Federal Reserve Chairman Ben Bernanke recently spoke to the International Builders Group of the National Association of Homebuilders in Orlando, Fla., and made the argument that the housing industry is hampering the Fed’s ability to assist in the country’s economic recovery. Addressing the concerns of homebuilders, Bernanke explained that foreclosure supply was squelching the need for new homes as well as driving down home values, which further lowers homebuyer sentiment. Bernanke pointed the finger at strict lending conditions that have made lower mortgage rates irrelevant, being that few can qualify to take advantage of those rates. For more on this continue reading the following article from JDSupra.
Last month, we posted about the white paper that US Federal Reserve Chairman Ben S. Bernanke submitted to Congress (read it here, along with the full text of that Federal Reserve white paper) and all the reactions to his submission. Some think the Fed Reserve Chairman is going too far, with Bernanke exceeding the limits of his authority with what he’s suggesting to Congress and essentially promoting in his speech last week.
Because Bernanke’s speech to the International Builders Group of the National Association of Homebuilders on February 10, 2012, was taken point by point from Bernanke’s arguments to Congress.
At least everyone can agree that Bernanke is a man with a mission.
In essence, Ben Bernanke is arguing that the Federal Reserve system is being hampered in its efforts to jump start the American economy because the U.S. Housing Industry is not cooperating. Specifically, the Federal Reserve Chairman is pointing fingers at the weak mortgage lending present in Florida as well as the rest of the country.
Weak mortgage lending means a weak housing market, which is a big problem for the Federal Reserve these days. A problem to be solved.
Bernanke Didn’t Talk Money to the Builders, He Talked Housing After acknowledging a fact that everyone in the real estate industry, if not the country at large, understands – that record low interest rates on home mortgages are not igniting home sales – Bernanke moved to suggestions for getting things moving.
Things like having government entities (land banks) take on home ownership thru donations of homes; buying of homes; and selling of homes, as well as having the power to clear up title questions.
Result? Many who are currently facing foreclosure in Florida may never move from their home; however, they may change from being “owner” to “tenant” with the government taking on the responsibility of home ownership. In the future, will the government sell that home back to the tenant who was facing foreclosure as a home owner? Probably – but that’s one of the big issues here: once the government owns the real estate, some are concerned that the government won’t let go.
Here is the full text of Federal Reserve Chairman Ben Bernanke’s speech in Orlando last Friday (click to view the entire speech), entitled “Housing Markets in Transition,” as it was presented at the National Association of Homebuilders’ International Builders Show:
The economic recovery began more than two years ago, but it doesn’t feel like much of a recovery for many Americans–certainly for those of you who depend on the housing sector for your living, as well as for the millions of others who have seen their home values plummet or lost their homes through foreclosure. Though some progress has been made in reversing the losses in jobs and income sustained during the recession, the pace of expansion has been frustratingly slow and the unemployment rate remains very high by historical standards. The state of the housing sector has been a key impediment to a faster recovery. In the typical economic recovery, a resurgent housing sector helps fuel reemployment and rising incomes. But as you know all too well, that scenario has not played out this time. Although the precipitous declines in construction that began in 2006 are, thankfully, now behind us, homebuilding remains depressed in most areas, relative both to where it was before the downturn and to where it will need to be to meet the needs of a growing population in the longer term.
The Federal Reserve has a keen interest in the state of housing and has been actively engaged in analyzing the housing and mortgage markets. Issues related to the housing market and housing finance are important factors in the Federal Reserve’s various roles in formulating monetary policy, regulating banks, and protecting consumers of financial services. Traditionally, mortgage interest rates have been a key transmission channel of monetary policy; and banks’ mortgage lending policies directly affect their own safety and soundness as well as the access of creditworthy households to mortgage credit. My remarks today will focus on current housing market conditions and on how housing problems have affected borrowers, lenders, communities, and the broader economy. I’ll also discuss some specific sources of our housing problems, including tight conditions in the mortgage market and the overhang of foreclosed and vacant homes.
Overview of the State of the Housing Market
One way to understand conditions in the housing market is to focus on the balance of supply and demand. For the past few years, the actual and potential supply of single-family homes has greatly exceeded the effective demand. The elevated number of homes that are currently vacant instead of owner occupied reflects the imbalance. According to the most recent estimate, about 1-3/4 million homes are currently unoccupied and for sale. While this figure has declined slightly during the past few years, it is nonetheless up dramatically from the first half of the 2000s, when readings of about 1-1/4 million vacant homes were the norm. Of course, housing conditions vary by region, and vacancy rates in some locations are substantially higher than the national average. For example, here in Florida the homeowner vacancy rate in the third quarter of 2011 averaged 3.2 percent, compared with the national average of 2.4 percent.
Moreover, a very large number of additional homes are poised to come on the owner-occupied market. In each of the past few years, roughly 2 million homes have entered the foreclosure process, and many of these homes have been put up for sale, crowding out much of the need for new building. Looking ahead, the relatively high rate of foreclosures is likely to continue for a while, putting additional homes on the market and dislocating families and disrupting communities in the process.
At the same time, a number of factors are constraining demand. Household formation has been down, particularly among young adults. High unemployment and uncertain job prospects may have reduced the willingness of some households to commit to homeownership. Availability of mortgage credit is an important constraint, to which I will return later.
Additionally, housing may no longer be viewed as the secure investment it once was thought to be, given uncertainty about future home prices and the economy more generally.
Not surprisingly, the large imbalance of supply and demand has been reflected in a drop in home values of historic proportions. Nationally, house prices have plunged about 30 percent in nominal terms from their peak and nearly 40 percent in real, or inflation-adjusted, terms. The imbalance of supply and demand has also been reflected in the decline in home construction that I mentioned earlier. Since 2009, the pace of single-family housing starts has averaged less than 500,000 units per year. During the 15 years before the financial crisis, the pace of single-family starts had never fallen below 1 million units per year.
In contrast to the situation for owner-occupied homes, rental markets around the country have strengthened somewhat. In particular, vacancy rates for rental properties have declined and now stand near the lower end of their range over the past eight years. Not surprisingly, rents have been increasing and the construction of apartment buildings has picked up.
To recap, the housing sector continues to suffer from serious imbalances–a marked excess supply for owner-occupied housing accompanied by a stronger rental markets. The narrative of the housing market over the next several years will revolve around the resolution of those imbalances.
Broader Implications of the Problems in the Housing Market
As homebuilders, you naturally pay close attention to the demand for new homes and their prices. These factors are important for the health of your industry, including its ability to create jobs in construction and related activities. But the problems in housing also have important implications outside the construction industry.
For instance, consider the effects on neighborhoods and communities. Foreclosures, particularly when they are geographically concentrated, can diminish the values of nearby properties. Many foreclosed homes are neglected or abandoned, as legal proceedings or other factors delay their resale. Deteriorating or vacant properties can, in turn, directly affect the quality of life in a neighborhood, for example, by leading to increases in vandalism or crime. Moreover, the continuing price declines typical in neighborhoods with many foreclosures depress the tax base of the community. A vicious circle can get started: Increasing vacancies together with decreasing tax revenue and consequent cutbacks in services can further depress home prices, putting the goal of neighborhood stabilization even further out of reach.
As I mentioned earlier, problems in the housing market have also restrained the broader economic recovery. For example, by some estimates, declines in house prices have reduced homeowners’ equity by more than 50 percent in the aggregate since the peak of the housing boom, resulting in more than a $7 trillion loss of household wealth.4 Indeed, about 12 million homeowners–more than 1 out of 5 with a mortgage–are underwater, meaning they owe more on their mortgages than their homes are worth. One of the effects of declines in housing wealth is to reduce the ability and willingness of households to spend. While estimates vary, homeowners are believed to spend somewhere between $3 and $5 per year less for every $100 of housing value lost.5 Based on those estimates, it appears that recent declines in housing wealth may be reducing consumer spending between $200 billion and $375 billion per year. That reduction corresponds to lower living standards for many Americans. And, importantly, lower sales of goods and services also reduce the incentives of firms to invest and hire, thereby slowing the recovery. Of course, these consumer-related effects are on top of the direct consequences of low rates of home construction for job creation and income.
Low or negative equity creates additional problems for households. It reduces financial flexibility: Homeowners who are underwater on their mortgages cannot tap home equity to pay for emergency health expenses or their children’s college educations. Mobility may be affected to some degree; underwater borrowers who have difficulty selling their homes may find it more difficult to move to take new jobs. Moreover, homeowners with underwater mortgages may find it difficult or impossible to take advantage of low interest rates by refinancing their mortgages, even if they are current on their payments.
The state of housing and mortgage markets may also be holding back the recovery of our financial system and the normalization of credit conditions. Mortgage delinquencies surged between 2007 and 2009 and remain high, imposing losses on lenders, mortgage insurers, and investors. Although some of the losses were the result of poorly underwritten mortgages, an increasing share of losses have arisen from prime mortgages that were originally fully documented with significant down payments, but that have defaulted due to the weak economy and housing market. The Federal Reserve and other bank regulators have used stress tests and other tools to help ensure that banks have enough capital to cover mortgage losses while continuing to lend. On the margin, though, some lenders might be inclined to respond to losses by tightening credit terms or being more cautious about extending loans rather than by raising additional capital. In short, housing problems affect the homebuilding industry, of course, but also have much broader effects–on neighborhoods and communities, on homeowners, on the financial system, and on the vitality of the economy as a whole. This observation underscores the importance of efforts to improve the condition of the housing market.
Availability of Mortgage Credit
So why has the recovery in housing been so slow? One important factor is restraints on mortgage credit. Since its peak in 2007, U.S. home mortgage credit outstanding has contracted about 13 percent in real terms. In prior recoveries, mortgage credit had begun to grow four years after the business cycle peak–but not this time around.
One reason for the very slow recovery in mortgage credit, despite monetary policy actions that have helped drive mortgage rates to historically low levels, is that many lending institutions have tightened underwriting conditions dramatically, relative to the pre-recession period.
Given the lax standards during the credit boom, some tightening was doubtless appropriate to protect consumers and ensure lenders’ safety and soundness. However, current lending practices appear to reflect, in part, obstacles that are limiting or preventing lending even to creditworthy households.
For example, mortgage originators appear to be reluctant to extend credit to some potential borrowers who could meet the underwriting standards currently set by 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. A number of possibilities could explain this reluctance to lend. In some cases, borrowers cannot obtain private mortgage insurance required by the GSEs. Thus, the weakened finances of private mortgage insurers could be damping mortgage credit availability for some potential borrowers. In other cases, lenders may be concerned about high servicing costs if mortgages become delinquent. Another set of concerns relates to so-called representations and warranties, which are contractual commitments by an originator concerning the quality of the loan. These contracts were designed to protect the GSEs or other purchasers of loans, but originators appear uncertain about how they will be enforced going forward and thus have been very cautious about making loans that could be viewed as less than perfect from an underwriting perspective. Learning from our experience with securitizations over the past decade, lenders and regulators alike should look carefully at rules and practices that may unduly diminish the origination of prudently underwritten mortgages.
Another reason for tight lending standards is that private-label mortgage securitizations have virtually disappeared. The difficulty of funding loans in the private-label securitization market may have discouraged lenders from originating loans to some borrowers who may be creditworthy but may not exactly fit the criteria of the GSEs or the Federal Housing Administration (FHA).
Potential first-time homebuyers have been disproportionately affected by the very tight conditions in mortgage markets. Lending to potential first-time homebuyers has dropped precipitously, even in parts of the country where unemployment rates and housing conditions are better than the national average. Indeed, the propensity of younger households–headed by adults aged 29 to 34–to take out their first mortgage has been much lower recently than it was 10 years ago, a period well before the most recent run-up in home prices.11 First-time homebuyers are typically an important source of incremental housing demand, so their smaller presence in the market affects house prices and construction quite broadly. Moreover, the lack of demand from first-time homebuyers may prevent current homeowners from moving up to larger homes, for example, to accommodate growing families.
An additional issue is the implication of tight mortgage credit conditions for monetary policy. Because some creditworthy households are finding it difficult to obtain mortgage credit or to refinance, the strong actions taken by the Federal Reserve to put downward pressure on longer-term rates and to improve financial conditions have had less effect on the housing sector and overall economic activity than they otherwise would have had.
The problem of tight mortgage credit will not be solved easily or quickly. The Federal Reserve, in its supervisory capacity, continues to encourage lenders to find ways to maintain prudent lending standards while serving creditworthy borrowers. But the slow recovery of the housing market and the economy, continued uncertainty surrounding the future of the GSEs and the regulatory environment for mortgage lending, the likely continued absence of a private-label market, and more cautious attitudes by lenders are all barriers to rapid normalization of the flow of mortgage credit.
Overhang of Empty and Foreclosed Homes
To date, policymakers have been focusing on refinancing creditworthy (but sometimes underwater) borrowers, on loan modifications, and on other ways to avert additional foreclosures. This work is obviously very important. But unfortunately, not all foreclosures can be prevented. Given the weak economy and high unemployment rates, some borrowers simply do not have the wherewithal to meet monthly mortgage payments even if their loans were to be substantially modified. Therefore, we have seen increased interest in whether anything can be done to reduce the overhang of empty and foreclosed homes.
We estimate that about one-fourth of the excess supply of vacant homes for sale in the second quarter of 2011 was owned by creditors; these homes are often referred to as real estate owned, or REO properties. Moreover, Federal Reserve staff estimate that distressed sales, which include both short sales and non-auction sales of foreclosed homes by REO holders, now account for 30 percent of home sales. Although it is difficult to forecast future REO flows, we estimate that an additional 1 million foreclosed properties could be added to the REO held by banks, guarantors, and servicers in each of the next few years. These inflows will continue to exert downward pressure on home prices.
In contrast to the markets for owner-occupied homes, rental housing markets across the nation have recently strengthened somewhat, as I mentioned earlier. Fueled by increased demand from families who are either unable or reluctant to purchase homes, rents are up and vacancy rates for multifamily properties are down in most metropolitan areas.
With home prices falling and rents rising, it could make sense in some markets to turn some of the foreclosed homes into rental properties. According to Federal Reserve staff calculations, most REO properties are in neighborhoods with median house values and incomes that are roughly similar to the medians for the metropolitan area overall. Moreover, these properties are not unusually far, in terms of commuting times, from where jobs are located. We have compared computations of the expected annual cash flows from renting properties to the discounted prices that REO property holders typically receive when selling a home. The comparison suggests that some REO holders might come out ahead by renting, rather than by selling, some of their properties.
Moreover, keeping paying tenants in homes–including leasing to the former owners at market rents–may, in some cases, be the best way to maintain property values and the quality of neighborhoods. REO-to-rental programs could potentially also minimize the amount of time that a vacant property languishes in REO inventory. That is, appropriately structured programs could help some involuntary renters become owners again by giving them options to purchase the homes they are renting.
REO-to-rental programs are not a “silver bullet” for the housing market, and, indeed, implementing them presents some challenges. For example, selling the properties in bulk to investors to rent out has proven difficult at times because of lack of financing, although the GSEs have just announced a pilot program to facilitate such purchases. In addition, many REO properties may not be appropriate for REO-to-rental programs, either because they are in very poor condition or because they are not part of a sufficiently large cluster of properties to allow for economies of scale in their management. Nevertheless, REO-to-rental programs appear to have some potential for success. As of early November 2011, about 60 metropolitan areas each had at least 250 REO properties for sale by the GSEs and the FHA–a scale that could be large enough to realize efficiency gains. Atlanta has the largest number of REO properties for sale by these institutions, with about 5,000 units. The next-largest inventories are in the metropolitan areas of Chicago; Detroit; Phoenix; Riverside, California; and Las Vegas, each of which have between 2,000 and 3,000 units. As I noted, not all REO properties are appropriate for rental, but many do appear to be physically adequate and potentially attractive to tenants. The number of properties suitable for rental is bound to increase, as the number of properties currently in the foreclosure process is more than four times the number of properties in the REO inventory.
Other options can help with foreclosed houses that have low value and are in poor condition, homes that are not likely to be dealt with adequately through the private market. For example, land banks could handle some of these properties. Land banks are typically governmental entities that have the ability to purchase and sell real estate, clear titles, and accept donated properties. Properties may be rehabilitated as rental or owner-occupied housing or, in extreme cases, demolished, depending on the needs of individual markets. While land banks are a promising option, only some states have passed legislation to establish land banks, and most existing land banks lack the resources to keep pace with the number of low-value properties in the current inventory. It is, of course, critical that local governments pursuing land banking, or similar strategies, have staff members with the appropriate skills as well as adequate oversight to ensure that public funds are employed efficiently.
REO-to-rental programs, land banks, and other neighborhood stabilization efforts are just a few examples of the approaches that policymakers could consider to help facilitate the adjustment of the housing market. To be sure, every program requires careful analysis to ensure that it is effective and meets reasonable cost-benefit tests. Experimentation with alternative approaches could help find the best way forward.
In sum, the economic recovery has been disappointing in part because U.S. housing markets remain out of balance. Many local markets have an overhang of empty and foreclosed homes, and many potentially creditworthy homebuyers cannot obtain mortgages. The weak housing market also impairs homeowners’ financial health and diminishes the quality and stability of neighborhoods and communities. For these reasons, and because the troubled housing market depresses construction activity and employment, we need to continue to develop and implement policies that will help the housing sector get back on its feet. No single solution will be sufficient. But sustained efforts to address the many interlocking factors holding back the housing market will pay dividends in the long run.