A housing bubble burst in 2008, pushing the US into its deepest recession since the Great Depression. In the aftermath, many countries developed new tools designed to squeeze the air out of real estate bubbles before they burst. The US has lagged in some ways, in part because of the Trump administration’s deregulatory zeal.
Sensing danger, some reformers want the Biden administration and the Federal Reserve to develop new tools and take action to catch up. Others fear that attempts to deflate bubbles will ultimately only hurt the poor and the middle class.
Due to developments this year, attention has been paid to this subject. House prices are rising at the fastest pace in history, fueling concerns that a new real estate bubble has emerged.
These double-digit home price increases have led some to call on the Fed to raise interest rates. So far, Federal Reserve Chairman Jerome Powell has resisted those calls, arguing that higher tariffs are hurting the entire economy and leading to job losses at a time when the effects of COVID have already left millions of Americans out of work.
Raising rates “to tackle asset bubbles…[is] not something we intended to do.” Powell told reporters that earlier this year. “We would rely on macroprudential and other tools to address financial stability issues.
So far, nothing has been done, despite protests from some Fed officials such as Boston Fed President Eric Rosengren, who recently argued that a “boom and bust cycle” in real estate is incompatible with financial stability.
read more: Fed official says new boom-and-bust housing market is unsustainable
Jeremy Kress, a former banking regulation attorney and policy group at the Federal Reserve and professor at the Ross School of Business in Michigan, criticized the Fed for not using a tool already in its arsenal: the countercyclical capital buffer.
This rule allows the Fed to require banks to fund themselves with larger amounts of equity in the form of retained earnings or money raised from shareholders and less from debt, he said.
“Raising capital requirements during boom times could signal a breakthrough for runaway asset prices,” Kress said. “The Federal Reserve, unlike other countries, has never engaged this discretionary buffer. Maybe now is a good time to activate it.”
There are other more specific ways the government can address housing bubbles.
Gregg Gelzinis, deputy director of economic policy at the Center for American Progress, told MarketWatch in an interview that the Financial Stability Oversight Committee, the group of heads of regulatory agencies created in response to the financial crisis, would be more effective if it Congress has the power to set nationwide limits on how much money banks can lend to real estate buyers.
“The array of tools that regulators have is imperfect, and there are other tools Congress could give them to bolster the arsenal,” Gelzinis said. Regulators in the UK and some countries in Europe may set limits on loan-to-value ratios that change based on the state of the economy. “You have one cap in normal times and another when the market is overheated,” he said.
Also see: An inflation storm is coming for the US housing market
Former Federal Reserve Vice Chairman Donald Kohn made a similar point in a speech in 2017 that regulators in Washington “need the power to set limits on loan-to-value and debt-to-income measures when easing standards, perhaps outside the banking system, threatens financial and economic stability.”
A loan-to-value ratio measures the size of a mortgage loan relative to the value of the property used to purchase it. High LTV ratios can suggest speculative behavior because the buyer could take out such a risky loan expecting the property to appreciate in value.
According to the International Monetary Fund, 19 different European countries have set loan-to-value limits ranging from 30% to 100%, with higher loan limits for first-time home buyers and lower limits for those buying second homes and investment properties. The IMF study said the results of these policies often slowed the pace of price growth in a particular real estate market, although those effects have been muted in some countries with severe restrictions on new home supply.
The Consumer Financial Protection Bureau, which was created by the Dodd-Frank financial reform bill, in part to protect Americans from robbery mortgages, has the authority to set these kinds of standards. In 2013, the regulator introduced a 43% debt-to-income limit on mortgages, if issuers wanted to qualify for a safe harbor that would protect them from customer lawsuits. A debt-to-income ratio compares how much the borrower’s monthly repayments are compared to monthly income.
However, under the Trump administration, the debt-to-income limit was removed for a market-based approach that relies on private insurers to determine whether a borrower is likely to default on a mortgage loan.
“The way they’ve done it, very few mortgages will be affected,” Laurie Goodman, a former mortgage banker and housing finance expert at the Urban Institute, told MarketWatch. “What they’ve done is prevented a major credit tightening by copying the rule they’ve done.”
The Task Force on Financial Stability, a group of private scientists, former regulators and industry practitioners released a report in June in which the costs and benefits of LTV caps were discussed. They wrote:
These precautions should be limited to cash-out refinancing and investor loans; they should not include purchase loans because of the importance of homeownership as a way for Americans to build wealth. While many other countries have put LTV limits on buying mortgages (with varying degrees of success), in the United States this would make it very difficult for first-time home buyers.
Goodman of the Urban Institute, who is a member of the task force, said mortgage lending is already very conservative even without federally mandated loan-to-value caps. She said mortgage lenders have demanded higher down payments and credit scores in recent years, a trend that accelerated during the pandemic as lenders worried about the state of the economy.
read more: The Fed is on the sidelines as house prices rise — but here’s what could get in the way:
“There is no doubt that the credit was too generous in the period 2005 to 2007,” she said. “As far as I’m concerned, the pendulum has swung way too far in the other direction.” Goodman argued that current banking standards, driven by government regulation and the industry’s fear of repeating the crisis of the past decade, have prevented too many Americans from “accessing homeownership’s greatest wealth-building tool,” he said. they.
Consumer and civil rights groups applaud the CFPB’s decision to do away with a hard DTI cap and consistently advocate policies that create better access to reasonably priced home loans. In April, a group of civil rights groups wrote to acting director of the CFPB, Dave Uejio, to uphold the Trump-era mortgage rules.
“An unnecessarily restrictive definition of a qualifying mortgage would push a significant portion of creditworthy borrowers — including a large proportion of colored borrowers — out of the mainstream mortgage market and possibly out of the mortgage altogether,” they wrote.
Meanwhile, CAP’s Geliznis argued that there are other steps the Financial Stability Oversight Council could take that would increase financial stability without necessarily making it harder for average Americans to get a mortgage. He argued that non-bank mortgage service companies, which lend and grant loans but do not keep them on their books, pose a greater threat to financial stability than lax credit standards and that FSOC should consider listing the largest of these companies as systemically important. and therefore subject to stricter regulation.
Goodman disputes the idea that another potentially catastrophic real estate bubble is emerging, driven by low interest rates and lax regulation. Instead, she argued that the evidence is clear that today’s rising home prices are largely the result of a surge in demand for new homes, led by a demographic wave of millennial buyers seeking their first home and other buyers. fleeing the cities for suburban single-family homes in the wake of the pandemic.
“The problem is about too much demand and too little supply,” she said. “Production costs have gone up, land value is skyrocketing, you have all kinds of zoning restrictions that increase land value,” and builders wonder “how many borrowers can afford what it actually costs you to produce.”