Fed’s Bitter Pill for Housing Market Recovery Plan

The Federal Reserve’s most recent look into the U.S. housing market recovery promises more losses to taxpayers as Fannie Mae and Freddie Mac continue to lose money, and …

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The Federal Reserve’s most recent look into the U.S. housing market recovery promises more losses to taxpayers as Fannie Mae and Freddie Mac continue to lose money, and a proposal to convert government-owned foreclosed homes to rentals that may only serve to lower overall rental values by shifting the “shadow inventory” from one market into another. The Fed paper reported that losses will be sustained by every player in the industry, from homeowners to lenders, but that those costs must be paid if a recovery is to ever take hold. For more on this continue reading the following article from TheStreet.

The Federal Reserve Chairman Ben Bernanke on Wednesday proposed policies that would force a recovery in housing, but cautioned that there was no single solution to the housing market’s problems and that everyone from investors to taxpayers would need to feel the pain.

In a 26-page white paper, the Fed outlined ways to ease some of the pressures afflicting the housing market.

While some of the weakness was due to weak labor market conditions and poor demand, policies that would address the excess inventory of foreclosed homes, borrower access to mortgage credit and inefficient foreclosure procedures should be considered, the central bank said.

Still, while policy action in these areas could facilitate the recovery of the housing market, "economic losses will remain, and these losses must ultimately be allocated among homeowners, lenders, guarantors, investors, and taxpayers," the Fed cautioned.

Some of the proposals in the white paper have been discussed before, including one that looks at the conversion of foreclosed homes to rental units. "..The large inventory of foreclosed or surrendered properties is contributing to excess supply in the for-sale market, placing downward pressure on house prices and exacerbating the loss in aggregate housing wealth. At the same time, rental markets are strengthening in some areas of the country, reflecting in part a decline in the homeownership rate," the paper noted.

"Reducing some of the barriers to converting foreclosed properties to rental units will help redeploy the existing stock of houses in a more efficient way. Such conversions might also increase lenders’ eventual recoveries on foreclosed and surrendered properties."

The regulator is considering issuing guidance to banking organizations and examiners to clarify supervisory expectations regarding rental of residential REO properties by such organizations while such circumstances continue (and within relevant federal and statutory and regulatory limits).

As of September 2011, U.S. commercial banks had $10 billion in residential REO properties on their balance sheets, while savings and loans had an additional $1.4 billion. But serviced-for-others REO portfolios managed by banking organizations are significantly larger than their owned portfolios.

Bank of America(BAC), JPMorgan Chase(JPM) and Wells Fargo(WFC) are the biggest mortgage originators in the country.

The Fed also urged policy makers to find a balance between "prudent lending and appropriate consumer protection" on one hand and "not unduly restricting mortgage credit" on the other, suggesting that the current tightness in mortgage credit might be overdone.

"Policymakers should recognize that steps that promote healthier housing and mortgage markets are good for safety and soundness as well," the paper argued.

The paper does not address the fate of Fannie Mae and Freddie Mac. Instead it makes a case for the agencies to take further action to boost the recovery in the market even if it means further losses to taxpayers in the near term.

"In many of the policy areas discussed in this paper–such as loan modifications, mortgage refinancing, and the disposition of foreclosed properties–there is bound to be some tension between minimizing the GSEs’ near-term losses and risk exposure and taking actions that might promote a faster recovery in the housing market," the Fed wrote. "Nonetheless, some actions that cause greater losses to be sustained by the GSEs in the near term might be in the interest of taxpayers to pursue if those actions result in a quicker and more vigorous economic recovery."

The Fed also suggested that banks actively consider alternatives to foreclosures such as deeds-in-lieu of foreclosure or short sales, which can help reduce transaction costs and minimize negative effects on communities.

The central bank warned that failure to take action would mean the adjustment process in the housing market will take longer adding to "deadweight" losses, pushing house prices lower and prolonging the downward pressure on the wealth of current homeowners and the resultant drag on the economy at large.

This article was republished with permission from TheStreet.

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