In an unusual move, the Federal Reserve has sent to Congress a whitepaper outlining policy options for the moribund housing market, lamenting tight lending standards and calling for efforts to turn a large inventory of bank-owned foreclosures into rental units.
Housing policy is not part of the mandate of the U.S. central bank. But in a letter sent Wednesday to Senators Tim Johnson, D-S.D., and Richard Shelby, R-Ala., the ranking members of the Senate Banking, Housing and Urban Affairs Committee, and to Congressmen Spencer Bacchus, R-Ala., and Barney Frank, D-Mass., the ranking members of the House Financial Services Committee, Fed Chairman Ben Bernanke said reviving the nation's flagging housing market was a "necessary part of a broader strategy for economic recovery."
The 26-page whitepaper frequently cites tight credit conditions as a problem that policymakers should find a way to correct. In a nearly pleading tone, the whitepaper says "continued efforts are needed to find an appropriate balance between prudent lending and appropriate consumer protection, on the one hand, and not unduly restricting mortgage credit, on the other hand. In particular, policymakers should recognize that steps that promote healthier housing and mortgage markets are good for safety and soundness as well."
The paper adds that only about half of the homeowners who could profitably refinance could qualify under today's credit standards. The Fed suggests an easing of credit that reduced monthly mortgage payments would "imply an earlier stabilization of house prices and reduced rates of mortgage delinquency, helping both borrowers and lenders. Neighborhoods would benefit from reduced rates of foreclosure and fewer vacant homes, while localities would experience gains, or less pronounced reductions, in property tax receipts."
The Fed also suggests that the increased risk aversion on the part of lenders today does not match the current housing mix. "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."
Data firm REIS Inc. has reported that apartment rental vacancies have fallen to their lowest level in over a decade. To that end, the Fed whitepaper calls for "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."
Adoption of any of these measures will require action from Congress, but the strength of the recommendations and the urgent tone of the report suggest the Fed for its part will not remain passive.
Quincy Krosby, chief market strategist, Prudential Annuities, said at a press gathering Wednesday in New York that she thinks the "Fed will probably give us QE3" this year, but will focus on buying mortgage-backed securities rather than Treasuries. She suggested that the quantitative easing would most likely take place "after the markets struggle"–something that a strengthening U.S. dollar could cause. A stronger dollar, she said "will be a test of the U.S. economy."
John Praveen, managing director and chief investment strategist for Prudential International Investments Advisors, agreed with Krosby that another round of Fed buying would be likely. However, he suggested that political considerations would make it more "likely to happen" in the second quarter rather than later in the year.
Specifically, he said the timing could be laid to Ben Bernanke's desire to keep the Fed from making moves that could be seen as benefiting the incumbent in a presidential election year, something he pointed out that still haunted Alan Greenspan, who was criticized by supporters of President George H.W. Bush as contributing to his loss in the 1992 election to Bill Clinton.
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