The Federal Reserve Weighs in on Housing Policy

Hal Singer —  3 February 2012

Last month, the Federal Reserve released a study, titled “The U.S. Housing Market: Current Conditions and Policy Considerations,” which offers prescriptions on how to cure the housing mess. Given the importance of this issue to the nation’s economic wellbeing—a large portion of our assets are tied up in real estate, and the associated housing-wealth effects are large—I am surprised how little attention the housing market is getting in the Republican debates. Debate sponsors, presumably driven by ratings, seem more interested in Newt’s love life and Mitt’s finances than in economic policy.

The concluding comments of the Fed study are worth repeating here:

The significant tightening in household access to mortgage credit likely reflects not only a correction of the unsound underwriting practices that emerged over the past decade, but also a more substantial shift in lenders’ and the GSEs’ willingness to bear risk. Indeed, if the currently prevailing standards had been in place during the past few decades, a larger portion of the nation’s housing stock probably would have been designed and built for rental, rather than owner occupancy. Thus, the challenge for policymakers is to find ways to help reconcile the existing size and mix of the housing stock and the current environment for housing finance. Fundamentally, such measures involve adapting the existing housing stock to the prevailing tight mortgage lending conditions–for example, devising policies that could help facilitate the conversion of foreclosed properties to rental properties—or supporting a housing finance regime that is less restrictive than today’s, while steering clear of the lax standards that emerged during the last decade. Absent any policies to help bridge this gap, the adjustment process will take longer and incur more deadweight losses, pushing house prices lower and thereby prolonging the downward pressure on the wealth of current homeowners and the resultant drag on the economy at large.

Translation: If we can expedite the transition of our housing stock, we can turn this economy around faster. The study offers several policy prescriptions, including facilitating the conversion of foreclosed properties to rental properties, minimizing unnecessary foreclosures through the use of a broad menu of types of loan modifications, and supporting policies that facilitate deeds-in-lieu of foreclosure or short sales.

On page 14 (of a 26 page report), the study offers yet another approach: land banks, which are described as “public or nonprofit entities created to manage properties that are not dealt with adequately through the private market.” Before the free-market crowd gets worked up, they should recognize that a string of abandoned homes generates a negative externality in a neighborhood, which is precisely the occasion for intervention. Properties acquired by land banks may be rehabilitated as rental units or demolished, as market conditions dictate, which could harness deflationary forces caused by excess supply and neighborhood blight.

My only nit with the section is that the Fed limits the land-bank option to “low-value properties,” which they seem to define as properties below $20,000. This is too timid: If land banks are successful at revitalizing neighborhoods—imagine a park in every neighborhood—then why limit the policy to homes that are effectively worthless? Despite this limitation, the Fed calls for increased funding and technical assistance to existing land banks and for creating a national land bank program.

Kudos to the Fed for taking such a bold stand! If only we could get the debate moderators to ask candidates how to solve the housing mess.