Fate of Housing Finance Poses Risk to Broader Economic Recovery: Lacker

JeffreyrnM. Lacker, President of the Federal Reserve Bank of Richmond and a voting member of the FOMC, told a Universityrnof Delaware audience that, while the economy is improving and inflation is low,rnthe growth is proceeding at a much slower pace than the country has seen inrnrecessions of the past.  This lag, hernsaid, is largely because this time housing is not driving the recovery. </p

Thernrecessions of 1973-1975 and 1981-82 ended with residential investment rising atrnan average of 40 percent in the each following year.  This time the economy is dealing with whatrnthe housing boom that preceded the recession left in its wake; a housing stockrnthat is too large in both numbers and size than what households want in lightrnof their current income prospects and credit market conditions.  </p

Not onlyrnis investment in housing itself lagging, Lacker said, but other household outlaysrnhave grown relatively slowly in this recovery as well. Consumer expendituresrnincreased at an annual rate just below 2 percent in the first five quarters ofrnthis recovery. In contrast, in the two other severe post-war U.S. recessions,rnhousehold spending grew by an average of 6-½ percent in the first year of expansion,rnthereby adding considerably to GDP growth.</p

Other than housing, many factors in the economy are encouraging; consumerrnspending has recently picked up speed, initial unemployment claims have been onrna downward trend since last summer and the unemployment rate has fallen by halfrna percent over the last two months and by more than a percentage point sincernthe fall of 2009, albeit because of a shrinking labor force. In addition manufacturers have added to payrolls over thernlast three months and average hourly earnings continue to advance. The recentrndecline in the personal saving rate also suggests that many households havernmade substantial progress toward repairing their balance sheets.  On the business front there are encouragingrnsigns that investment in equipment and software and in new structures isrnimproving and prospects for export growth are also positive.  </p

The Fed chief said that despite all that the economy has going for it,rnthere are still substantial challenges ahead. rnHousing activity continues to be depressed, residential investment hasrnfallen nearly 60 percent from its peak at the end of 2005 and with the largerninventory of vacant homes and continuing foreclosures any advance inrnresidential investment is likely to be slow and uneven.  “Having said that, residentialrninvestment is only 2-1/4 percent of GDP so the damage this sector is capable ofrninflicting is in some sense limited.”  </p

Those are the near-term prospects, but longer term the government’srnfiscal policies could have a significant impact on growth.  “We have a serious, long-term mismatchrnbetween the trajectories of federal spending and taxes” and thernCongressional Budget Office’s most recent projections show deficits shrinkingrnas a percentage of GDP only until 2015 when they will begin to risernsteadily.  “The ratio of debt to GDPrnrises from the current level of around 60 percent to 150 percent in 2030,”rnLacker said.</p

One area that could present serious fiscal risk is the still openrnquestion of the federal government’s role in housing finance.  Washington is preparing to consider the faternof the government sponsored enterprises (GSEs) Freddie Mac and Fannie Mae andrnmany proposals would make government guarantees explicit and priced rather thanrnimplicit as was the case before the crash. rnBut Lacker believes “perpetuating guarantees for housing-relatedrndebt will continue to artificially stimulate the risky leverage that criticallyrnfueled the disastrous housing boom.” rnThe resulting consequences suggest that government backstops are notrn”worth the price of over-built, over-leveraged and at times overheatedrnhousing markets, on top of the fiscal burden of large contingentrnliabilities.”  He believes we shouldrnphase out government guarantees for home mortgage debt; home-ownership may be arnlaudable goal, he said, “but if that is our objective, we should subsidizernhousing equity, not housing debt.</p

He pointed out that the Federal Reserve’s decision last fall to purchasern$600 billion in long-term Treasury securities was done with an eye to its riskrnand a commitment to regularly review the pace and size of the effort.  The improvement in the economic outlook sincernthe program was initiated, he said, suggests that such a re-evaluation shouldrnbe taken seriously.

All Content Copyright © 2003 – 2009 Brown House Media, Inc. All Rights Reserved.nReproduction in any form without permission of MortgageNewsDaily.com is prohibited.