Why the Fed is powerless to fix the housing mess

Federal Reserve Board policymakers face a terrible dilemma. They can’t do what needs to be done to stimulate a near moribund economy. And what they can do won’t help very much.

By MSN Money Partner Aug 3, 2012 1:27PM

By Merrill GooznerThe Fiscal Times


Federal Reserve Board policymakers, meeting this past week in Washington, face a terrible dilemma. They can’t do what needs to be done to stimulate a near moribund economy. And what they can do won’t help very much.
The dilemma stems from the core problems facing the economy, which slowed to 1.5 percent in the second quarter. First and foremost is the continued economic drag from government budget cuts, which has cost over 600,000 state and local public employees their jobs over the past 18 months and over 50,000 federal employees their jobs in the past year. Without those job losses, unemployment in the U.S. would be a half to a full percentage point less than what it is today, economists say.


The second major headwind facing the economy comes from Europe, where budget austerity and bond market turmoil have triggered deep recessions along the eurozone’s southern tier. That’s depressed U.S. exports, reduced the overseas earnings of U.S.-based corporations and created a worldwide  climate of economic uncertainty that impedes spending and investment.

The Fed can encourage its European counterparts to take action. But it can’t pull the trigger.


The final and perhaps biggest headwind is the continuing near depression in the U.S. housing market, which is still operating at half to three-quarters of its pre-Great Recession peak. New housing starts in June totaled an annual rate of 760,000 units, about half the 1.5 million units registered in the mid-2000s. Sales of new and existing homes are running at about 4.7 million units a year, well below the 6 million units a year considered normal.


You would think the Fed has real power to intervene on the housing front, primarily through its ability to buy mortgage-backed securities and lower interest rates to stimulate the market. But as we’ll see in a moment, there are financial sector roadblocks to wielding that power in an effective manner.


Fed chairman Ben Bernanke directly addressed the fiscal issue in his testimony before both houses of Congress in July. He repeatedly implored legislators on both sides of the aisle to adopt a sustainable fiscal policy that would combine a short-term stimulus to get the economy moving again with a long-term plan that would bring the nation’s yawning budget deficits under control.

Instead, Congress kicked the can down the road and left businesses and the American public with the gnawing fear that renewed stalemate after the election will result in the government running the economy off a fiscal cliff -- a combination of large tax increases and budget cuts looms, which would inevitably lead to renewed recession.


How about the housing market? The Fed’s chief tool to provide help there would be a third round of quantitative easing that would achieve lower long-term interest rates by increasing the Fed’s purchases of mortgage-backed securities.


An aggressive move by the Fed on that front could succeed in lowering mortgage rates to 2.5 to 2.75 percent, a full percentage point below current levels and the lowest rates of the modern era. In theory, that should cause a rush of new home buyers to scoop up houses that are now selling for inflation-adjusted prices that in most parts of the country are about where they were in the late 1990s.


But high unemployment, stagnant incomes, especially for younger families, and fear that home prices could fall farther continues to depress new and existing home sales. And as events in other precincts of Washington on Tuesday showed, there are structural reasons why lower rates might not work in clearing up the twin plagues of the post-bubble era: foreclosures and underwater mortgages.


While foreclosures have gotten most of the attention, the single biggest deadweight dragging down housing activity is the 11.1 million American homeowners who are stuck with mortgages worth more than the value of their homes – so-called underwater mortgages. Fully 80 percent of these homeowners are not deadbeats. They make their payments every month – often at rates far above what is available in the current marketplace since they were acquired near the height of the housing bubble when first mortgages were close to 6 percent and second mortgages could be 7 percent or higher.


But when these responsible borrowers show up at the bank to refinance, they get turned away. They can’t get a loan because the appraised value of their homes is below the mortgage value. Often it is far below. A report issued Tuesday by the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, said more than half of its underwater mortgages, and those two agencies back about 41 percent of the 11.1 million underwater loans, had loan-to-value ratios above 115 percent.


Some Congressmen are pushing FHMA to use leftover funds from the Toxic Asset Relief Program – the bank bailout bill passed in October 2008 – to write down the principle of mortgages where homeowners have remained current in their payments. But FHMA acting director Edward DeMarco rejected that idea on Tuesday.


“Given our multiple responsibilities to conserve the assets of Fannie Mae and Freddie Mac, maximize assistance to homeowners to avoid foreclosures, and minimize the expense of such assistance to taxpayers, FHFA concluded that (principle reduction) did not clearly improve foreclosure avoidance while reducing costs to taxpayers relative to the approaches in place today,” he said.


Clearly, the overseer of Fannie and Freddie is no different than the private banks and bondholders who own mortgage-backed securities. While they face some risk that underwater homeowners will walk away from their loans, 80 percent don’t. That means the lenders continue to benefit from the high cash flow from overpriced mortgages taken out at the peak of the housing bubble. 


If these same homeowners could refinance at current rates – about 3.5 percent – it would save an estimated $500 to $750 per month per household in lower interest costs, according to a spokesman for Sen. Jeff Merkley, D-Ore., who has sponsored an alternative approach to the problem. His bill would replicate a depression-era housing refinance corporation that could sell federally-backed bonds (now costing about 2 percent a year) to raise cash to purchase the old loan. Charging the homeowners about 4 percent on the new loans would be sufficient to create a fund for anticipated losses while insuring that the program didn’t cost taxpayers anything.


Given the likelihood that the current Congress won’t act on his innovative proposal, Merkley last week pressed Treasury Secretary Timothy Geithner at a hearing on the Libor scandal to experiment with a pilot project for underwater homeowners. It will take a new Congress actually open to solving some of the nation’s pressing economic problems to get movement on the Hill.

“It would help reduce the remaining pressures that housing is putting on the economy as a whole,” Geithner agreed. “We’d be very supportive of progress in that area.”


“Underwater mortgage debt is strongly linked with weak consumption, high unemployment, and sluggish wage growth,” said Mike Konczal, a fellow at the Roosevelt Institute. “The blockage of prepayment has created a windfall for creditors in a weak economy with low interest rates.”


Congress and the White House could, of course, wait until home values return to pre-recession levels – in essence, letting the market clear on its own. Or they could devise a program that actually helps underwater homeowners – something previous programs have failed to do.
One thing is certain. One more round of the Fed lowering interest rates through quantitative easing isn’t going to get the job done.   

Merrill Goozner is a Senior Correspondent at The Fiscal Times. Subscribe to The Fiscal Times' FREE newsletter.

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Aug 3, 2012 9:18PM

First the banks tank the housing industry with liar loans then get bailed out by Obummer!

They get this money to help HOMEOWNERS keep their homes!

The banks then take that money and purchase futures based on thier rigged libor rate!

In the mean time take more homes and bleed the rest of us out dry!!!

Congress!! The Senate!! The Fed!! and Obummer all knew this!

We all know Timmy Treasurer did!

How else do the banks repay all those loans off so quick when the housing values have just kept dropping and dropping!!!???

Our government needs to be replaced and all should have term limits!!

Aug 5, 2012 10:28AM
The only thing Congress should be doing now is working on ways to help improve the economy. It should be every discussion, every proposal, every bill and every law.

Start passing some CLEAN bills. Cut out the pork and bullcrap....then we can see who is truly on the side of Americans.

Aug 5, 2012 8:44AM
The FEDs need to STOP this welfare mantra on wall street! QE3 will do NOTHING!! The too big to fail banks need to be broke up ! Deposits and investment banking needs to be seperate , not together! Wall street should not be using margin buys ! Everything on wall street should be in CASH. The FEDs needs to RAISE int rates not lower them ! 1.5% at the FED window should do the trick! Americans need to save and build cash , not all this free money that pays no interest on my savings! We have all these problems and guess what ? CONGRESS went on a 5 week vacation! So if republicans in the house that they control and the Dems in the senate that they control ! LOL Nothing makes mmore sense as to go on Vacation while Rome BURNs ... Only in the USA land of the free? Home of the truly STUPID...
Aug 13, 2012 9:22PM

Face it folks, the weak economy is tied to the overall weakness of the "consumer networth".  The majority of consumers are sadled with low or negative networth in their main investment vehicle - their homes...The value of housing is linked to the well being of the consumer/buyer and since this well being is dependent on their ability to earn a living the near future doesn't look good...


QE3 will "give" cheap money to the bankers but with consumers not buying...this wont work either in lifting any "real part" of the economy... 

Aug 7, 2012 9:31AM
A key to revitalizing the housing market lies in being able to significantly shore up the home prices of currently owned homes while allowing new housing activity to operate in a free market based mortgage interest environment restoring mortgage interest rates going forward in the housing market to historic norms.  This can be accomplished by allowing all presently owned homes to be refinanced at about 4% interest whenever those homes are sold over the next  30 years regardless of what the going mortgage interest rates are for new housing activity over the 30 years.   If the mortgage interest rate for new housing activity rises for example to 7%,  the value of the homes which were previously owned will not drop significantly if at all because those previously owned homes will be able to be sold to new owners and financed at 4% interest for the next 30 years.  As the 30 year period is used up the time value of the 4% financing benefit will decrease slightly each year lowering the value at which the previously owned homes can be sold in relation to new housing activity.  At the end of the 30 years when there is no longer a 4% mortgage option attached to the previously owned homes which had been applied to all homes owned at the beginning of the 30 year period, the prices of the previously owned homes at the beginning of the 30 years and the prices of comparable homes
which were on the market at free market mortgage rates will have converged.  At that point
after the 30 years with the 4% option had elapsed, all homes sold would be sold at the free
market mortgage rate and the effects of the mortgage rate freeze on the prices of a portion of the market will have ended.

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