In a letter to the chairs and ranking members of the
Senate Banking and House Financial Services Committees on Wednesday, Federal Reserve
Chairman Ben S. Beranke said "Restoring the health of the housing market is a
necessary part of a broader strategy for recovery." The letter accompanied a white paper developed
by the Fed which Beranke called a "framework for thinking about certain issues
and tradeoffs that policymakers might consider."
In its opening pages the white paper titled The U.S. Housing Market: Current Conditions and Policy Considerations
acknowledges that much of the weakness in the housing market is related to poor
labor market conditions and will take time to be resolved but outlines three
dimensions along which policymakers could take
action to ease some of the pressures on the housing market:
1. Moderating the
inflow of properties into the large inventory of unsold homes
inventory of foreclosed or surrendered properties (REO), perhaps representing
one-quarter of the 2 million vacant homes for sale in the second quarter of
2011, is putting downward pressure on house prices, and exacerbating the loss
in household wealth. The continued
influx of new REO, perhaps as many as 1 million properties per year in 2012 and
2013, will continue to weigh on house prices for some time. To the extent that REO holders discount
properties in order to sell them quickly, the near-term pressure on home prices
might be even greater.
At the same
time, strengthening rental markets in some areas are reflecting the decline in
homeownership with vacancy rates falling and rents rising in many markets. The price signals in the markets, that is the
decline in house prices and the rise in rents, suggest that it might be
appropriate in some cases to convert foreclosed homes into rental properties
and, at this time, with no indication that the downturn in homeownership being
likely to reverse in the immediate future, there are indications of a
longer-term need for expanded rental housing stock.
investors are currently buying and converting foreclosed properties to rentals,
this is a limited solution and larger-scale conversions have not occurred for
at least three interrelated reasons. First,
it can be difficult for an investor to assemble enough properties within a
sensible geographic area to achieve efficiencies of scale. Second, attracting investors to bulk sales
has typically required REO holders to offer significantly higher discounts
relative to those given owner occupants, in part because it can be difficult to
investors to obtain financing for such sales, and third, the supervisory policy
of GSE and banking regulators has generally encouraged sales of REO properties
as early as practicable.
Intertwined in these issues is the
unresolved role of the government sponsored enterprises (GSEs) Fannie Mae and
Freddie Mac which, because of their outsized presences, affect not only their
own holdings but the larger market with their actions. Despite the mandate of the Federal Housing
Finance Agency (FHFA) as conservator of the GSEs to minimize taxpayer losses,
some actions that cause greater losses to the GSEs in the near term might be
advantageous if they lead to a quicker and more vigorous recovery. The paper presents a number of suggestions
for dealing with inventory held by the three principal government related
agencies while suggesting it will discuss properties held by federally
regulated banks at a later date.
An REO to rental
program that relies on sales to third-party investors will be more viable if
the cost-pricing differential can be narrowed which might be done by (a)
structuring sales as competitive auctions; (b) making sales packages more
attractive to a variety of investors, or (c) providing investors with the debt
financing. In the latter case REO
holders could probably increase sales prices by providing financing but this
may be at the cost of reducing their future income stream.
The paper also
suggests some innovations for reducing the amount of time that a vacant
property remains in inventory such as auctioning the rights to acquire a future
stream of properties that might be foreclosed in a given neighborhood rather
than auctioning existing REO holdings or to encourage deed-for-lease programs which
circumvent the REO process entirely by exchanging a deed-in-lieu for a
might be for the REO holder to convert the properties to rentals
themselves. The value of this suggestion
may become more apparent as the inventories increase. The paper also suggests that land-banking,
perhaps with the assistance of federal subsidies, could be an option for
2. Remove some of
the obstacles preventing creditworthy borrowers from accessing mortgage credit.
touches only lightly on this topic, saying that the regulators have been in
consultation with the GSEs and originators about the sources of the apparent
tightness in lending standards and that balance is needed between prudent
lending and appropriate consumer protection on one hand and not unduly
restricting credit on the other.
3. Limit the number of homeowners who are pushed into
an inefficient and overburdened foreclosure pipeline.
personal suffering, foreclosures can be a costly and inefficient way to resolve
mortgage payment obligations because they can result in "deadweight losses",
i.e. costs that do not benefit anyone such as neglect and deterioration of
properties and neighborhoods and the impact of that in putting additional
downward pressure on prices. Some
foreclosures might be avoided if loan modifications are pursued more
aggressively and servicers given greater incentives to do so. Where modifications are not feasible there
should be more expedient ways to exit from homeownership.
Many homeowners who could benefit from
refinancing are unable to do so, and the paper credits recent changes in HARP
with helping in this area but suggests possible further expansion to borrowers
whose existing mortgages are not guaranteed by the GSEs even though this raises
a host of risk management issues.
The Fed suggests changes to the HAMP
loan modification program as well. One
would be to eliminate the 31 percent debt-to-income (DTI) floor that currently
exists in the program. Another is
eliminating the focus on modifications for borrowers who have become
unemployed, concentrating instead on payment deferment through the period of
unemployment which might avoid permanent foreclosures arising out of a
The paper also suggests that the focus of HAMP on
net present value to the lender is short sighted and there may be other types
of modifications which may be socially beneficial even if not in the best
interests of the lender. This, they
concede, may be a tough sell to lenders and likely to involve more taxpayer
Large scale modifications involving principal
reduction may be too costly to consider.
The paper calculates that the 12 million underwater mortgages in the
country represent about $425 billion in negative equity and targeting
underwater borrowers who are likely to default raises issues of fairness in
addition to expenses. An alternative
would be aggressively facilitating refinancing for underwater borrowers who are
current on their loans, expanding modifications for borrowers who are
struggling with payments, and providing a streamlined exit from homeownership
for borrowers who want to sell their homes.
Expanding short-sale and deed-in-lieu opportunities
have many advantages but the barriers to short sales include willing buyers at
prices acceptable to the REO holder and a timeline that allows the transaction
to close before the foreclosure. Deeds-in
lieu are often not pursued because of complications such as junior liens, dealing
with deficiency claims, and the burden of additional REO. On the other hand, borrowers may not even
realize the existence of such an alternative and instead remain in their homes through
the entire drawn-out foreclosure process.
Figuring out ways to surmount these obstacles is crucial.
The paper also addresses the shortfalls in loan
servicing that have been widely discussed and some of the solutions that have
been proposed such as changing the compensation structure, making changes to
the MERS registry, and better monitoring the servicers.
It is clear from the conclusion to the paper that
the Fed is not just searching for short-term solutions to the current market
disruptions, but a fundamental restructuring of the system so that these
problems are better packaged for management in the future. "The challenge for policymakers is to find
ways to help reconcile the existing size and mix of the housing stock and the
current environment for housing finance.
Fundamentally, such measures involve adapting the existing housing stock
to the prevailing tight mortgage lending conditions or supporting a housing
finance regime that is less restricting than today's while steering clear of
the lax standards that emerged during the last decade."