By Steven K. Beckner

NEW YORK (MNI) – The housing market collapse and related mortgage
credit constraints have stymied the Federal Reserve’s monetary efforts
to stimulate the economy, justifying the kind of housing policies which
the Fed has recommended for consideration, according to a report
released Friday at a conference featuring a number of monetary

However, the report urges that policies to ease mortgage
refinancings and to convert foreclosed properties to rental units should
be “targeted” and advises against a generalized effort to reflate the
housing bubble.

Because of “severe problems” in the housing and mortgage credit
markets, there is a large “gap” or “wedge” between the interest rates
that the Fed influences and the rates at which many people are actually
able to borrow, according to the report. This echoes complaints from Fed
officials themselves about the clogging up of the “monetary transmission

That aside, there remains such a large overhang of unsold and
foreclosed homes that mortgage rates would have to be “negative” to
clear the market, says the report.

The report was written by economists Michael Feroli of JP Morgan
Chase, Ethan Harris of Bank of America Merrill Lynch, Amir Sufi of the
University of Chicago Booth School of Business and Kenneth West of the
University of Chicago was presented at a Monetary Policy Forum sponsored
by the Booth School.

San Francisco Federal Reserve Bank President John Williams and St.
Louis Fed President James Bullard are set to discuss the paper. Later
New York Federal Reserve Bank President Williams Dudley and Philadelphia
Fed President Charles Plosser will participate in a panel discussion on
fiscal challenges around the world.

While concurring with many of the findings of the Fed “white paper”
on housing which Fed Chairman Ben Bernanke sent to Congress last month,
the report stops short of fully supporting all of the housing policy
options it contained.

“Weakness in housing presents challenges to the transmission of
monetary policy to the real economy,” the economists conclude. “The
sensitivity of real economic activity to changes in rates that the
Federal Reserve can affect may be substantially lower given the housing

“In light of these challenges, we are in support of programs that
directly tackle issues in housing, such as programs that facilitate
refinancing for underwater mortgages and help transition foreclosure
inventory into rentals,” they continue. “In this sense, we are in
agreement with recent policy advice emerging from members of the Federal

“However, we also believe that policies must recognize the
possibility that a dramatic overinvestment in housing driven by
unsustainable house price growth during the boom will not be magically
cured,” the report goes on. “In this sense, policies should identify
specific market frictions and target those frictions, rather than
attempt to boost house prices artificially.”

Echoing what a number of Fed officials have said, the four
economists write that “weakness in housing and residential investment is
a main impediment to a robust recovery” and that “problems related to
housing have affected the transmission of monetary policy.”

In the typical recovery, low interest rates induce a sharp rebound
in housing and in home prices, which in turn increases household wealth,
consumer spending and so forth.

But this time residential investment has been “particularly
dismal,” and “the collapse in housing markets may hinder the ability of
monetary policy to operate through these channels.” say Feroli et al.

“In particular, the physical overhang of existing properties
introduces a serious headwind that may require very large and
unrealistic reductions in the user cost of housing to generate a
recovery in residential investment,” they write. “Foreclosures and
depressed house price expectations only add to this problem.”

“Further, the collapse in house prices and tight credit conditions
may limit the ability of borrowers to access low interest rates,” they
go on. “Or in other words, problems related to housing introduce a large
wedge between rates that the Federal Reserve can affect and the rates at
which households can realistically borrow.”

The report estimates that the housing stock remains about 9% above
its desired level, which means that “mortgage interest rates would need
to be negative to bring down the user cost to a level that would equate
desired housing with actual housing.”

They warn that there will be another 7 1/2 million in distressed
home sales (foreclosure or short sales) and note that home prices
nationally are down 33% from their peak.

As a result, the report says, “physical overhang presents a
significant headwind to monetary policy–even if long term mortgage
rates were reduced substantially from their already historical lows, the
desired housing stock would likely still be lower than the existing
housing stock.”

Further exploring the challenges which the housing collapse
presents to monetary policymakers, the four economists write that “even
with an aggressive attempt to lower long-term interest rates on
mortgages, the large physical overhang of existing residential
properties may still be above the desired stock. Our calculations
suggest that long-term interest rates would need to be negative to
equate the desired and actual stock of homes.”

“Second, our analysis suggests that frictions related to lending
markets mean that the economy may be less sensitive to Fed policy,” they

While supporting the kind of housing policies suggested in the Fed
white paper, the economists caution “it is important to recognize that
there was likely over-investment in housing during the boom, and that
consumption was likely partially driven by unrealistic expectations
about house prices going forward.”

This was a point made recently by Bullard, who contended “it is not
reasonable to think that these particular areas of (real estate)
investment should robustly expand in the aftermath of a collapse real
estate bubble.”

“Given this sentiment, it is crucial that policy-makers think
carefully about the market frictions that justify a policy response,”
Feroli and his colleagues write. “A mistake would be to adopt policies
that seek to artificially boost house prices and residential investment
going forward.”

On the other hand, they maintain that there are “real frictions” in
the credit market that “justify policy interventions.

One policy path already being pursued, with very mixed success, by
the Obama administration is efforts to facilitate refinancing activity.
But the economists are skeptical of that approach.

“In our view, however, an effective program to aid underwater
homeowners will require large budgetary resources that are unlikely to
prove politically palatable,” they write.

The report is more favorable to converting distressed properties
into rental units to meet a rising demand for rentals.

“Of the options outlined in the 2012 Fed white paper the one that
we think most likely to be adopted is the one in which government REOs
(Real Estate Owned) could be sold to investors who would rent them out,”
the four economists write.

“This would be done through bulk sales, which means pooling REOs
together, presumably by region, to sell to investors at once,” they
continue. “This approach would likely include government financing to
investors for bulk purchases, and in particular would relax current
rules restricting the number of units that can be financed by Fannie or
Freddie when properties are sold in bulk.”

“We agree with the 2012 white paper that predicting the effects of
such a program is difficult,” they go on. “But in our view, such a
program moves the housing market in the right direction and should be

“There are many challenges to this program, but we believe the
biggest is to remove the credit constraint for investor demand,” they
add. “Given the importance of getting the housing market back on its
feet, it seems clear to us that it is worth trying.”

The report maintains that “a successful own-to-rent policy (would)
speed the efficient reallocation of resource, ease pressure on home
prices and speed the turn in the housing market.” And it says “an added
benefit to the Fed, is that by taking pressure off of rent and owners
equivalent rent, it would help contain inflation.”

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