Six Ideas to Revive Housing that Congress Might Actually Support

Posted by: Stan Humphries    Tags:  , , , , , ,     Posted date:  November 23, 2011  

Chicken or egg? Which comes first, the housing recovery or the economic recovery?

Normally, three years after the beginning of a recession we would be experiencing both a boom in housing and the economy. Economists like to measure housing’s kick to the recovery by focusing on “residential investment.” This term refers not only to the purchases of homes but also to homebuilder and remodeler spending on wood, nails, bricklayers, and those wonderfully nutty interior designers on HGTV.

You might be surprised to know that residential investment represents only a small share of overall gross domestic product. It’s just 2.2% right now. But residential investment is volatile. And in the first few years of economic recovery it can spike, contributing crucially to GDP growth. In the past three recoveries, residential investment booms helped drive construction employment upwards by an average of 4% in the first two years.

Why does residential investment heat up so early? First, it’s because people pay for homes and home improvements with mortgages and home-equity loans. And those are cheap after a recession thanks to interest rate cuts instituted by the Federal Reserve during the crisis. Second, it’s thanks to a natural post-recession jump in the number of households. Think here of how, say, four college roommates decide to keep living together while the recession is raging but later get jobs and move into four different condos.

Now get this: Even homeowners who don’t boost their residential investment at all end up contributing hugely to the recovery. Look at what happened to the cost of servicing mortgage debt during and after the recessions that ended in November 1982, March 1991, November 2001, and June 2009. Peak to trough, the cost of servicing a 30-year, fixed-rate mortgage loan fell 20% on average. If you were spending 25% of your gross income to service a home loan, it felt like getting a 5% raise at exactly the moment you needed some extra spending money.

So you see why, in the words of a recent Goldman Sachs analysis, “Housing punches above its weight” when it comes to economic recoveries. A housing lift gives consumers that essential early boost in confidence, and their spending accounts for 70% of our $14 trillion GDP.

But it’s not quite working this time.

Sure, mortgage interest rates are way down. Between August 2008 and October 2010, the average monthly cost of servicing a new mortgage fell 22%. If you had borrowed, say, $300,000 at 6.5% to buy a house in the summer of 2008 and refinanced in the fall of 2010, you slashed your house payment by nearly $5,000 per year.

According to the Boston Fed, residential investment grew over 30% on average in the first two years of the prior three recoveries but has declined this time around. Remember how the construction sector grew by 4% in the first two years of previous recoveries? This time, it’s down by 9%. Stung by the weak job market, some 22 million households are still doubling up with one another. Anxious over falling home values, renters who could afford to buy homes are reluctant. So demand is weak. On the supply side, we still have a substantial number of vacant homes in the country, so homebuilders are sidelined. On and on.

Some of these problems require broader economic progress while others can be more directly addressed in the housing sector itself. But a fundamentally low level of housing demand can really only be solved by stabilized home values and increased economic certainty, both of which would increase the confidence of consumers buying homes. That’s why measures like the federal home-buyer tax credits, which put $26 billion of taxpayer money in the pockets of home buyers who were mostly going to buy a home anyway, didn’t turn the market around. We’re going to have boost housing demand the old fashioned way—by improving the economy and being patient.

Still, there are some things the government can do to coax the housing recovery along a little faster. Here are a few suggestions that both Democrats and Republicans should be able to embrace.

Go bigger on refinancing Fannie/Freddie mortgages. In a speech in Las Vegas on October 24, President Obama promised that the Federal Housing Finance Agency would prod banks to give homeowners who are under water with their Fannie and Freddie mortgages an opportunity to refinance. I don’t object to the President’s plan. I’m just afraid it doesn’t go far enough. Instead of helping only one million homeowners refinance their homes, we should try to help out the 16.5 million homeowners who are under water with their mortgages.

Columbia University professor Christopher Mayer proposes that the government consider giving homeowners who are current on their mortgages permission to refinance, regardless of their credit score. These folks are current on their house payments and the loans are secured by real estate. What difference does it really make if elsewhere in their lives, they’ve missed a credit-card payment or paid late on their electric bills?

Nor is there need to get an appraisal of the house or verify income. Charge them a few hundred dollars to alter the paperwork to reflect the lower interest rate and be done with it. “Reward the people who’ve been really good credits throughout the crisis and have struggled to make it,” says Mayer. The number of households that fit into this category is in the tens of millions.

Facilitate more bulk sales of distressed mortgages backed by Fannie, Freddie, and the FHA to the private sector. Right now, these enterprises typically acquire distressed homes at the end of the foreclosure process, often after the previous homeowner is no longer in the property. It’s the neutron bomb for housing: eliminate the people but leave the building standing. What a waste.

An alternative to this approach comes from a pilot program the FHA has been running for the past couple years. The failing mortgages are sold in bulk to private investors before foreclosure. Those investors can opt to help the homeowner, perhaps by arranging a short sale, a principal reduction, refinancing to lower rates, or deeds in lieu of sale with the option for the current occupant to remain in the home as a renter.

Okay, usually only 20% of the homeowners end up staying in their homes, but so what? That’s an improvement over the current system, where people lose their homes 100% of the time.

Let Fannie and Freddie make more than 10 loans to small real estate investors. Right now, small-time real estate investors are America’s best friends. They’re using a mix of their own equity plus debt from Fannie and Freddie to buy and rehab foreclosures, then flipping them to homebuyers or converting them to rentals. This is how a private market heals itself.

Alas, the government limits the number of loans that Fannie or Freddie can make to any one of these small investors to 10, putting a pretty severe constraint on how much the investors can do. They can’t easily get small mortgages from commercial banks. And they can’t get much from economies of scale owning just 10 homes.

So ease that limit a little. Make it 20 or 30 loans. Doing so would invite additional buyers into the foreclosure-conversion game, soaking up the glut. And when housing finally does recover, it will mean significant windfalls for the thousands of small, part-time real estate investors who are taking a risk on the markets now.

Grant visas to immigrants who buy U.S. homes. We’ve got an excess supply of homes in this country right now and not enough people who want to buy them. But we’ve got plenty of foreigners who’d love to get in on U.S. real estate, especially since home values are back to mid-2003 levels (and even worse in some markets). It’s a match made in heaven. Senators Schumer (D-NY) and Lee (R-UT) have proposed legislation along these lines already. Let’s pass it.

Naturally, we’d want to watch this program carefully with an eye to shutting it down if increased demand leads to another speculative bubble. But I think we can all agree this is not a problem we’re in danger of having in many markets right now.

Allow people to set aside a portion of their retirement funds for down payments. The Progressive Policy Institute has championed a concept they call HomeK, under which individuals can set aside up to half of their contributions to existing retirement accounts into a housing-specific subaccount. The money in this subaccount could then be used for a one-time disbursement toward a down payment on a first-time home loan used to buy a primary residence (up to the local loan limit for an FHA-financed mortgage). Unlike withdrawals for home purchases from current retirement plans, withdrawals from this housing subaccount would be tax-free for lower-income buyers and at steeply reduced tax rates for middle-class buyers.

One thing we’ve learned from the housing downturn is that defaults are less likely when people have skin in the game and, unlike proposals to reduce down payment requirements or provide a tax credit for use as a down payment, this proposal keeps the buyer on the hook but creates incentives for them to get over the hurdle sooner.

Give the market foreclosure clarity. A slew of states have banded together to sue lenders over the robo-signing scandal of last year. Lenders don’t know how the lawsuits will end, so they’ve slowed the pace of foreclosures. Unfortunately, the longer it takes to clear the foreclosures out of the system, the longer we must wait until prices can begin to rise again.

The White House and Congress can’t force state attorneys general to settle with Bank of America, Citibank, JPMorgan Chase, Wells Fargo and the rest. But the President and Congressional leaders should encourage the AGs to reach a conclusion as quickly as possible. The sooner the banks can clear the mess that they helped create off their books, the sooner we can all move on.


About the author
Stan Humphries
Stan is Zillow Group's Chief Analytics Officer. To learn more about Stan, click here.