Economic Recovery: Escaping From A Vicious Circle

Once again, the news this week points out weakness in the economy, concentrating on lower home sales. Despite a general tone of optimism on the economy, home sales are weak and prices still have not stabilized. One cause of this slippage is tough credit, which is unlikely to change until lenders reform their policies for qualification for loans, as I discuss below.

Why should we worry about this? The New York Times noted In a May 24, 2011 editorial that “Until the [housing] market recovers, the entire recovery is imperiled.” Paul Krugman echoed that concern on February 5th when he expressed some doubt that the recent increase in jobs may be a harbinger of economic recovery. He noted a precondition for that to be true: that housing must recover. 

What will cause housing to recover? Here the conventional wisdom gets really confused: housing will recover because as jobs increase, more people will be able to afford housing. But this is circular reasoning: once the economy starts to recover, housing will recover, but the whole economy cannot recover while housing is still in the dumps. This is a vicious circle. We can’t get an economic recovery until we first get a recovery.

With the kind of leadership that fails to see this contradiction, it is no wonder that middle class and poorer people are suffering.

Everyone seems to be overlooking the role that simple changes in mortgage lending policy could have in getting us out of that vicious circle.

One easy way to produce new jobs and make housing more affordable is to do an “extreme makeover” of existing houses to reduce their energy costs. NRDC has estimated that a thorough energy makeover might cost as much as $15,000 but would cut utility costs by $40,000 over the life of the mortgage.

If we did this for all of the homes that needed it, we would create some 100,000 permanent jobs. That action in itself would help us break out of the vicious circle. But more importantly, it would change something fundamental: the makeover would allow more people to afford to buy a home.

Solving this problem requires three policies that reinforce:

  • Finding an trusted independent source of information on what your home needs to have done and how much it should cost; also how much money you will save
  • Finding a contractor who is trained and certified to do energy upgrades
  • Finding the financing to pay the contractor

Many people will be surprised to find that the first two policies are already in place. You can get an energy rating—a simple score like a miles per gallon rating for cars—from one of thousands of RESNET-certified raters. The rating will include the needed information on what actions to take and what their cost and savings will be.

It is also easy to find a trained, certified contractor. Both RESNET and the Building Performance Institute have done this for us.

What is missing is the financing piece. How many of us have $10,000 or so lying around to spend on remodeling, even if the money will be paid back in energy cost savings? How many of us are “underwater” on our loans and couldn’t borrow money?

This problem would be simple to rectify. Banks could take energy costs into consideration when underwriting loans. Fannie Mae, Freddie Mac, and FHA could do this tomorrow if they wanted. Since they have taken no action yet, Congress is considering the bipartisan SAVE Act to require them to do so.  This legislation is being supported by a broad coalition including NRDC, the Leading Builders of America, the Appraisal Institute, the US Chamber of Commerce and the National Association of Manufacturers.

Table 1 illustrates the problem. A buyer with typical income and good credit scores confronting Choice A might barely be able to qualify for a loan. But if he or the seller performs the energy upgrade to give us Choice B, a choice which is $25,000 more affordable, the loan will be denied.

The same problem confronts a homeowner who doesn’t want to move: a second mortgage that covers the makeover costs also takes us from Choice A to the more affordable Choice B, but most lenders won’t allow the second mortgage.  

Table 1. The Costs of Housing and Utilities

Based on Energy Efficiency



Choice A


Choice B

Energy Efficient

Cost of home



Cost of utilities (over life of mortgage)



Cost of energy makeover



Total Cost of Housing




This choice is even weirder than it seems from the bank’s point of view or from the investor’s. Which loan is more likely to default?

Clearly the answer is Choice A: because not only are the cash demands on the borrower lower, but if the borrower is in distress in the middle of winter and can’t pay both his mortgage and the gas company, which will he pay first?

Not only are the total payments more affordable with Choice B, but evidence suggests that the theory is borne out by actual loan performance. So from a lender’s point of view, choice B is more profitable directly as well as being lower in risk.

The same problem is seen, with even more dire consequences on housing markets, with transportation costs, which are more than 4 times higher than energy costs. And the solution is also the same.

If lenders were to take transportation and energy costs into account, this action would correct two different problems. Evidently, the changes would allow more buyers to qualify for loans for energy and location efficient homes. But by considering risk factors that up till now had been ignored, lenders could scale back some of the tough credit conditions that they imposed to compensate for the failure to consider energy and transportation costs and the risks that they impose on the mortgage holders.

We can break out of this vicious circle if we want to. Do we?