In an unusual step, the Federal Reserve sent a white paper to congressional committees last week, urging them to look again at what ails the U.S. housing market and at possible remedies. More can be done, the Fed says, to help it revive.
Good advice. Housing is where the recession started, and it remains one of the main things holding back the recovery. Friday’s unemployment numbers -- nonfarm payrolls grew by 200,000 in December, and the jobless rate ticked down to 8.5 percent from 8.7 percent -- join other tentative signs of an improving economy, but the housing mess is mostly getting worse. There’s still a grave risk it might stop, not just delay, the expansion.
The Fed’s paper underlines the scale of the problem. The decline in U.S. house prices has wiped out a staggering $7 trillion in home equity. The ratio of housing wealth to disposable income has crashed from 140 percent at its peak to 55 percent, the lowest since the figures began to be collected in the 1950s. The number of “underwater” mortgages has grown to 12 million: More than one in five homeowners owes more than the property is worth. It’s surprising the economy is making any headway at all into a gale of this force.
House prices dropped again in October, according to the S&P/Case-Shiller index. The pipeline of delinquencies and future foreclosures is full, which continues to blight the prospects for recovery. Efforts to date, such as the Home Affordable Modification Program, have helped, but less than hoped.
Fannie Mae and Freddie Mac have been told to worry more about avoiding short-term losses than stabilizing the wider housing market (which might actually reduce their long-term losses). Banks and other mortgage lenders have severely tightened their standards, making it hard for distressed borrowers to refinance at historically low interest rates.
The Fed says there are no easy answers, but makes several suggestions that Congress should take up. The first is to encourage conversions from owner-occupation to rental. The rental market has strengthened lately: Rents are up and vacancies down. A faster rate of conversions would keep rents in check and relieve the pressure of unsold homes on house prices. Fannie, Freddie and the Federal Housing Administration account for about half of the inventory of foreclosed properties. Many of these, according to Fed research, are viable as rentals. A government-sponsored foreclosure-to-rental program aimed at clearing away regulatory hurdles would make a big difference.
A second idea is to encourage refinancings. The administration tweaked an existing scheme -- the Home Affordable Refinance Program -- in October, easing some of the earlier restrictions on eligibility. More might be done, says the Fed, and we agree.
One example involves the fees that lenders pay to Fannie and Freddie for supposedly taking on new risks when loans to distressed borrowers are refinanced. These charges could be cut further or eliminated, even though Congress just voted to push them back up to help pay for the payroll-tax extension. The fees make no sense: The credit risk is already on their books, and refinancings most likely reduce it.
Borrowers with high loan-to-value ratios and mortgages not guaranteed by Fannie and Freddie get no help from HARP or any other scheme. Fannie and Freddie should be encouraged to back refinancing of these loans. Unlike the fee-elimination proposal, this would increase credit risk on the agencies’ books, but limiting the help to borrowers who meet underwriting standards and are current on repayments would mitigate the problem.
Potentially, this is a big deal. The Fed calculates that as many as 2 million borrowers would meet HARP standards for assistance except for the fact that their loans aren’t guaranteed by Fannie or Freddie.
A third approach is to revisit loan modification, including measures to cut principal. Here, the Fed is more cautious, emphasizing the possible cost to taxpayers and the difficulty of accurately targeting the help to deserving homeowners. Those are valid concerns, but we think a lot more principal reduction makes sense, nonetheless. HAMP already allows it, but under tight restrictions and with a too-narrow objective: improving affordability rather than reducing negative equity.
Negative equity is a problem in its own right. Among other things, it increases the risk of strategic default, where borrowers walk away from loans even though they can afford to keep paying. More principal reduction, combined with equity participation by the lender, should be part of the mix.
The Fed has other suggestions, some of them all too familiar -- smoother foreclosure or quasi-foreclosure procedures; better incentives for loan servicers to help in resolving delinquent loans; a national online registry of liens (the current system, says the Fed, is “antiquated, largely manual, and not reliably available in cross-jurisdictional form”) and so on. Four years into the worst housing slump in 70 years, it is shameful that steps such as these are still being talked about but not urgently implemented.
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