Ben S Bernanke: Housing markets in transition
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve
System, at the 2012 National Association of Homebuilders International Builders' Show,
Orlando, Florida, 10 February 2012.
* * *
The economic recovery began more than two years ago, but it doesn't feel like much of a
recovery for many Americans - certainly for those of you who depend on the housing sector
for your living, as well as for the millions of others who have seen their home values plummet
or lost their homes through foreclosure. Though some progress has been made in reversing
the losses in jobs and income sustained during the recession, the pace of expansion has
been frustratingly slow and the unemployment rate remains very high by historical standards.
The state of the housing sector has been a key impediment to a faster recovery. In the
typical economic recovery, a resurgent housing sector helps fuel reemployment and rising
incomes. But as you know all too well, that scenario has not played out this time. Although
the precipitous declines in construction that began in 2006 are, thankfully, now behind us,
homebuilding remains depressed in most areas, relative both to where it was before the
downturn and to where it will need to be to meet the needs of a growing population in the
longer term.
The Federal Reserve has a keen interest in the state of housing and has been actively
engaged in analyzing the housing and mortgage markets.1 Issues related to the housing
market and housing finance are important factors in the Federal Reserve's various roles in
formulating monetary policy, regulating banks, and protecting consumers of financial
services. Traditionally, mortgage interest rates have been a key transmission channel of
monetary policy; and banks' mortgage lending policies directly affect their own safety and
soundness as well as the access of creditworthy households to mortgage credit. My remarks
today will focus on current housing market conditions and on how housing problems have
affected borrowers, lenders, communities, and the broader economy. I'll also discuss some
specific sources of our housing problems, including tight conditions in the mortgage market
and the overhang of foreclosed and vacant homes.
Overview of the state of the housing market
One way to understand conditions in the housing market is to focus on the balance of supply
and demand. For the past few years, the actual and potential supply of single-family homes
has greatly exceeded the effective demand. The elevated number of homes that are
currently vacant instead of owner occupied reflects the imbalance. According to the most
recent estimate, about 1-3/4 million homes are currently unoccupied and for sale. While this
figure has declined slightly during the past few years, it is nonetheless up dramatically from
the first half of the 2000s, when readings of about 1-1/4 million vacant homes were the norm.
Of course, housing conditions vary by region, and vacancy rates in some locations are
substantially higher than the national average. For example, here in Florida the homeowner
vacancy rate in the third quarter of 2011 averaged 3.2 percent, compared with the national
average of 2.4 percent.2
Moreover, a very large number of additional homes are poised to come on the
owneroccupied market. In each of the past few years, roughly 2 million homes have entered the
foreclosure process, and many of these homes have been put up for sale, crowding out
much of the need for new building. Looking ahead, the relatively high rate of foreclosures is
likely to continue for a while, putting additional homes on the market and dislocating families
and disrupting communities in the process.
At the same time, a number of factors are constraining demand. Household formation has
been down, particularly among young adults. High unemployment and uncertain job
prospects may have reduced the willingness of some households to commit to
homeownership. Availability of mortgage credit is an important constraint, to which I will
return later. Additionally, housing may no longer be viewed as the secure investment it once
was thought to be, given uncertainty about future home prices and the economy more
generally.
Not surprisingly, the large imbalance of supply and demand has been reflected in a drop in
home values of historic proportions. Nationally, house prices have plunged about 30 percent
in nominal terms from their peak and nearly 40 percent in real, or inflation-adjusted, terms.
The imbalance of supply and demand has also been reflected in the decline in home
construction that I mentioned earlier. Since 2009, the pace of single-family housing starts has
averaged less than 500,000 units per year. During the 15 years before the financial crisis, the
pace of single-family starts had never fallen below 1 million units per year.
In contrast to the situation for owner-occupied homes, rental markets around the country
have strengthened somewhat. In particular, vacancy rates for rental properties have declined
and now stand near the lower end of their range over the past eight years. Not surprisingly,
rents have been increasing and the construction of apartment buildings has picked up.
To recap, the housing sector continues to suffer from serious imbalances - a marked excess
supply for owner-occupied housing accompanied by a stronger rental markets. The narrative
of the housing market over the next several years will revolve around the resolution of those
imbalances.
Broader implications of the problems in the housing market
As homebuilders, you naturally pay close attention to the demand for new homes and their
prices. These factors are important for the health of your industry, including its ability to
create jobs in construction and related activities. But the problems in housing also have
important implications outside the construction industry.
For instance, consider the effects on neighborhoods and communities. Foreclosures,
particularly when they are geographically concentrated, can diminish the values of nearby
properties.3 Many foreclosed homes are neglected or abandoned, as legal proceedings or
other factors delay their resale. Deteriorating or vacant properties can, in turn, directly affect
the quality of life in a neighborhood, for example, by leading to increases in vandalism or
crime. Moreover, the continuing price declines typical in neighborhoods with many
foreclosures depress the tax base of the community. A vicious circle can get started:
Increasing vacancies together with decreasing tax revenue and consequent cutbacks in
services can further depress home prices, putting the goal of neighborhood stabilization even
further out of reach.
As I mentioned earlier, problems in the housing market have also restrained the broader
economic recovery. For example, by some estimates, declines in house prices have reduced
homeowners' equity by more than 50 percent in the aggregate since the peak of the housing
boom, resulting in more than a $7 trillion loss of household wealth.4 Indeed, about
12 million homeowners - more than 1 out of 5 with a mortgage - are underwater, meaning
they owe more on their mortgages than their homes are worth. One of the effects of declines
in housing wealth is to reduce the ability and willingness of households to spend. While
estimates vary, homeowners are believed to spend somewhere between $3 and $5 per year
less for every $100 of housing value lost.5 Based on those estimates, it appears that recent
declines in housing wealth may be reducing consumer spending between $200 billion and
$375 billion per year. That reduction corresponds to lower living standards for many
Americans. And, importantly, lower sales of goods and services also reduce the incentives of
firms to invest and hire, thereby slowing the recovery. Of course, these consumer-related
effects are on top of the direct consequences of low rates of home construction for job
creation and income.
Low or negative equity creates additional problems for households. It reduces financial
flexibility: Homeowners who are underwater on their mortgages cannot tap home equity to
pay for emergency health expenses or their children's college educations. Mobility may be
affected to some degree; underwater borrowers who have difficulty selling their homes may
find it more difficult to move to take new jobs. Moreover, homeowners with underwater
mortgages may find it difficult or impossible to take advantage of low interest rates by
refinancing their mortgages, even if they are current on their payments.6
The state of housing and mortgage markets may also be holding back the recovery of our
financial system and the normalization of credit conditions. Mortgage delinquencies surged
between 2007 and 2009 and remain high, imposing losses on lenders, mortgage insurers,
and investors. Although some of the losses were the result of poorly underwritten mortgages,
an increasing share of losses have arisen from prime mortgages that were originally fully
documented with significant down payments, but that have defaulted due to the weak
economy and housing market. The Federal Reserve and other bank regulators have used
stress tests and other tools to help ensure that banks have enough capital to cover mortgage
4
See Board of Governors, "The U.S. Housing Market," p. 1 (see note 1).
5
See, for example, Raphael Bostic, Stuart Gabriel, and Gary Painter (2005), "Housing Wealth, Financial
Wealth, and Consumption: New Evidence from Micro Data (PDF)," Marshall School of Business and School of
Policy, Planning and Development Working Paper (Los Angeles: University of Southern California, June),
www.rst.nus.edu.sg/research/symposium_files/s.gabriel.pdf; Christopher D. Carroll, Misuzu Otsuka, and Jiri
Slacalek (2011), "How Large Are Housing and Wealth Effects? A New Approach," Journal of Money, Credit
and Banking, vol. 43 (February), pp. 55-79; Karl E. Case, John M. Quigley, and Robert J. Shiller (2011),
"Wealth Effects Revisited 1978-2009," NBER Working Paper Series 16848 (Cambridge, Mass.: National
Bureau of Economic Research, March), www.nber.org/papers/w16848; and, John V. Duca, John Muellbauer,
and Anthony Murphy (2011), "House Prices and Credit Constraints: Making Sense of the U.S. Experience
(PDF)," Research Department Working Paper 1103 (Dallas: Federal Reserve Bank of Dallas),
http://dallasfed.org/research/papers/2011/wp1103.pdf.
6
For more discussion of the effects of low household equity on the ability of homeowners to improve their
financial positions, see Christopher Mayer, Karen Pence, and Shane M. Sherlund (2009), "The Rise in
Mortgage Defaults," Journal of Economic Perspectives, vol. 23 (Winter), pp. 27-50.
losses while continuing to lend. On the margin, though, some lenders might be inclined to
respond to losses by tightening credit terms or being more cautious about extending loans
rather than by raising additional capital.7 In short, housing problems affect the homebuilding
industry, of course, but also have much broader effects - on neighborhoods and
communities, on homeowners, on the financial system, and on the vitality of the economy as
a whole. This observation underscores the importance of efforts to improve the condition of
the housing market.
Availability of mortgage credit
So why has the recovery in housing been so slow? One important factor is restraints on
mortgage credit. Since its peak in 2007, U.S. home mortgage credit outstanding has
contracted about 13 percent in real terms. In prior recoveries, mortgage credit had begun to
grow four years after the business cycle peak - but not this time around.8
One reason for the very slow recovery in mortgage credit, despite monetary policy actions
that have helped drive mortgage rates to historically low levels, is that many lending
institutions have tightened underwriting conditions dramatically, relative to the pre-recession
period.9 Given the lax standards during the credit boom, some tightening was doubtless
appropriate to protect consumers and ensure lenders' safety and soundness. However,
current lending practices appear to reflect, in part, obstacles that are limiting or preventing
lending even to creditworthy households.
For example, mortgage originators appear to be reluctant to extend credit to some potential
borrowers who could meet the underwriting standards currently set by the
governmentsponsored enterprises (GSEs). Indeed, fewer than half of lenders are offering mortgages to
borrowers with a FICO score of 620 and a down payment of 10 percent, even though such
loans could be within the GSE purchase parameters.10 A number of possibilities could
7
The effect of bank capital on lending is a critical determinant of the linkage between financial conditions and
real activity, and has received special attention in the recent financial crisis. Modest effects of bank capital
ratio changes on lending are reported in Jose M. Berrospide and Rochelle M. Edge (2010), "The Effects of
Bank Capital on Lending: What Do We Know, and What Does It Mean?" International Journal of Central
Banking, vol. 6 (December), pp. 5-54.
For an example of a macromodel where the balance sheet condition of financial institutions plays an important
role in determining asset prices and economic activity, see Michael T. Kiley and Jae W. Sim (2011), "Financial
Capital and the Macroeconomy: Policy Considerations," Finance and Economics Discussion Series 2011-28
(Washington: Board of Governors of the Federal Reserve System, May), www.federalreserve.
gov/pubs/feds/2011/201128/201128abs.html. Empirical evidence on bank capital shocks affecting the level of
economic output is provided in Macroeconomic Assessment Group (2010), Assessing the Macroeconomic
Impact of the Transition to Stronger Capital and Liquidity Requirements, final report (Basel, Switzerland: Bank
for International Settlements, December), available at www.federalreserve.gov/pubs/feds/2011
/201128/201128abs.html.
8
For an analysis of four types of credit-home mortgages, commercial mortgages, consumer credit, and
nonfinancial business credit-around business cycle peaks since 1952, see Diana Hancock and Rochelle M.
Edge (2009), "U.S. Credit Cycles: Past and Present (PDF)," study available at
www.treasury.gov/initiatives/financial-stability/results/cpp/cppreport/Documents/Fed%20US%20Credit%20Cycles%20072409.pdf.
9
For example, bank responses to the Federal Reserve Board's quarterly Senior Loan Officer Opinion Survey
on Bank Lending Practices indicate net tightening in lending standards for mortgage originated from 2007
through 2009. Surveys since then have yet to provide evidence of unwinding that tightness even for prime
mortgages that can be backed by guarantees from Fannie Mae, Freddie Mac, or the Federal Housing
Administration.
10
FICO scores are based on information that a credit bureau (for example, Experian, TransUnion, and Equifax)
keeps on an individual. The higher the score, which ranges from 300 to 850, the lower the credit risk. Credit
scores are used to inform lenders when they assess an individual's credit risk. See Board of Governors, "The
U.S. Housing Market," p. 6 (see note 1).
explain this reluctance to lend. In some cases, borrowers cannot obtain private mortgage
insurance required by the GSEs. Thus, the weakened finances of private mortgage insurers
could be damping mortgage credit availability for some potential borrowers. In other cases,
lenders may be concerned about high servicing costs if mortgages become delinquent.
Another set of concerns relates to so-called representations and warranties, which are
contractual commitments by an originator concerning the quality of the loan. These contracts
were designed to protect the GSEs or other purchasers of loans, but originators appear
uncertain about how they will be enforced going forward and thus have been very cautious
about making loans that could be viewed as less than perfect from an underwriting
perspective. Learning from our experience with securitizations over the past decade, lenders
and regulators alike should look carefully at rules and practices that may unduly diminish the
origination of prudently underwritten mortgages.
Another reason for tight lending standards is that private-label mortgage securitizations have
virtually disappeared. The difficulty of funding loans in the private-label securitization market
may have discouraged lenders from originating loans to some borrowers who may be
creditworthy but may not exactly fit the criteria of the GSEs or the Federal Housing
Administration (FHA).
Potential first-time homebuyers have been disproportionately affected by the very tight
conditions in mortgage markets. Lending to potential first-time homebuyers has dropped
precipitously, even in parts of the country where unemployment rates and housing conditions
are better than the national average. Indeed, the propensity of younger households - headed
by adults aged 29 to 34 - to take out their first mortgage has been much lower recently than
it was 10 years ago, a period well before the most recent run-up in home prices.11 First-time
homebuyers are typically an important source of incremental housing demand, so their
smaller presence in the market affects house prices and construction quite broadly.12
Moreover, the lack of demand from first-time homebuyers may prevent current homeowners
from moving up to larger homes, for example, to accommodate growing families.
An additional issue is the implication of tight mortgage credit conditions for monetary policy.
Because some creditworthy households are finding it difficult to obtain mortgage credit or to
refinance, the strong actions taken by the Federal Reserve to put downward pressure on
longer-term rates and to improve financial conditions have had less effect on the housing
sector and overall economic activity than they otherwise would have had.
The problem of tight mortgage credit will not be solved easily or quickly. The Federal
Reserve, in its supervisory capacity, continues to encourage lenders to find ways to maintain
prudent lending standards while serving creditworthy borrowers. But the slow recovery of the
housing market and the economy, continued uncertainty surrounding the future of the GSEs
and the regulatory environment for mortgage lending, the likely continued absence of a
private-label market, and more cautious attitudes by lenders are all barriers to rapid
normalization of the flow of mortgage credit.
Overhang of empty and foreclosed homes
To date, policymakers have been focusing on refinancing creditworthy (but sometimes
underwater) borrowers, on loan modifications, and on other ways to avert additional
foreclosures. This work is obviously very important. But unfortunately, not all foreclosures
can be prevented. Given the weak economy and high unemployment rates, some borrowers
simply do not have the wherewithal to meet monthly mortgage payments even if their loans
were to be substantially modified. Therefore, we have seen increased interest in whether
anything can be done to reduce the overhang of empty and foreclosed homes.13
We estimate that about one-fourth of the excess supply of vacant homes for sale in the
second quarter of 2011 was owned by creditors; these homes are often referred to as real
estate owned, or REO properties.14 Moreover, Federal Reserve staff estimate that distressed
sales, which include both short sales and non-auction sales of foreclosed homes by REO
holders, now account for 30 percent of home sales. Although it is difficult to forecast future
REO flows, we estimate that an additional 1 million foreclosed properties could be added to
the REO held by banks, guarantors, and servicers in each of the next few years. These
inflows will continue to exert downward pressure on home prices.
In contrast to the markets for owner-occupied homes, rental housing markets across the
nation have recently strengthened somewhat, as I mentioned earlier. Fueled by increased
demand from families who are either unable or reluctant to purchase homes, rents are up
and vacancy rates for multifamily properties are down in most metropolitan areas.
With home prices falling and rents rising, it could make sense in some markets to turn some
of the foreclosed homes into rental properties. According to Federal Reserve staff
calculations, most REO properties are in neighborhoods with median house values and
incomes that are roughly similar to the medians for the metropolitan area overall.15 Moreover,
these properties are not unusually far, in terms of commuting times, from where jobs are
located.16 We have compared computations of the expected annual cash flows from renting
properties to the discounted prices that REO property holders typically receive when selling a
home. The comparison suggests that some REO holders might come out ahead by renting,
rather than by selling, some of their properties.
Moreover, keeping paying tenants in homes-including leasing to the former owners at market
rents - may, in some cases, be the best way to maintain property values and the quality of
neighborhoods. REO-to-rental programs could potentially also minimize the amount of time
that a vacant property languishes in REO inventory. That is, appropriately structured
programs could help some involuntary renters become owners again by giving them options
to purchase the homes they are renting.
REO-to-rental programs are not a "silver bullet" for the housing market, and, indeed,
implementing them presents some challenges. For example, selling the properties in bulk to
investors to rent out has proven difficult at times because of lack of financing, although the
GSEs have just announced a pilot program to facilitate such purchases. In addition, many
REO properties may not be appropriate for REO-to-rental programs, either because they are
in very poor condition or because they are not part of a sufficiently large cluster of properties
to allow for economies of scale in their management.
Nevertheless, REO-to-rental programs appear to have some potential for success. As of
early November 2011, about 60 metropolitan areas each had at least 250 REO properties for
sale by the GSEs and the FHA - a scale that could be large enough to realize efficiency
gains.17 Atlanta has the largest number of REO properties for sale by these institutions, with
about 5,000 units. The next-largest inventories are in the metropolitan areas of Chicago;
Detroit; Phoenix; Riverside, California; and Las Vegas, each of which have between 2,000
and 3,000 units. As I noted, not all REO properties are appropriate for rental, but many do
appear to be physically adequate and potentially attractive to tenants. The number of
properties suitable for rental is bound to increase, as the number of properties currently in
the foreclosure process is more than four times the number of properties in the REO
inventory.
Other options can help with foreclosed houses that have low value and are in poor condition,
homes that are not likely to be dealt with adequately through the private market. For
example, land banks could handle some of these properties. Land banks are typically
governmental entities that have the ability to purchase and sell real estate, clear titles, and
accept donated properties. Properties may be rehabilitated as rental or owner-occupied
housing or, in extreme cases, demolished, depending on the needs of individual markets.
While land banks are a promising option, only some states have passed legislation to
establish land banks, and most existing land banks lack the resources to keep pace with the
number of low-value properties in the current inventory. It is, of course, critical that local
governments pursuing land banking, or similar strategies, have staff members with the
appropriate skills as well as adequate oversight to ensure that public funds are employed
efficiently.
REO-to-rental programs, land banks, and other neighborhood stabilization efforts are just a
few examples of the approaches that policymakers could consider to help facilitate the
adjustment of the housing market.18 To be sure, every program requires careful analysis to
ensure that it is effective and meets reasonable cost-benefit tests. Experimentation with
alternative approaches could help find the best way forward.
Conclusion
In sum, the economic recovery has been disappointing in part because U.S. housing markets
remain out of balance. Many local markets have an overhang of empty and foreclosed
homes, and many potentially creditworthy homebuyers cannot obtain mortgages. The weak
housing market also impairs homeowners' financial health and diminishes the quality and
stability of neighborhoods and communities. For these reasons, and because the troubled
housing market depresses construction activity and employment, we need to continue to
develop and implement policies that will help the housing sector get back on its feet. No
single solution will be sufficient. But sustained efforts to address the many interlocking
factors holding back the housing market will pay dividends in the long run.