Moody’s Mark Zandi Calls for Government Support of Housing

Five years into the housing slump, and home sales remain weak with prices falling again in many parts of the country as foreclosures and short sales are ramping up.

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Mark Zandi, chief economist for ""Moody's Analytics"":http://www.moodys.com, says while it certainly won't be the popular move, it may be time for the government to step up temporary support for the housing market.

Zandi underscores ""three policy recommendations"":http://www.economy.com/mark-zandi/documents/To-Shore-Up-the-Recovery-Help-Housing.pdf that he believes could help ensure housing stays on course. He says the federal government should consider (1) facilitating more refinancing, (2) delaying the impending reduction in conforming loan limits, and (3) supporting principal-reducing loan modifications more aggressively.

Thirty-year fixed mortgage rates have fallen back near 4.5 percent. With these rates, Zandi says the government should require ""Fannie Mae"":http://www.fanniemae.com/kb/index?page=home and ""Freddie Mac"":http://www.freddiemac.com/ to provide more refinancings via the Home Affordable Refinancing Program (HARP).

To date, Zandi says fewer than 700,000 homeowners have refinanced using HARP. Results he calls ""especially disappointing"" since HARP allows borrowers to refinance up to 125 percent of a property's value, specifically to help those who are underwater.

Conforming loan limits for ""Fannie"":http://www.fanniemae.com/kb/index?page=home, ""Freddie"":http://www.freddiemac.com/, and the FHA are set to be lowered in October. Without an extension, Fannie and Freddie's loan limit will drop from $729,750 in the highest-cost areas of the country to $625,000. FHA loan limits are likely to fall even more.

""Reducing the loan limits will test whether private lenders are willing and able to step up as the government steps back, but doing so this year may be premature,"" according to Zandi.

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A more dramatic and costly policy step, but one that Zandi says presents the best odds for ending the housing crash quickly and definitively, would have the government facilitate loan modifications with substantial principal write-downs.

The main concerns surrounding principal cuts are moral hazard and fairness. To deal with these, Zandi says the program must be well-targeted, with clearly articulated eligibility requirements, a long vesting period - as much as five years - and some type of clawback provision for future capital gains to guard against fraud.

Zandi outlines a list of recommended program criteria, which he says approximately 600,000 current homeowners would meet. Even assuming a re-default rate of 25 percent, this would result in approximately 450,000 sustainable modifications.

This is just about the number of modifications, in addition to those that would take place regardless, needed to forestall anticipated home price declines, according to Zandi. He says without such a plan, the distress share of home sales is expected to rise from approximately one-third to 40 percent late this year.

Decisions to default depend critically on expectations about future house prices, according to Zandi. If homeowners think prices will rise, he says, they are more likely to hold on, but if they believe more price declines are coming, they may decide to give up.

""This can quickly become a vicious cycle, as occurred during the depths of the recession,"" Zandi said.

He says it took a ""massive policy effort"" to break the last circling series of downward indicators â€" an effort that involved placing ""Fannie"":http://www.fanniemae.com/kb/index?page=home and ""Freddie"":http://www.freddiemac.com/ into conservatorship, expanding FHA's role, increasing conforming loan limits, three rounds of housing tax credits, and a $1.25 trillion mortgage bond buying spree. The government also took an active role in the mortgage modification effort and encouraged refinancing.

""Although it is easy to criticize individual elements of this policy response,"" Zandi said, ""it is important to remember that it was devised and implemented quickly, under extreme circumstances. Moreover, in its totality, the policy response worked; the housing market stabilized beginning in 2009.""