Janet L Yellen: Housing market developments and their effects on
low- and moderate-income neighborhoods
Speech by Mrs Janet L Yellen, Vice Chair of the Board of Governors of the Federal Reserve
System, at the 2011 Federal Reserve Bank of Cleveland Policy Summit, Cleveland, Ohio,
9 June 2011.
* * *
The original speech, which contains various links to the documents mentioned, can be found
on the US Federal Reserve System's website.
Good morning. I very much appreciate your invitation to speak today. The theme of this ninth
annual Federal Reserve Bank of Cleveland Policy Summit, "Housing, Human Capital, and
Inequality," could not be timelier. Almost no community in America has escaped the effects of
the economic downturn, but many low- and moderate-income communities were hit
especially hard, including a large number in and around our host city of Cleveland. As one
sobering example, almost 10 percent of current Cleveland residents who have ever taken out
a mortgage have a foreclosure reflected on their credit report-a rate double that of the rest of
the nation.1
I will focus today on the state of the housing market and emphasize developments pertaining
to low- and moderate-income neighborhoods. I will then discuss policy initiatives to address
some of the challenges confronting the housing market.2
The state of the housing market
As you know, house prices are a critical element in understanding the state of the housing
market. Nationally, house prices have been falling for six years, and most industry analysts
expect further declines before prices bottom out. Households are equally pessimistic about
the trajectory of house prices. According to one prominent survey, only 15 percent of
homeowners expect house prices to increase over the next year, and barely half expect
house price increases over the next five years.
Largely because of the fall in house prices and the sustained high rate of unemployment,
about 4-1/2 percent of mortgages in the United States are currently in foreclosure, and three
or more payments have been missed on an additional 3-1/2 percent. In total, 2-1/2 million
foreclosures were initiated in 2010, and a similar number of foreclosure starts are expected
in 2011.
One factor depressing house prices is the large number of "distressed" home sales. A
distressed sale occurs when a borrower sells a house through a short sale or when a lender
sells a property that it acquired through a foreclosure; these sales have represented about
half of all home sales in recent months. The condition of the property can deteriorate
considerably over the course of the foreclosure proceedings, and these damaged properties
are typically sold to the next buyer at a significant discount. Commonly, market values of
properties and the selling price of similar homes in the neighborhood become depressed as
a consequence. The blight associated with these properties can further depress the value of
nearby homes.
Housing market conditions are also being hurt by the large inventory of empty and unsold
homes in the United States. Nearly 2 million homes were estimated to be vacant in the first
quarter of 2011. Although this number is down some from the highs seen in 2008, it is about
60 percent higher than the average level over the 20 years before the 2008 surge. And, with
the pipeline of delinquent and foreclosed homes overflowing, the inventory of empty and
unsold homes will likely stay elevated for some time, which will maintain downward pressure
on house prices and damp construction of new homes.
Recovery in the housing market is being restrained further by tight mortgage credit.
According to the Federal Reserve's April 2011 Senior Loan Officer Opinion Survey on Bank
Lending Practices, commercial banks have begun to ease standards on credit card and other
consumer loans, but they have not yet started to ease standards for residential mortgages,
even for those extended to borrowers in the prime market.3 One sign of this tight credit is the
higher credit scores on recent mortgage originations. For example, the median credit score
on a prime mortgage originated to purchase a home rose from around 740 in the
2005-07 period to around 780 since mid-2010. Part of this rise may reflect borrower
characteristics-perhaps demand for housing has fallen more among borrowers with lower
credit scores-but tighter terms and standards undoubtedly play a significant role. These tight
standards indicate that some households that might like to purchase a home simply can't
obtain the credit to do so.
Under these circumstances, it's not surprising that the demand for housing remains weak.
Builders of new homes overwhelmingly report "low to very low" traffic of prospective buyers,
as well as expectations of "poor" sales in the months ahead. Similarly, about one-third of the
respondents to the Senior Loan Officer Opinion Survey noted weaker demand for mortgages
in the first quarter of 2011. Demand is low, in part, because households remain uncertain
about the durability of the economic recovery and therefore do not want to commit to such a
large investment-especially an investment that may decline further in price.
Although economists may disagree about which of these factors is playing the largest role in
the ongoing fall in house prices, all agree that the collapse has left deep scars on many
American families and their financial well-being. The drop in house prices is a major factor in
the sharp declines in household net worth during the recession. Newly released data from
the Federal Reserve Board's 2007-09 Survey of Consumer Finances panel, for example,
indicate that the typical homeowner saw a drop in his or her real net worth of about
19 percent over the 2007-09 period. For some homeowners, the loss in net worth was much
larger; indeed, nearly one-fourth of homeowners saw their net worth drop by 50 percent or
more.4
House prices have continued to decline, on net, since 2009, and at this time, more than
one-fourth of mortgage borrowers are underwater-that is, have mortgage balances that
exceed the current values of their homes. Because of their negative equity stake, many
households cannot take advantage of lower interest rates by refinancing their mortgages, nor
can they easily sell their homes to pursue better job opportunities elsewhere. In addition,
borrowers who are underwater-especially those who also experience a job loss or a cut in
work hours or wages-are more likely to default on their mortgages and possibly face
foreclosure.
One consequence of the weak demand for housing and the sky-high rate of foreclosures has
been a significant drop in the homeownership rate. After fluctuating in a fairly narrow range
around 64 percent for nearly three decades, the homeownership rate rose significantly
between 1994 and 2004, reaching a peak of 69 percent. Since then, however, the
homeownership rate has retraced about half of its earlier increase as many former
homeowners have moved into rental housing or made other living arrangements, such as
moving in with family members.
Are there any bright spots in this gloomy picture? As the macroeconomy has begun to
improve, albeit at an uneven rate, the share of homeowners becoming newly delinquent on
their mortgages-that is, missing a payment for the first time-has decreased. In addition, low
interest rates and lower house prices have made homeownership potentially more
affordable. In fact, by one measure, housing is hovering around its most affordable level in
the 22-year history of the series.5 Of course, tight credit standards have precluded many
households from taking advantage of the affordable conditions. Over time, however, as the
economy continues to grow and credit conditions improve, more households should be able
to benefit from the greater affordability.
The housing market in low- and moderate-income communities
As I indicated earlier-and as many of you already know-these sobering national trends have
had even more devastating effects in low- and moderate-income neighborhoods. To
investigate this issue further, researchers at the Federal Reserve classified neighborhoods
into three broad categories: low and moderate income, middle income, and high income.6 A
comparison of housing and mortgage market conditions in low- and moderate-income
neighborhoods with conditions in high-income neighborhoods reveals several interesting
facts.7
One notable fact is that house prices in low- and moderate-income neighborhoods rose more
than in other neighborhoods during the national boom in house prices, and subsequently fell
more during the bust. For example, from 1998 through 2006, house prices, as measured by
the CoreLogic repeat-sales house price index, rose 11 percent per year on average in
low-and moderate-income neighborhoods, compared with 9 percent per year in high-income
neighborhoods. Likewise, during the bust from 2007 to 2010, house prices fell 8 percent per
year in lower-income neighborhoods, compared with 7 percent per year in high-income
neighborhoods. House price changes also varied more across lower-income neighborhoods
than high-income neighborhoods, implying that a greater share of lower-income
neighborhoods exhibited price swings that were more dramatic than the overall average.
Linked inextricably to the volatility in house prices in these communities was the volatility of
mortgage lending. Mortgage lending surged in low- and moderate-income neighborhoods
during the housing boom, and subsequently contracted sharply. Over 2003 to 2006,
purchase mortgage originations increased 60 percent in low- and moderate-income
neighborhoods but less than 20 percent in high-income neighborhoods.8 Unfortunately,
during this surge in lending many borrowers were encouraged to take out subprime
mortgages with teaser rates and prepayment penalties as well as alt-A mortgages with
negative amortization features. When these markets collapsed, precipitating an overall
tightening in credit conditions, mortgage originations through 2009 fell by 65 percent in
low- and moderate-income neighborhoods and 50 percent in high-income neighborhoods.
The greater decline in house prices in low- and moderate-income neighborhoods has had
several unfortunate consequences for mortgage borrowers. As of March 2011, borrowers
with prime mortgages who lived in these neighborhoods were twice as likely to be
underwater as borrowers with prime mortgages in high-income neighborhoods. Because
houses are, on average, a much larger share of assets for homeowners in low- and
moderate-income neighborhoods, these homeowners had few other assets to draw upon to
compensate for the drop in house prices.9 As a result, borrowers in these neighborhoods
who suffered a job loss or other economic misfortune were more likely to default on their
mortgages. Indeed, 13 percent of mortgages originated to borrowers in low- and
moderate-income neighborhoods were 90 days or more overdue in the first quarter of 2011,
compared with 6 percent of mortgages originated to borrowers in high-income
neighborhoods.
The higher rates of delinquency suggest that homeownership may have been a riskier
proposition over the past decade for households in low- and moderate-income
neighborhoods than in high-income neighborhoods. Delinquency rates are higher, in part,
because borrowers in these communities were more likely to end up in complicated or
inappropriate mortgage products, unacceptably often as a result of unfair and deceptive
lending practices. But borrowers in these communities may also be more sensitive to house
price declines because they may have fewer financial resources outside of housing, and they
may have had little equity in the property to begin with.10
Although investing in a home has risks, it also has positive qualities. Households may feel
more comfortable investing in housing than in other investments because houses are
familiar, tangible, and provide concrete ties to the community. Regular mortgage payments
may serve as a useful savings commitment device. Finally, homes pay out a "dividend" in the
form of housing services-that is, providing a place to live. The housing services provided by
an owner-occupied home-such as control over one's own space-may be preferable to those
provided by a rental.
In making a decision about homeownership, prospective buyers need to consider the risks as
well as the benefits-in particular, the possibility that house prices can fall and that such
declines can have long-lasting effects on their financial well-being. The current decline in
national house prices and the preceding run-up were, of course, unusually large even by
historical standards. But even during times when house prices were rising nationally, prices
fell steeply in certain local markets, such as Texas in the mid-1980s or Massachusetts in the
8
For a further discussion of the increase in lending over this period, see, Christopher Mayer, and Karen Pence
(2008), "Subprime Mortgages: What, Where, and to Whom?" Finance and Economics Discussion Series
2008-29 (Washington: Board of Governors of the Federal Reserve System, June).
9
Houses represented nearly three-fourths of total assets for homeowners in low- and moderate-income
neighborhoods in 2007, according to the Survey of Consumer Finances. In contrast, homes typically
represented a bit over half of gross assets for homeowners in higher income neighborhoods in 2007.
10
The median combined loan-to-value ratio on securitized subprime purchase mortgages originated in 2005
through 2007 was 100 percent. See Christopher Mayer, Karen Pence, and Shane M. Sherlund (2008), "The
Rise in Mortgage Defaults," Journal of Economic Perspectives, vol. 23(1), pp. 27-50.
For an example of the relationship between house prices and homeownership outcomes, see Kristopher
Gerardi, Adam Shapiro, and Paul Willen (2007), "Subprime Outcomes: Risky Mortgages, Homeownership
Experiences, and Foreclosures ," Working Paper 2007-15 (Boston: Federal Reserve Bank of Boston).
early 1990s. And homeowners are not alone in their difficulty in predicting house prices: The
record of industry analysts and economists is also mixed. Although many professionals
understood that house values were high at the peak of the recent cycle-probably
unsustainably so-there was no consensus about the extent or severity of the coming fall.11
In light of this experience, it makes sense to think about the development of wealth-building
vehicles for low- and moderate-income households that have some of the desirable qualities
of homeownership as an investment, but perhaps have less of the risk. Such instruments
should be simple and transparent and might include a savings commitment component.
Although households will likely need to take on some risk in order to accumulate wealth, the
risk should not have the potential to destroy a household's financial security. Continued
research in this area is badly needed.
Looking forward
Looking forward, I unfortunately can envision no quick or easy solutions for the problems still
afflicting the housing market. Even once it begins to take hold, recovery in the housing
market likely will be a long, drawn-out process. For its part, the Federal Reserve will continue
to use its policy tools to support the economic recovery and carry out its dual mandate to
foster maximum employment in the context of price stability. As the economic recovery
progresses and potential homebuyers become more confident about the durability of the
recovery, it seems probable that more families will be willing to enter the housing market.
The other factors weighing on the housing market-the high share of distressed sales, the
large inventory of vacant homes, and tight mortgage credit-are not affected as directly by
macroeconomic policy. Alleviating these conditions will require a different set of responses.
Next I will discuss some Federal Reserve initiatives in these areas, and highlight areas in
which work still remains to be done.
The high share of distressed sales and the large inventory of vacant homes stem, in large
part, from the elevated levels of foreclosures. Federal Reserve officials have stated time and
again over the past several years that we believe that lenders and servicers should work
actively with troubled borrowers to pursue mortgage modifications whenever possible. The
consequences of not conducting modifications are simply too high-for borrowers, for lenders,
for the local communities, and for the overall economy.
In the event that a borrower in default no longer wishes to remain in the home, we have
urged lenders to make every effort to pursue alternatives to foreclosure, such as short sales
or deeds-in-lieu of foreclosure.12 These alternatives may help the borrower transition to a
better housing situation as quickly and seamlessly as possible. In addition, these alternatives
may shorten the length of time that a property lies vacant. The deterioration of a property
while it lies vacant not only reduces the market value of the property, but also imposes
considerable costs on the surrounding community by depressing the prices of neighboring
homes, attracting crime, and creating financial burdens for local governments.
The effects of vacant homes on local communities are an example of what economists call a
negative externality-that is, an action taken by one party that imposes an uncompensated
burden on another. In this case, the externality occurs because lenders, investors, and
servicers typically do not bear the burdens resulting from the negative effects of foreclosures
on neighborhood house prices, crime, and government budgets. As a result, fewer short
sales likely occur than would be best for communities overall. This externality is one of the
reasons why a government program that provides financial incentives to servicers and
borrowers for pursuing short sales or deeds-in-lieu of foreclosure remains undersubscribed.13
Indeed, as of March 2011, only about 12,000 agreements had been initiated under the
program. This is an area where lenders can and certainly should do more.
The Federal Reserve, in conjunction with other financial banking regulators and government
agencies, has embarked on initiatives to help resolve the existing stock of vacant properties
and prevent even more properties from entering foreclosure.14 The first initiative involves
revisions to the rules governing the Community Reinvestment Act (CRA) that took effect in
January. Under the revised rules, depository institutions receive positive consideration in
CRA examinations for participating in community stabilization activities in areas designated
as eligible for funds under the Neighborhood Stabilization Program authorized by the
Congress. Such activities might include donating properties that they've taken possession
of-known as real estate owned-to nonprofit housing organizations or providing financing for
the purchase and rehabilitation of foreclosed, abandoned, or vacant properties. Although it is
too early to assess the effect of these CRA changes, the participation of more than
600 banks and industry stakeholders in a webinar recently hosted by the Federal Reserve
indicates that there is interest and potential in this tool. Our host today, the Federal Reserve
Bank of Cleveland, played a key role in envisioning these changes to the CRA rules.
The second initiative, which is ongoing, is the development of uniform national servicing
standards. These standards should address the proper handling of both performing and
non-performing loans, including loss-mitigation procedures and foreclosure processing, and
should lead to improved customer treatment and better transparency and oversight of
mortgage servicers' processes. The intent is for servicers to be held to the same standards
regardless of their regulator and regardless of whether the loans being serviced are held on
the originator's books, have been sold, or have been securitized. By having a common set of
standards for the mortgage servicing industry, the financial regulatory agencies will
emphasize the importance of servicing practices that promote the best interests of borrowers
and the broader housing market.
Let me turn finally to mortgage credit. No one wants to see a return to the loose lending
standards that prevailed in the run-up to the crisis, but households and the economy will
benefit if we can foster sustainable homeownership with an increase in responsible lending.
The Federal Reserve, in coordination with other agencies, has recently published two notices
of proposed rulemaking that will affect the provision of mortgage credit. I will describe these
rules and explain how we are attempting to balance the objectives of better underwriting and
access to credit in the rulemaking process. I should note that both rulemakings are open for
comment, and we very much welcome your feedback.
The first set of rules implements the risk-retention provisions of the Dodd-Frank Wall Street
Reform and Consumer Protection Act. Broadly speaking, these provisions require issuers of
all types of asset-backed securities, including mortgage-backed securities, to retain 5 percent
of the credit risk of the assets they securitize.15 In the run-up to the financial crisis, a
disproportionate share of mortgage loans was made by lenders who funded their originations
through securitizations and effectively retained none of the risk. These lenders had little
financial stake in whether the borrowers ultimately repaid the mortgages-sometimes known
as having skin in the game-and thus had a reduced incentive to engage in careful
underwriting.
The proposed rules outline a flexible menu of ways that securitizers can meet the
risk-retention requirement. The proposed rules also have provisions that affect the mortgage
market in particular. The rules recognize that the guarantees provided by Fannie Mae and
Freddie Mac lead them to retain 100 percent of the credit risk of the mortgages they
securitize, and because this guarantee is currently backed by financial support from the
government, the proposed rules do not require these government-sponsored enterprises to
retain additional risk. Further, as required by the Dodd-Frank Act, the proposed rules exempt
securitizations backed entirely by very high-quality mortgages-so-called qualified residential
mortgages (QRMs)-from risk retention. The act directed the regulators with rulemaking
authority to define QRMs taking into account "underwriting and product features that
historical loan performance data indicate result in a lower risk of default." To define QRMs,
regulators conducted extensive research on the types of mortgages that have low credit risk,
even in stressful economic environments. Under the proposed definition, a qualified
residential mortgage must be a closed-end, first-lien mortgage to purchase or refinance a
one- to four-family property. Mortgage features cannot include negative amortization,
interest-only payments, or the potential for large interest rate increases. Debt-to-income
ratios must be conservative, and the borrower's credit history must be relatively clean.
Finally, the maximum loan-to-value ratio is 80 percent for purchase mortgages, with no junior
lien at closing; 75 percent on rate and term refinance loans; and 70 percent on cash-out
refinance loans.
We know that some have expressed anxiety that this narrow definition will result in many
borrowers paying higher mortgage rates or being excluded from the credit markets. However,
with many creditworthy mortgages not qualifying under the QRM standards, deep funding
markets for these products are more likely to develop. As a consequence, we expect that the
price difference between mortgages that do and do not qualify under the QRM standard will
be relatively small.
Another recently proposed set of rules seeks to ensure that, from now on, all mortgages
meet higher underwriting standards, regardless of whether the mortgages are sold into
securitizations or retained by lenders on their balance sheets. The QRM standards must also
be at least as conservative as these universal higher standards. These revisions to the
regulations implementing the Truth in Lending Act are also required by the Dodd-Frank Act.
The proposed rules, which were released by the Board in April, establish expanded "ability to
repay" requirements for most consumer credit transactions secured by a dwelling. These
rules will be finalized by the Consumer Financial Protection Bureau, the new independent
agency created by the act.
I know that we are approaching the end of this session, and I fear that my recital of the woes
of the housing market may have prevented you from fully enjoying your lunch. So let me
close with a reminder that although the problems in the housing market are challenging,
many individuals and groups are making a difference, including several pioneering
community groups here in Cleveland. We in the Federal Reserve System are pleased to
support these efforts by providing data, research, and support, including facilitating important
conferences and conversations like the one here today.
Thank you very much for your attention. I look forward to answering any questions you might
have.