2008 Annual Report: Video

How the Housing Crisis Cycle Unfolded in the Federal Reserve Fourth District

We didn’t suffer from the crash of hyper-inflated housing prices, as people did in California, Florida, and other overheated housing markets. We suffered from over-lending.

In a vicious cycle, delinquencies led to defaults, which led to a high number of foreclosures, which led to an oversupply of housing, which led to home prices depreciating, which led mortgage lenders and servicers to suffer big losses that weakened their financial positions.

In normal times, backstops help deal with delinquencies and vacated homes; but during this severe economic downturn the number of homes heading into delinquency and foreclosure became too much for the system to handle.

The foreclosure rate was especially high in our area, but the problem is widespread. At the end of 2008, the percentage of U.S. mortgage loans in foreclosure was a record-setting 3.3 percent.

In strong markets, where population is on the rise, this problem—having more houses on the market than there are buyers—could see some relief once the economy begins to turn. Vacant houses could be absorbed by the increasing number of people living in the area (view video of 4-D Housing Crisis).

In the 4th District, however, some communities are seeing their population fall which means the vacant homes won’t be so easily absorbed following a turnaround.

Federal Reserve Bank of Cleveland Proposal for Breaking the Housing Crisis Cycle

Unless we attack the housing crisis cycle at multiple points, there’s a chance our efforts will fall short

If we only focus on delinquencies and foreclosures, and fail to address the problem of what to do with the excess of homes on the market, we won’t break the cycle.

The focus should be on a set of coordinated, long-term policies that target multiple points in the housing crisis cycle.

Loan modifications. We believe in compensating mortgage servicers who modify loans to keep people in their homes. We also think we should look at temporarily shielding lenders from investor lawsuits that might be filed as a result of their loan modification efforts.

Convert some of the excess housing stock to rental property. Policymakers may find it necessary to subsidize the first movers, but putting renters in houses that might be left vacant by borrowers who’ve been foreclosed on could help preserve the health of neighborhoods. So could allowing borrowers to remain in their homes as renters instead of owners.

Land banks are another useful tool for helping local governments deal with the problem of abandoned homes. For land banks to happen, legislation needs to be passed, and it has been, in places such as Cuyahoga County, which includes Cleveland, Ohio. Land banks are effective at addressing the problem of having an oversupply of housing that drives property prices down, and we think they can be a great help in preventing neighborhoods from sliding into ruin.

Robust code enforcement. A problem local governments face is that efforts to keep homes from falling into disrepair are often cumbersome and expensive. They spend a lot of money and time locating and serving notices and taking legal action when necessary. We propose funding for robust code enforcement programs to give local governments the resources they need to keep homes, and ultimately entire neighborhoods, from losing their value.

Recapitalize the banking system. If our financial institutions are not strong enough to lend confidently, growth will suffer. Over the past several months, the Treasury has launched a number of initiatives to help recapitalize the banking system, and the Cleveland Federal Reserve continues to study recapitalization strategies.

For the housing crisis cycle to be broken, we think that it would be ineffective to look for one big idea that works equally well for everyone everywhere. The problem is interconnected, and our solution should be, as well. We also need to take a long-term view. These conditions were not created overnight, and it’ll take a multi-faceted, coordinated, and sustained effort to break the cycle that has too many Americans in its grip.