What the Fed Needs to Do to Create Jobs

The Federal Reserve is said to be considering a new initiative to stimulate housing demand by bringing down the price of home loans.  This policy is called  “quantitative easing”; in the past it has been  used to reduce economy-wide long term mortgage rates. But in this case it means using cash to buy mortgage-backed bonds to drive down long-term interest rates and thereby spur home sales.

The idea of stimulating housing demand makes sense: this is one of the most depressed parts of the economy. But the Fed’s proposal can’t do much in this area – the action won’t drive down prices enough to spur home ownership and it certainly won’t drive demand for new housing.  On the other hand, action by the Federal Housing Finance Administration (the federal agency that now runs Fannie Mae and Freddie Mac), can solve the problem in a way that costs less and doesn’t meddle as much with the economy.  It already knows how:

It’s called the Location Efficient™ Mortgage program, and it factors in a homebuyer’s transportation costs (which are larger than the mortgage payment on average) when assessing his or her ability to buy the home. Fannie Mae ran this pilot project over a decade ago, and it was a great success: none of the Location Efficient™ Mortgages went into default.  How often do you get a 100% success rate these days?

But back to the Fed’s proposal and why it won’t work:

The median price of a new home is now about $225,000. If the buyer gets 80% financing, the monthly payments at today’s interest rate of 3.5% is $882 a month. Even if quantitative easing can lower the rate to 3%, this only lowers the payment to $828.

Seriously, how much difference can this make? How many new buyers will be pulled into the market by lowering payments by $54 a month?

And even if it mattered, with a continuing inventory of defaulted homes, selling a few more of them will not increase new construction much.

That brings us back to the real solution – the Location Efficient™ Mortgage.  This program was designed to address a cause of the mortgage meltdown and the resultant crash in housing that has been hidden in plain sight for more than 5 years.

The hidden cause is the high cost of household transportation. While a median new house entails a loan of $180,000, the price of traveling to and from the home averages over twice as much. That is why the defaults that have already occurred have been disproportionately in urban sprawl.

Sprawl housing truly is and will remain expensive—and unaffordable to many—because of the high transport costs it imposes.

Because lenders don’t recognize the importance of transportation costs in explaining why some households default, when they tightened up loan qualification requirements, they only did so in the areas that they DO understand. Since they are missing a critical factor in predicting defaults, they are restricting credit too much for buyers who are NOT buying a home in sprawl. Unless these qualification requirements are loosened for borrowers with more affordable transportation, it doesn’t really matter how low mortgage interest rates go—lending is limited by qualification, not by interest rate.

For example, if you (truly) can’t afford to make your mortgage payments after paying over $11,000 a year on your cars, then the lender assumes you also can’t make the payments even if you are spending only $5,000 a year on transportation. Even if you really can afford this choice!

This hidden factor of transportation costs makes it difficult to solve the nation’s housing problem without changes in the rules for mortgage qualification. That’s because the new generation of home buyers by-and-large doesn’t want sprawl housing anyway. Where the market is underbuilt—where most young people want to live—is in more compact and transit-served neighborhoods. These areas cost a little more in today’s market, but the difference is more than paid back by the reductions in transportation costs, often reductions of 50% and more.

Thus the housing recovery is being held back by these obscure but important regulations on lending. Unless we change them, we are unlikely to get housing to recover much, and even if it starts to recover, the financial system will be unsustainable because those large transportation costs truly are unaffordable to many.

These regulations force choices on consumers that they don’t want to make as well as compromising the quality of the mortgage loan. They could be changed next week if anyone wanted to do so. It is very simple: lenders simply subtract the monthly savings in transportation costs from the monthly mortgage payment when determining if the borrower has enough income to qualify for the mortgage.

This is a win/win solution. America can allow more people to qualify for a loan and spend more on their housing than they do now, and can buy homes in the types of neighborhoods where predicted demand is the highest. And it can do so while reducing the likelihood of default, reducing the federal deficit.

Now we just need the Federal Reserve to ring up the Federal Housing Finance Administration to tell them they’ve already got the solution in hand.