Federal Reserve Governor Tarullo on Housing and Jobs

Yesterday, Federal Reserve Governor Daniel Tarullo gave speech on the national economy at the World Leader’s Forum at Columbia University. His remarks focused on ongoing problems in labor markets, which he classified into three areas of concern:

First, the acute problems are largely, though not completely, the result of a shortfall of aggregate demand following the financial crisis and recession. As such, they can be addressed through measures designed to increase total investment and consumption spending in the economy.

Second, because the recession arose from a financial crisis, which itself followed a buildup of asset bubbles and unsustainable debt in important areas such as housing, the policies likely to be most effective at increasing aggregate demand may be somewhat different from those associated with a more typical recession and, even so, are not likely to work as quickly.

Third, if labor market conditions remain this unfavorable for a long period, the problems I have described as acute could transform into another chronic problem. I refer not just to the despair and desperation that workers and their families must feel as weeks of unemployment stretch into months and even years, which alone should be enough to elicit a policy response, but also to what occurs when the ranks of the unemployed remain so great for so long–the erosion of skills and labor market attachment may affect the productive capacity of the economy as a whole.

In describing the overall (depressing) status of the U.S. labor market, Tarullo cited the following statistics:

..the unemployment rate, which, except for a couple of months earlier this year, has been at or above 9 percent since mid-2009. This is only the second time since the Great Depression that the jobless rate has been so high, and it is the first time since the 1930s that it has been so high for so long.

About 9 million workers who would like a full-time job can find only part-time work. Millions of others are working at jobs for which they are likely overqualified and earning less than in their previous jobs. Meanwhile, another 6 million people who are not officially counted among the unemployed say that they would like a job but have stopped looking for one, in many cases because they have become discouraged by the poor state of the job market.

The proportion of the U.S. population that is employed now stands at about 58 percent, the lowest level since 1983. Finally, more than 6 million workers–nearly one-half of all the unemployed–have been jobless for more than six months. The long-term unemployment rate is by far the highest it has been since data on the duration of unemployment began to be collected in 1948.

The level of payroll employment fell by nearly 9 million during and just after the recession. To date, only about one-fourth that number of jobs has been restored.

Analyzing reasons for the lack of robust job creation, the Fed Governor commented on possible explanations:

First, some have suggested that the traditional willingness of American workers to move from weaker labor markets to stronger ones has been impeded by the sharp decline in residential property prices and especially by the large number of mortgages that are now greater than the values of the properties securing them. But research to date suggests that such “house lock” has probably not had more than a small effect on structural unemployment thus far.7 As noted earlier, migration rates have been falling for some time. But the declines during the recession have not been larger for homeowners than for renters. Nor has migration declined more in areas where workers are more likely to have underwater mortgages because of particularly large declines in housing prices.

A second factor, the one most often cited in support of the structural unemployment hypothesis, is skills mismatch. While it is quite plausible that certain features of the current labor market reflect some skills mismatch contributing to a rise in structural unemployment during the recession, closer examination reveals that they explain less of this increase than might first appear

Tarullo cited housing and household debt as a reason for lackluster economic growth:

With the bursting of the housing bubble, debt levels that may have looked manageable to consumers who believed their homes were appreciating suddenly appeared burdensome as house prices declined. In some parts of the country, this decline was dizzyingly rapid. There has been some progress in working off or writing down some forms of debt, such as credit card balances. But housing continues to hang like an albatross around the necks of homeowners and the economy as a whole, with millions of underwater mortgages, a staggering inventory of foreclosed homes, and depressed levels of sales.

And he said housing policy action is necessary for making this recovery feel like a true economic recovery:

I agree that without more effective efforts to address the manifold problems affecting the housing market, there is a good chance that the recovery will lack strong momentum for some time to come. But aggregate demand policies are still important. For one thing, debts will surely be less burdensome as incomes rise. Moreover, the confluence of housing debt and aggregate demand problems suggests that particular attention should be paid to policies that could buttress aggregate demand while addressing at least some housing market problems.

I believe we should move back up toward the top of the list of options the large-scale purchase of additional mortgage-backed securities (MBS), something the FOMC first did in November 2008 and then in greater amounts beginning in March 2009 in order to provide more support to mortgage lending and housing markets.

A large-scale MBS purchase program has many of the benefits associated with purchases of longer-duration Treasury securities, such as inducing investors to shift to other assets, including bonds and equities. But it could also have more direct effects on the housing market. By increasing demand for MBS, such a program should reduce the effective yield on those MBS, which in turn should put downward pressure on mortgage rates. The aggregate demand effect should be felt not just in new home purchases, but also in the added purchasing power of existing homeowners who are able to refinance. Indeed, homeowners who refinance get the equivalent of a permanent tax cut. Concerns about central banks making sectoral credit allocation decisions are understandable in general. But here we are talking about a widely traded instrument in a sector that appears, now more than ever, to be central to the slow pace of recovery.

Proposals for promoting refinancing have been made by many academics, policymakers, and policy analysts. Any proposals that could sensibly and effectively be implemented would increase the effect of an MBS purchase program. For example, action could be taken to bring the benefits of refinancing to underwater borrowers. In principle, borrowers with mortgages that are guaranteed by government-sponsored enterprises (GSEs) such as Fannie Mae and that have loan-to-value ratios of up to 125 percent can refinance through the Home Affordable Refinance Program. In practice, though, numerous obstacles have kept the program from helping many potentially eligible borrowers. Underwater borrowers whose loans are not guaranteed by GSEs are essentially unable to refinance at all. Policy changes directed at this last, larger group of homeowners would have to be carefully designed so as not to transfer credit risk from private investors to the government, and could well require legislation.

Needless to say, though, an MBS repurchase program will not cure all that ails the housing market, much less fill the whole aggregate demand shortfall. There is a host of other problems, including continuing issues in mortgage servicing, uncertainty as to when house prices will have bottomed out in local markets, ambiguity about the scope of putback risk for securitized mortgages, and the substantial part of the underwater mortgage problem that cannot be solved by refinancing. But I believe that MBS purchases are worth considering as a monetary policy option precisely because they carry the promise of addressing the feature of the current aggregate demand shortfall that differs from typical recessions and recoveries.

In a period when many policymakers and presidential candidates are ignoring the ongoing crisis in housing, it is a positive development to see a Federal Reserve Governor examine the challenges in the housing market and their relationship to sustainable job creation.

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