Tight standards are an obstacle to mortgage refinancing as well. The credit scores on new refinancings have risen in line with the credit scores on home purchase loans. Low or negative home equity presents an additional barrier to refinancing, with perhaps only about half of homeowners who could profitably refinance having the equity and creditworthiness needed to qualify for traditional refinancing. Although government programs have facilitated refinancing for many borrowers, many others have still not benefited from the low levels of interest rates.
Surprisingly, this tightness persists even when guarantees from the government-sponsored enterprises (GSEs) or the FHA are available to shield lenders from credit risk. Estimates by Federal Reserve staff suggest that less than half of lenders currently offer purchase mortgages to borrowers whose credit metrics fall into the lower range of GSE purchase parameters. Lenders reportedly attribute this hesitancy to concerns about the high cost of servicing in the event of loan delinquency, and to fears that the GSEs could force lenders to repurchase loans if the borrower defaults. Although this ability of the GSEs to "put back" loans to lenders helps protect the taxpayers from losses, an open question is whether the costs of the associated contraction in credit availability outweigh the benefits of risk mitigation.
At the same time that housing demand has weakened, the number of homes for sale is elevated relative to historical norms, due in large part to the swollen inventory of homes held by banks, guarantors, and servicers after completion of foreclosure proceedings. These properties are known as real estate owned, or REO, properties. Furthermore, sales by REO owners are often characterized as distressed sales because the regulatory and contractual constraints they face affect their options and incentives for disposing of the properties and may affect their willingness to improve the properties or to sell them at a discount, which in turn would affect home prices beyond the increase in overall supply.
Since 2008, distressed sales have consistently accounted for one-third or more of existing home sales, compared with only a small fraction of sales in preceding decades. In addition to increasing the supply of homes for sale, these distressed sales may have an effect on all house prices in a given area if appraisers do not adjust for the differences between distressed and nondistressed sales. And as these discounted transactions go on the books, they can effectively contribute to tighter credit conditions both because they might lower mortgage appraisals for nearby nondistressed properties and because mortgage lenders are motivated to offer tighter credit terms in declining markets. Taken together, these mechanisms create a negative feedback loop between prices, credit terms, and inventories of distressed property in falling markets that may cause prices to overshoot their underlying values.
Given the severity of problems with supply and demand in the housing market, it is unlikely that any single policy solution will provide the full answer, but a number of different policies each have the potential to yield incremental improvement in housing and economic recovery. In the long term, policymakers will need to decide the future role, if any, that the government will play in housing finance. And they will need to decide how to best wean the GSEs away from government conservatorship. In the short term, however, I believe policymakers should at least consider policies that take into account the role the GSEs could play in hastening the healing of the housing market rather than focusing entirely on minimizing losses to the GSEs. In the end, breaking the current logjam created by large numbers of loans severely past due or in foreclosure and high levels of distressed sales should help reduce losses to the GSEs by breaking the downward cycle in prices. And, I think it is plausible that a faster recovery in the housing markets could speed, rather than slow, the end of GSE conservatorship.
In recent months, a group of staff at the Federal Reserve has been studying ways in which the housing market is hindering the economic recovery and possible remedies for those difficulties. This week we published a white paper that discusses issues and trade-offs to consider in developing policies that would facilitate recovery in the housing market. It contains discussions of a number of policies that I believe, if implemented effectively, could result in better economic performance.
For example, policies that increase credit availability for homeowners or investors seeking to purchase a home or to refinance an existing mortgage would allow more borrowers to access lower interest rates and thus improve the transmission of monetary policy to the economy. Renewed attention to a broad menu of options to modify existing mortgages would provide aid to struggling homeowners and would help to reduce the flow of foreclosed homes into distressed inventory. When foreclosure cannot be avoided, incentives provided to homeowners that encourage short sales and deeds-in-lieu of foreclosure can reduce the time and costs of foreclosure and minimize negative effects on communities.
In addition, expanding the options available for holders of foreclosed properties to dispose of their inventory responsibly could reduce the number of distressed sales and the effect of those sales on home prices. For example, in many housing markets the demand for rental housing is much stronger relative to supply than in the market for owner-occupied homes. Reducing some of the barriers to converting foreclosed properties to rental units will help to redeploy the existing stock of houses in a more efficient way. Along the same lines, aggressive neighborhood stabilization efforts, including transferring low-value properties to public or nonprofit entities, such as land banks, that can manage properties that are not dealt with adequately through the private market, could lessen the effect of foreclosures on the prices of homes in the surrounding neighborhoods.
Finally, the housing crisis highlighted the destructive power of weak underwriting, inadequate disclosure, conflicting incentives, incomplete data, and uneven infrastructure. Any long-term solution must address all of these issues through regulation, standardization of contracts, and effective use of technology. Private investors are not likely to return to mortgage markets until there are common standards as well as consistency and transparency in both mortgage securitization and mortgage servicing. A modern national lien registry that clearly identifies the current servicer of a mortgage and all the liens that encumber the property could increase transparency, improve the quality of mortgage servicing, and facilitate loan modifications.
As I noted earlier, I believe that continued weakness in the housing market poses a significant barrier to a more vigorous economic recovery. Although there is no miracle cure here, these actions have the potential to help the economy recuperate more quickly than I currently expect it to, moving us closer to full employment sooner and improving the lives of many Americans.
Conclusion
To sum up, I expect continued moderate recovery in 2012. My forecast is for the unemployment rate to gradually (and perhaps fitfully) move lower and for inflation to settle over coming quarters at or below levels consistent with the Federal Reserve's dual mandate. In this environment, I believe that the current stance of monetary policy is appropriate. However, the economic situation remains very uncertain, and I see considerable risks, on both the downside and the upside, to the forecast I've laid out here. While potential spillover from the situation in Europe certainly represents a downside risk to this forecast, I also believe that the steadily improving consumer debt picture represents an upside risk. And any acceleration in the repair of housing and mortgage markets could add even stronger momentum to recovery. As always, the FOMC will continue to assess the economic outlook in light of incoming information, and we are prepared to employ our tools as appropriate to foster economic recovery in a context of price stability.
For the entire speech, go to the Federal Reserve site.
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