Federal Reserve Bank Chairman Ben S. Bernanke, speaking to the National Association of Home Builders, said that the typical post-recession behavior of the housing market, resurging to help fuel reemployment and rising incomes, has not played out this time and housing remains a key impediment to a recovery.

The chairman reviewed the current state of the housing market, telling the builders of a major imbalance between supply and demand with 1-2/4 million homes currently unoccupied and for sale and 2 million more in the foreclosure process.  At the same time, factors are constraining demand such as a decline in household formation, high unemployment and uncertain job prospects, and wariness about home ownership as an investment.  The availability of credit is another constraint.  This imbalance has been reflected in a drop in home prices of historic proportions.

In contrast, he said, rental markets have strengthened somewhat; vacancy rates have declined, rents have increased, and the construction of apartment buildings has picked up.

Home builders pay close attention to these issues, Bernanke said, but the problems in housing have important implications outside the construction industry.  Foreclosures diminish the value of nearby properties and can directly affect the quality of life in a neighborhood by leading to increases in vandalism or crime.  Declining neighborhoods depress the tax base leading to cutbacks in services and thus a vicious circle which putts neighborhood stabilization further out of reach.

The decline in home prices and consequent loss of owner equity has reduced the ability and willingness of households to spend.  There are estimates that homeowners spend between $3 and $5 less for every $100 of housing value they lose which means the loss of housing wealth may have an impact on the economy of $200 to $375 billion in consumer spending per year.  Low or negative equity also means homeowners cannot tap equity to pay for emergencies or college tuition, sell their homes to move to better job markets, or take advantage of low interest rates by refinancing.

Returning to the subject of mortgage credit, Bernanke said home mortgage credit has contracted about 13 percent since its peak in 2007.  "In prior recoveries," he said, "mortgage credit had begun to grow four years after the business cycle peak--but not this time around."  Much of this is a reaction by lenders to the fallout from earlier lax standards, but current practices may be limiting or preventing lending even to creditworthy households.  Some lenders are reluctant to loan even to borrowers who could meet the underwriting standards of the government-sponsored enterprises (GSEs).  "Indeed, fewer than half of lenders are offering mortgages to borrowers with a FICO score of 620 and a down payment of 10 percent, even though such loans could be within the GSE purchase parameters."   Bernanke said this may be because of the difficulty of obtaining private mortgage insurance or a concern on the part of lenders about representations and warranties.  Another reason for tight lending is that private label mortgage securitizations have virtually disappeared which may have discouraged lenders from originating loans that don't exactly fit GSE or FHA criteria.

Tight credit has disproportionately affected lending to first-time homebuyers which has dropped dramatically.  Younger households are taking out mortgages at lower rates than 10 years ago, well before prices began their run-up.  First-time buyers are an important source of incremental housing demand so this affects house prices and construction and may also prevent existing homeowners from buying up.

Tight money has implications for monetary policy as well and Federal Reserve actions to put downward pressure on longer term rates and to improve financial conditions have had less effect on both the housing sector and overall economic activity than they otherwise would have.

Policymakers have been focusing on refinancing borrowers, loan modifications, and other ways to prevent more foreclosures which is important but not all foreclosures can be prevented and there has been increased focus on reducing the overhang of empty and foreclosed homes.

Bernanke said with home prices falling and rents rising, it could make sense in some markets to turn foreclosed homes into rental properties.  The Federal Reserve calculates that most REO properties in metropolitan areas are in neighborhoods with median house values and incomes similar to those in the area as a whole and tend to commutable to where jobs are.  A financial comparison of annual cash flows from renting properties to discounted sales of REO suggests that some lenders might come out ahead renting rather than selling some of their properties.

In addition, keeping paying tenants in home, including leasing to former owners could be the best way to maintain property values and the quality of neighborhoods and appropriately structured REO-to-rental programs could help some involuntary renters become owners again.

Such rental programs have drawbacks.  Bulk selling to investors can present financing problems, some properties are in too poor condition to be attractive, and it may be difficult to put together sufficiently large clusters of properties to allow for economies of scale in their management but Bernanke pointed to a number of cities where appropriate conditions exist.

Land banks are another option for foreclosed houses with low value or in poor condition.  Land banks have the ability to purchase and sell real estate, clear titles, accept donated properties, rehabilitate properties for resale or rental or even demolish the structure.  Not all states have passed legislation to permit land banks and most existing ones lack the resources to keep pace with the number of low value properties in the current market.

Bernanke concluded by saying that we need to continue to develop and implement policies that will help housing get back on its feet.  Sustained efforts to address the many interlocking factors hold the market back will pay dividends in the long run.