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Government Should Do More to Spur Housing Recovery

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In a recent speech at the Economic Club of New York, William C. Dudley, president of the Federal Reserve Bank of New York stated that "the fundamentals underpinning the U.S. economy are improving and monetary policy is gaining additional traction. But this may not immediately lead to stronger growth because of the recent increase in fiscal restraint".

He added, "as a result, I expect that labor market conditions will improve only slowly and that inflation will remain muted. Consequently, it will be appropriate for monetary policy to remain very accommodative."

Dudley explained the slow growth track that has persisted since the recession ended in mid-2009 on the fiscal drag.  In 2012, real GDP grew just 1.6%, below the 2.2% rate of the preceding two years.

Fiscal restraint, or a smaller budget deficit, is often blamed for the slow recovery, but it is government policy that has been in the driver's seat since 2003 that is holding the economy back. The policy of liberal housing and consumer debt financing allowed the subprime bubble to form. The government's decision to rescue the banking system in 2008 was a costly one. Government spending to combat the Great Recession has helped the federal deficit top $1 trillion a year in recent years and driven the national debt over $16 trillion.

Dudley argues household debt has declined significantly relative to income since 2009 and the household financial obligations ratio has fallen to levels last seen in the early 1980s. This may be a result of prudent household behavior and not a clear indictor that families are ready to take on new debt.  Yet, they need to get back on the credit horse for the economic recovery to hold.

It is indeed good news that housing prices are rising, and Dudley correctly sees recovery in home prices as particularly important for home building. So why hasn't the government done much more since the fall of 2008 to spur a housing recovery? Low interest rates and purchases of mortgage-backed securities by the Fed, currently running at $40 billion a month, is not enough by itself to increase mortgage lending by banks. There is still an overhang of houses in the foreclosure process and in underwater valuation situation.

The Fed could have avoided much of the pain of the Great Recession and lingering slow growth had it acted on monetary policy that linked the government's rescue of the banking system to a reasonable amount of lending to creditworthy individuals, households and businesses.

Lawmakers and regulators should have required or incentivized banks to lend as a condition of the bailout. The Fed's quantitative easing, for instance, could have been directly linked to passing on lower rates to consumers looking to refinance or take out new mortgage loans. This could have prevented a prolonged housing glut and depressed property prices from 2008 to 2012. Instead, its monetary policy has failed in transmitting excess free reserves in the banking system to the real economy. What good does it do to have excess reserves sitting in a bank vault?

The Fed, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and other federal and state agencies should now take steps to encourage banks to use their excess reserves to accommodate credit demand by individuals.

Additionally, while lenders should not be encouraged to return to the lax lending standards that preceded the housing crisis, the underwriting standards banks have adopted in reaction to the bursting of the bubble and Dodd-Frank stipulations are an overreaction toward safety and they are slowing the credit expansion and thus the economic recovery. Lawmakers and regulators should collectively revisit these parameters.

If QE3 is to succeed, the housing and business sectors need more accessible financing to move the GDP growth to the trend line of 4%.

Surendra K. Kaushik is a professor of finance at Pace University's Lubin School of Business in New York.

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Comments (4)
With an attitude like this I can't imagine how Mr. Dudley became President of the NY Fed. He is talking from both side of his mouth, saying he doesn't want a return to lax lending, but wants banks to lend for more housing, using excess reserves.
Does he mean use the excess reserves to charge off the loans we shouldn't have made in the first place?
The same attitude persists on small business loans.
Posted by loanmaker | Thursday, April 04 2013 at 10:15AM ET
I totally disagree with blaming it all on banks and the lack of lending is responsible for housing not recovering. If you are a professor teaching finance, do you truly understand what you are teaching? The national debt is exploding and causing lack of jobs and savings in this country. I do not know about everyone else but in my area we bankers fight over good loans because they are not out there! No one has jobs or if they do they do not have the down payment to buy the house. What planet do you live one sir?

Mandykate2
Posted by Mandykatie2 | Friday, April 05 2013 at 10:38AM ET
I totally disagree with blaming it all on banks and the lack of lending is responsible for housing not recovering. If you are a professor teaching finance, do you truly understand what you are teaching? The national debt is exploding and causing lack of jobs and savings in this country. I do not know about everyone else but in my area we bankers fight over good loans because they are not out there! No one has jobs or if they do they do not have the down payment to buy the house. What planet do you live one sir?

Mandykate2
Posted by Mandykatie2 | Friday, April 05 2013 at 10:39AM ET
It's hard to propose consumer willingness to take on more debt these days. If something untoward does happen down the road, you can rest assured that as a borrower, you'll get no mercy from the lending institution, the collection agencies or the courts. We've all witnessed the abandonment of consumers: the robosigning settlement basically yielded one month's rent for being victimized by a less than ethical foreclosure processes (whatever happened to banks being held liable for their mismanagement of operational and legal risk? The world wonders), and the mortgage review process is basically revealed as a scam where "independent" reviewers are skimming 20 times what paltry relief a homeowner may eventually see. In other words, the consumer climate sucks, banks are the enemy, we are on our own, and the only sane thing borrowers can do under these circumstances is deleverage as quickly as possible and never get into that position again. Welcome to the "new normal". The real cost of 2008 is a whole new generation of depression-scarred consumers with severely diminished prospects (recent college graduates are taking hourly wage jobs in record numbers, btw. Studies show that the earnings disparity between them and those lucky enough to land a position in an healthy economy lasts their entire working lives, too) and everybody I know, and I mean EVERYONE, has ratcheted their expectations way down. Think I'm overstating this? Maybe you can tell me where the "wealth effect" has disappeared to then.
Posted by papicek | Friday, April 05 2013 at 12:45PM ET
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