The Federal Reserve has launched a potentially controversial push to revive the battered U.S. housing market, calling on other government officials to act after largely exhausting its own tools to support the fragile economic recovery.
After the Fed slashed interest rates to near zero more than three years ago and amassed $2.3 trillion in bonds to spur growth, the U.S. economy showed some momentum toward the end of 2011. But many analysts are doubtful the recovery will achieve take-off velocity in 2012 and housing is one of the biggest drags.
House prices have fallen 33 percent from their 2006 peak, resulting in an estimated $7 trillion in household wealth losses, the Fed said last week as it took the unusual step of making an array of recommendations on housing policy to Congress.
Currently, about 12 million homeowners are saddled with mortgages worth more than their properties, a situation which affects roughly half of all mortgage borrowers in states suffering from the worst of the slump, such as Florida and Nevada.
"Distress in the housing sector is perhaps the main factor slowing the recovery," said New York University economics professor Mark Gertler.
In a normal recession, the Fed can stimulate housing demand and housing prices by cutting interest rates, but that is no longer possible.
"With the Federal Funds rate effectively at the zero lower bound, however, the kinds of unconventional policies being discussed may be necessary," Gertler said.
A VICIOUS CYCLE
The housing sector is caught in a vicious cycle: on top of the millions of so-called underwater homeowners owing more than properties are worth, prices are only expected to bottom out this year and a flood of newly-foreclosed homes may yet hit the market.
Fed officials are trying to use the central bank's influence to overcome political resistance to expanding the government's role in housing, which has been an important driver for the U.S. economy as it emerged from past recessions.
That resistance is likely to be strong and could produce a backlash against the Fed and the Obama administration. Both are under fire from Republicans on the presidential campaign trail, who see it as big government overreaching. Calls by Republican candidates to rein in the Fed are guaranteed to draw applause at campaign events.
The Fed's push also runs counter to Chairman Ben Bernanke's vow when he took office in 2006 to keep the central bank's focus on monetary policy issues after his predecessor, Alan Greenspan, had drawn fire for wading into political debates over taxes and spending. However, Fed officials feel that the impact of monetary policy is being undercut by overly tight credit in mortgage markets.
What that means for policymakers is that any effort to lower mortgage rates by further central bank purchases of mortgage debt - which several policymakers advocate -- would have only a limited impact.
Any additional buying of mortgage-related debt would deliver a much bigger bang for the buck if regulators and mortgage finance enterprises Fannie Mae and Freddie Mac, which play an outsized role in the housing sector, took action to free up credit.
Beginning with a speech by Fed Governor Daniel Tarullo in October - when he said "housing continues to hang like an albatross around the necks of homeowners" -- Fed officials have seemed willing to risk controversy by proposing a range of politically sensitive remedies to the housing crisis.
Fed lobbying reached a crescendo last week after Bernanke sent recommendations to Congress. Later in the week, several Fed officials urged steps to help homeowners and one warned of likely penalties against mortgage servicers for shoddy practices.
The Fed itself could buy more mortgage-backed securities to lower interest rates for mortgages, as Tarullo and others have suggested. But the Fed was sharply criticized for its November 2010 bond-buying initiative and many economists question how many homeowners would benefit from what would probably be only a small further fall in already record-low mortgage interest rates. The Fed, they say, may hold another round of purchases in reserve for a serious wobble in the recovery.
Taking a different tack, the Fed suggested last week that Congress should consider legislative changes to allow Fannie Mae and Freddie Mac - which the government rescued in 2008 - to play a greater role in refinancing underwater mortgages to help stem the tide of foreclosures.
The Fed also urged their regulator, the Federal Housing Finance Agency, to place the recovery of the housing markets ahead of short-term goals of limiting losses at the firms, freeing them up to enable more homeowners to refinance at lower rates. But with costs of the government takeover at $169 billion and rising, those recommendations may be controversial.
The agency's head, Edward DeMarco, has argued the funds the companies have received are meant to get them back on their feet, not to provide broad relief to the housing market.
On Friday, the influential head of the New York Fed, William Dudley, broached the taboo subject of principal write-downs for distressed buyers. It was this very issue, and the accompanying sense OF outrage among some Americans at the prospect of helping homebuyers who they saw as irresponsible borrowers, that spawned the Tea Party.
Dudley framed principal reductions in moral as well as economic terms, saying many borrowers simply had the bad luck to buy just before the bubble burst.
He said the New York Fed believes the waves of foreclosure will continue as more and more Americans give up on their mortgages, a move which would threatening the momentum that appears to have begun to build in the U.S. economy.
"We have to recognize that there is more to economic policy than just monetary policy," Dudley said. "There are workable solutions to our housing problems at costs that I deem very reasonable relative to the economically inefficient path we are on."
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