Fed Reserve Governor Elizabeth Duke Suggests Some Some Housing Market Recovery Proposals

We are excerpting the Housing Proposals of Federal Reserve Governor Elizabeth A. Duke's from her speech to the Virginia Bankers Association in Richmond on January 5, 2012:

sals to Support Housing Market Recovery Elizabeth Duke
Back on US shores, I want to focus the remainder of my discussion today on the housing and mortgage markets, which are so important for the economic recovery. As I alluded to earlier, and as I am sure you are all very well aware, housing markets have shown little sign of improvement so far in this recovery. This stands in sharp contrast to the important role that the housing sector has typically played in propelling economic recoveries. During a downturn, reduced spending on durable goods — including housing — generates pent-up demand, which in itself helps sow the seeds of recovery. Once the cycle bottoms out, improving economic prospects and diminishing uncertainty usually help unleash this pent-up demand. This upward demand pressure is often augmented by lower interest rates, to which housing demand is typically quite responsive. Moreover, spillovers from increased housing demand — such as wealth effects from higher house prices, purchases of complementary goods such as furniture and appliances, as well as strengthening bank balance sheets — have, in the past, provided a powerful additional impetus to the recovery.

Thus far, however, the housing sector has not contributed to the recovery. In addition to the lack of any meaningful improvement in residential construction, the expansion has also been hindered by the steep descent of house prices. To date, house prices have fallen by nearly one-third from their peak, pushing home equity as a share of personal income to its lowest level on record and wiping out $7 trillion of housing equity. Further, this decline in housing wealth — and the associated hit to consumer confidence — has not only been a meaningful and persistent drag on overall consumer spending, it has also been enough to push nearly 12 million homeowners underwater on their mortgages, that is their houses are now worth less than their mortgage balances. Without equity in their homes, many households who have suffered hardships such as unemployment or unexpected illness have been unable to resolve mortgage payment problems through refinancing their mortgages or selling their homes. The resulting mortgage delinquencies have ended in all too many cases in foreclosure, dislocation, and personal hardship. Neighborhoods and communities have also suffered profoundly from the onslaught of foreclosures, as the neglect and deterioration that frequently accompany vacant properties makes neighborhoods less desirable places to live and may put further downward pressure on house prices.

The problems that led to the mortgage crisis and the potential policy solutions to those problems are numerous and varied. Even though time does not permit a full discussion of them here, I do believe that forceful and effective housing policies have the potential to significantly influence the speed and strength of our economic recovery. The Federal Reserve has already acted to reduce mortgage rates by purchasing longer-term assets, in particular through the purchase of agency mortgage-backed securities. Indeed, low rates combined with falling house prices have contributed to historically high levels of housing affordability. At the same time, rents have been rising, which should make homeownership a more attractive option relative to rental housing.

Despite this record affordability, home purchase and mortgage refinancing activity remains muted. The failure of home sales to respond to conditions that would otherwise seem favorable to home purchases indicates that there are other factors weighing on demand for owner-occupied homes. High levels of unemployment and weak income prospects are likely precluding many households from purchasing homes. In addition, some potential buyers may be delaying house purchases out of fear of purchasing into a falling market. Weak prices also contribute to the reportedly large number of purchase contracts that are canceled due to appraisals that come in too low to support financing.

Finally, many households are unable to purchase homes because of mortgage credit conditions, which are substantially tighter now than they were prior to the recession. Some of this tightening is appropriate, as mortgage lending standards were lax, at best, in the years before the peak in house prices. However, the extraordinarily tight standards that currently prevail reflect, in part, new obstacles that inhibit lending even to creditworthy borrowers. These tight standards can take many forms, including stricter underwriting, higher fees and interest rates, more stringent documentation requirements, larger required down payments, stricter appraisal standards, and fewer available mortgage products. This tightening in mortgage credit can be seen in the increase in the credit scores associated with newly originated prime and Federal Housing Administration (FHA) mortgage originations, which suggests that borrowers who likely had access to mortgage credit a few years ago are now essentially excluded from the mortgage market.

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Fed Reserve Governor Elizabeth Duke Suggests Some Some Housing Market Recovery Proposals

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