Fed's proposals to fix housing fall short

Major obstacles lie in income documentation, mortgage insurance rules

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted Feb. 13, 2012

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Major obstacles lie in income documentation, mortgage insurance rules

Jack Guttentag
Inman News®

In an important break from prior practice, Federal Reserve Chairman Ben Bernanke early in January delivered a staff document to both houses of Congress that called for important changes in housing policy. The major theme was that "continued weakness in the housing market poses a significant barrier to a more vigorous economic recovery," and "there is scope for policymakers to take action ..."

Backdrop: the reduced effectiveness of monetary policy

Before the financial crisis, the housing sector was a major part of the mechanism through which monetary policy impacted the economy. Monetary easing during recessions stimulated refinancing, homebuying and new home construction as a counterforce to weaknesses elsewhere in the economy. But not this time.

While the Fed has reduced mortgage rates to the lowest levels ever, the impact has been weakened by tighter mortgage lending terms and eligibility requirements, an erosion of homeowner equity due to home-price declines, a drastic rise in defaults and foreclosures, and an enormous inventory of existing homes for sale with many being distress sales. The spark of monetary easing has fallen on wet grass.

The Fed document is an excellent summary of the problems now afflicting the housing sector. Its discussion of potential remedies, however, is spotty.

Short-run vs. long-run remedies

The Fed does not here distinguish remedies that could be implemented quickly enough to impact the current economic weakness, and remedies that would take too long, however useful they might be from a long-run perspective.

For example, the proposal for additional pricing reductions by Fannie Mae and Freddie Mac under the HARP program could be implemented very quickly, but creating a badly needed national online mortgage registry would take years, if not decades.

Shift more REO properties to the rental market

REO properties are those acquired through foreclosures or deeds-in-lieu of foreclosure. Their subsequent sale, often at distress prices, places downward pressure on home prices generally and retards recovery. Since the rental market has been strong, partly because homeowners who lost their homes to foreclosure are now renters, it would be helpful if ways could be found to shift more REO properties to the rental market.

Discussion of various ways to accomplish this objective comprises a major part -- and the strongest part -- of the Fed document. Since about half of the REO inventory is held by Fannie Mae, Freddie Mac and FHA, these agencies and FHFA, the regulator of Fannie and Freddie, must be involved in the effort. An inter-agency group is working on this problem now.

Ease lending standards

The Fed shares the consensus view of informed observers that housing recovery has been hampered by excessively restrictive lending standards set by Fannie Mae and Freddie Mac. In meeting their conservatorship obligation to "preserve assets," the agencies are not giving sufficient weight to the impact of their actions on total housing demand, and thence on home prices and foreclosures. Their excessively tight standards could result in fewer assets to preserve, rather than more.

Beyond this, the Fed's analysis is superficial and incomplete.

Lenders are more restrictive than the agencies: Fed data show that while Fannie and Freddie purchase loans with borrower credit scores as low as 620, most lenders have minimums of 640 or 660. The Fed attributes this to a fear of high servicing costs on loans to chronically delinquent borrowers and/or to a fear that the agency will require them to buy loans back if they don't perform.

But this doesn't explain why lenders don't compensate for low credit scores with higher down-payment requirements, higher payment reserves, or lower maximum debt ratios.

There no longer seems to be any underwriter discretion in connection with conforming loans, but the reasons are not clear. My surmise is that it is connected to the complex contracts that govern the relationships between the agencies and the lenders that sell to them. Political inhibitions may be the reason the Fed did not explore this topic, but it would be a good project for the Government Accountability Office (GAO).

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