Private Finance Is Needed to Fix U.S. Housing

Despite some signs of improvement, most of the housing news is grim. Since the 2006 peak, housing prices have dropped more than 30 percent. This plunge in home prices has destroyed homeowner equity by more than 50 percent - a nearly $8 trillion loss in household wealth. This destruction, as Federal Reserve Chairman Ben Bernanke recently pointed out, leads to a reduction in homeowner spending by $3-$5 for every $100 in home value destroyed. Since consumer spending constitutes two-thirds of GDP, steep declines in home prices can significantly curb spending and thus put a substantial brake on the nascent economic recovery.

Recent housing facts are startling. Single-family housing starts have averaged roughly 500,000 units per year in the past three years, compared to more than one million units a year for the prior 15 years. The number of lenders seizing properties from homeowners in default broke records in 2010, with millions more still at risk of default. The supply of unsold homes is staggering, with vacant houses hovering near the highest recorded level in 2009. With nearly two million homes entering the foreclosure process in the past few years, this is a major hurdle to new construction.

Getting mortgage credit continues to be a struggle for most potential home buyers, and the increase in such credit that typically becomes available in a recovery has yet to materialize. This week's final Case-Shiller numbers for 2011 indicate that housing prices continued to fall from the previous year in every major metro area, with the exception of already-devastated Detroit.

A further problem is that nearly 11 million homeowners are "underwater" - their homes are worth less than they owe on their mortgages. The tendency for property prices to fall as foreclosures mount submerges values even more, and contributes to a further downward spiral for neighborhoods and local and state governments that must depend on property taxes to support critical services.

The resources that the government can draw upon to support the housing market are much smaller than those of the global capital markets, and often times less efficiently deployed. The current dependence upon the Federal Reserve and government-run agencies Fannie Mae, Freddie Mac and the Federal Housing Administration for housing market activity is unsustainable. Indeed, in the past few years the private sector's investment in residential mortgages and mortgage backed securities has declined by more than $3 trillion, while the Federal Reserve and federal government's investments have increased by more than $1 trillion. This has led to a reduction in residential mortgages and mortgage-backed securities of about $2 trillion.

Given this situation, we need to get the private sector to return to its traditional role in supporting the housing market through providing credit, and soon. But how?

The most important step is to make a decision about the future role of Fannie Mae and Freddie Mac. At present, this uncertainty is a barrier to greater private sector involvement in the housing sector. Moreover, it is difficult for private financial firms to compete with these two government-run mortgage giants.

An easy fix would be to combine the two entities and only have the new entity guarantee home mortgages. There is additional uncertainty created as the financial regulatory authorities continue to implement the various requirements of the Dodd-Frank Act, leaving financial firms unable to assess the full impact on the cost and changes in their operations until all the regulations are finalized. This puts many of their actions regarding housing on hold. Furthermore, these firms find it difficult to plan as long as the policies of the government to deal with pending and potential home foreclosures, not to mention rising federal debt, remain in flux.

Reducing this uncertainty will go a long way to providing the necessary incentives for the private sector to get back to supporting housing in a bigger way.

One saying in economics is that trends that can't go on forever won't. The dominant role the government has been playing in recent years in the housing market is certainly one trend that can't - and shouldn't - continue.