For a More Aggressive Cleanup of Housing Finance
Lawrence Summers:
Why the housing burden stalls America’s economic recovery: The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence, more borrowing and lending--and more spending.
Most policy failures in the US stem from a failure to appreciate this truism, and therefore from taking steps that would have been productive pre-crisis but are counterproductive now with the economy severely constrained by lack of confidence and demand.
Thus even as the gap between the economy’s production and its capacity increases, fiscal policy turns contractionary, financial regulation focuses on discouraging risk-taking and monetary policy is constrained by concerns about excess liquidity.
Most significantly US housing policies--especially with regard to Fannie Mae and Freddie Mac, institutions whose purpose is to mitigate cyclicality--have become a case of disastrous procyclical policy.
Construction of new single family homes has plummeted from about 1.7m in the middle of the last decade to about 450,000 at present. With housing starts averaging well over a million during the 1990s, the shortfall in housing construction now dwarfs the excess during the bubble and is the largest single component of the shortfall in gross domestic product.
Losses on owner-occupied housing have reduced consumers’ wealth by more than $7,000bn over the past five years, and uncertainty about the future value of their homes and the inability to refinance at reasonable rates deters household outlays on durable goods. The continuing weakness of the housing sector is a major risk for US financial institutions, raising significantly the costs of the loans they offer.
In retrospect it would have been better if financial institutions and those involved in regulating them, especially the Federal Housing Finance Agency, recognised that house prices can go down as well as up, if more rigour had been applied in providing credit, if the government-sponsored enterprises (GSEs) had been more careful in monitoring those originating and servicing loans, and if there had been more vigilance about fraudulent behaviour. The question now is what should be done…. [T]he FHFA… has taken a narrow view of the public interest… has not acted to ensure the GSEs stabilise the US housing market, and taken no account that the narrow financial interest of the GSEs depends on a national housing recovery…. A better approach would involve several changes in policy.
First… credit standards for those seeking to buy homes [now] are too high and rigorous….
Second… those on GSE-guaranteed mortgages should… be able to take advantage of lower rates….
Third, stabilising the housing market will require doing something about the large and growing inventory of foreclosed properties….
Fourth… [while] the Obama administration’s home affordability modification programme has been criticised for overly restrictive eligibility criteria, the reality is that a large fraction of those receiving assistance have ultimately been unable to meet even their reduced obligations…. Surely there is a strong case for experimentation with principal reduction strategies at the local level. The GSEs should be required to drop their posture of opposition to experimentation and move to a more constructive position.
Fifth… allowing negotiation over the past to dominate present policy creates overhangs of uncertainty that impose huge costs on the financial system and inhibits lending….
With a constructive approach by independent regulators, far better policies could be in place six months from now. The anticipation of a change to supportive policies could change the tone of the market even sooner. There is nothing else on the feasible political horizon that can make as large a difference in driving American economic recovery.
