A Federal Reserve white paper urging more aggressive government action to strengthen the ailing housing market is attracting considerable attention – and drawing fire from Republican lawmakers and some economists, who think government should be reducing, not expanding, its housing role.
The white paper argues that housing needs more attention because the deep and prolonged downturn in that sector is impeding the broader economic recovery. The paper suggests several steps that would stabilize the market, among them:
- Expand the Home Affordable Refinance Program (HARP) to permit more underwater borrowers to refinance at today’s near-record low interest rates. This would require authorizing Fannie and Freddie to purchase loans on which borrowers have less than 20 percent equity without private mortgage insurance. (Recent revisions to HARP allow underwater refinances only on loans the GSEs already hold.)
- Require Fannie and Freddie to ease their enforcement of lender repurchase requirements on defaulted loans. The paper argues that current policies are discouraging lenders from originating new loans, which is exacerbating the housing downturn.
- Encourage the GSEs to rent properties on which they have foreclosed rather than reselling them. Fed analysts calculate that for at least 40 percent of the properties they have acquired through foreclosure, renting would produce lower losses than selling.
These steps would increase both the costs and potential liabilities of the two GSEs, which are operating under government conservatorship, and have received billions of dollars in taxpayer aid already. But the Fed’s white paper argues broadly that the GSEs’ policies should focus less on the near-term goal of strengthening their balance sheets and more on the longer-term need to bolster the housing market. “Some actions that cause greater losses to be sustained the GSEs in the near term might be in the interest of taxpayers [in the long term],” the paper contends.
Critics blasted the paper from several directions, decrying the prospect of investing more federal money in the enterprises, and warning that the Fed was meddling dangerously in areas in which it should not be involved.
"I believe that it is important to the interests of the Federal Reserve, including the independence of monetary policy, that the Fed refrain from providing any hint of activism regarding what are clearly fiscal policy choices," Orrin Hatch (R-UT), the ranking member on the Senate Finance Committee, told Reuters. "I am sure that the Fed would not appreciate a white paper from Congress outlining how to think about and execute monetary policy," he added.
A Principal Solution
The Federal Reserve’s broad prescriptions for bolstering the housing market did not include reducing the principal balance on underwater loans, but two Fed officials have endorsed that move. In separate speeches, Fed Governor Sarah Bloom Raskin and William Dudley, president of the New York Fed, both suggested that this strategy, criticized by many conservative lawmakers and rejected thus far by the Federal Housing Finance Agency (which regulates Fannie and Freddie), should be considered.
Responding to a question following her speech to the Association of American Law Schools, Raskin said principal reduction for under water home owners is among the remedies regulators should consider when determining appropriate penalties for lenders whose “misconduct and negligence” contributed to the foreclosure crisis. "The notion of how we can bring principal reduction into an enforcement action I think is a good question and one that as we think through what remedies and tools that we have…should stay on the table," she said.
Dudley similarly supported the use of “accelerated principal reduction” to modify the loans of struggling homeowners, as a means of reducing foreclosures and stabilizing the housing market. “Such a program would strengthen the incentives for mortgage holders who are underwater to continue to stay current on their loans and reduce the likely number of defaults," Dudley told a banking industry group.
Sen. Bob Corker (R-TN) responded immediately and negatively, warning that providing unwarranted assistance for delinquent borrowers would increase taxpayer costs and boost interest rates for future home buyers.
“Reducing the principal on home loans for borrowers who put no money down amounts to a massive wealth transfer from places like Tennessee, where most homeowners have borrowed responsibly, to places like California and New York, where exotic mortgages were widely used to finance a speculative housing boom,” Corker told reporters, adding, "It is absolutely egregious that the Federal Reserve would insert itself in this manner and ask people in Tennessee who played by the rules to bail out reckless borrowers in other parts of the country."
Try, Try Again
Don’t underestimate the determination of prospective home buyers. The National Association of Realtors (NAR) has been reporting elevated levels of failed transactions for the past two years, citing overly conservative appraisals and restrictive underwriting standards as the major reasons a high percentage of “pending sales” aren’t consummated. But a rebound in the NAR’s pending sales index (up 7.3 percent in November over the prior month) indicates that many of the buyers involved in failed transactions are picking themselves up and starting the process over again.
For that reason, Lawrence Yun, the NAR’s chief economist, cautions against interpreting the November gain as evidence of an overall increase in home buying activity. “I suspect that buyers [who had deals fall through] are probably searching for another home and signing another contract,” so the recent statistics may reflect previously unsuccessful buyers “reentering” the market rather than new buyers making their first purchase efforts.
Prospective buyers may be encountering another obstacle as they try to seal home purchase deals: A large gap between what they are willing to pay for a home and the price sellers are willing to accept. Although recent surveys have found buyers increasingly convinced that this is a good time to buy, surveys have also found that seller attitudes are moving in the opposite direction.
Seller sentiment has plunged from an average of 40 percent to 60 percent with a favorable view of the market between 1992 and 2005 to a record low of 7.6 percent in a recent poll ― that’s 7.6 percent of current owners who think this is a good time for them to sell, according to a report produced by the Mortgage Bankers Association’s Research Institute for Housing America.
Gary Engelhardt, an economics professor at Syracuse University, and the author of the MBA study, suggests several possible explanations for the severely negative mood of sellers:
- The large inventory of unsold homes and the continuing foreclosure flood may be contributing to the conclusion that the current market does not favor sellers.
- Sellers may be pricing their homes unrealistically, based on market conditions before the downturn. "If owners update these anchor prices infrequently, then a wide gap in buyer and seller sentiment would emerge in the face of sharp, prolonged declines in market values, such as those seen in the last few years," he explains. “As market values have fallen, potential sellers have not adjusted their target selling prices downward fast enough to bring buyer and seller sentiment more in line with one another.”
- Sellers with underwater mortgages either can’t or won’t adjust their selling prices accordingly.
Engelhardt predicts that as the housing market stabilizes this year, homebuyer sentiment will continue to strengthen. But stability will come on the heels of further declines in home prices, which won’t do anything to improve the sentiments of home sellers.
Parental Aid
Home buyers are making larger down payments than they did in the housing boom days, when ‘zero down’ mortgages were common – now averaging 12 percent nationally, a recent survey by lending Tree found. But that’s still below the 20 percent minimum required to meet the “qualified residential mortgage”(QRM) standard regulators have proposed for loans that will be exempt from the “risk retention” requirement mandated by the Dodd-Frank financial reform legislation. That law requires lenders to retain 5 percent of the risk when they sell mortgages that do not meet the QRM standards, which regulators are still trying to finalize.
The Lending Tree study found that down payments don’t average 20 percent anywhere in the country, indicating that most of the loans originated in the past year would not have qualified for the risk retention exemption that most lenders will want to secure. Industry executives have warned that a 20 percent down payment requirement will slam the door on many, if not most, first-time buyers, dealing another blow to an already decimated housing market.
"Right now you have buyers who can't buy and sellers who can't sell and financing that can't get done, and we just sit here and stagnate," Doug Lebda, chief executive of Lending Tree, told American Banker.
The first-time buyers who are making larger down payments, and there are a fair number of them, are doing so largely with the help of loans or gifts from their parents, according to data compiled by the National Association of Realtors (NAR). The NAR reports that nearly one-third of first-time buyers last year received a gift, a loan, or both from their families. Although that is pretty much in line with the averages over the past decade, some industry analysts think the data understate the family assistance trend. They note, among other factors, that some parents are transferring funds well in advance of the home purchase, so the gift doesn’t have to be disclosed; some parents are also buying homes outright for their children and structuring the loan arrangement after-the fact, these analysts suggest.
Another indication that buyers are getting a financial boost from their parents: Cash purchases by first-time buyers hit an all-time high of 13 percent last year, according to data compiled by Inside Mortgage Finance. Analysts say it is probably reasonable to assume that in most cases, it was the parents writing those checks.
Property Rights Encore
The U.S. Supreme Court is tackling another closely watched property rights case this year. A few years ago, the court reviewed the limits on a government’s right to take private property for public purposes. In this case (Sackett v. EPA), the court is assessing the appropriate balance between the rights of property owners and the regulatory authority of government. The Sacketts purchased a vacant lot in a subdivision zoned for residential development, in which other homes had been and were being constructed. They obtained the required permits and got a verbal go-ahead from the Army Corps of Engineers, which concluded that although the site had water on it periodically, it did not meet the regulatory definition of a wetland.
The Environmental Protection Agency (EPA) disagreed. The agency ordered the Sacketts to halt construction on their home, replant the trees they had removed and otherwise restore the site to its original condition and maintain it as a wetland. Moreover, citing its authority under the Clean Water Act, the EPA said the Sacketts could not appeal the wetlands order until after they had completed all the remediation work the agency had ordered. That’s the issue the Supreme Court will decide – whether the agency can require property owners to comply with an order before giving them an opportunity to appeal it.
The lower courts sided with the EPA, saying the agency acted within its statutory authority; the Sacketts and a host of real estate industry groups supporting them argue that allowing the EPA to, in effect, seize private property without judicial review denies the owners the due process to which they should be entitled.
Media reports have characterized the case as a “David v. Goliath” fight defending private property rights against an “overreaching” federal agency. A CNN report noted “wide support” for the Sacketts when the Supreme Court heard oral arguments in early January, citing this comment by Justice Samuel Alito: “If you related the facts of this case ― as they come to us — to an ordinary homeowner, don’t you think most ordinary homeowners would say this kind of thing can’t happen in the United States?”
