no longer possible. Both the housing market and consumer confidence will keep falling simply because the heights they reached couldn't be supported by anything except clapping your hands and saying you believed in Greenspan. Housing values were based on a credit market that no longer exists. And consumer confidence was based on housing values that no longer exist.

Which leaves us with the most important question of all: What should the government do? I'll try to answer that one on Wednesday. Essentially, though, instead of trying to prop up prices at unrealistic levels, the government has to manage an orderly decline. This isn't going to be easy. But it is necessary. And contrary to popular opinion, it won't be bad for the entire country. Fact is, for everyone who's losing money on his home, there's another person who will find housing more affordable. On Wednesday I'll explain why the government shouldn't help the first at the expense of the second.