[T]he problems are sufficiently widespread that they suggest structural problems in the mortgage servicing industry. The servicing industry overall has not been up to the challenge of handling the large volumes of distressed mortgages. The banking agencies have been focused for some time on the problems related to modifying mortgage loans and the large number of consumer complaints by homeowners seeking loan modifications. It has now become evident that significant parts of the servicing industry also failed to handle foreclosures properly.

The extent of Congressional meddling in this market has been astonishing to the point where one can barely identify what the private sector outcomes would be in the absence of intervention.

To the extent possible, we need to let the private sector provide the bulk of U.S. housing finance going forward, without the incentive‐distorting set of government programs and taxpayer guarantees that caused our current system to collapse. Those programs meant well, but ended up costing everyone dearly.

Even in the case of a servicer who has every best intention of doing "the right thing," the bottom-line incentives are largely misaligned with everyone else involved in the transaction, and most certainly the homeowners themselves.

Note that I’m talking about land, not housing. Theoretically, it is hard to motivate the existence of significant overvaluation in housing structures (they’re readily replaceable). Empirically, there is considerably less evidence of overvaluation for structures than for land. Here, I refer to data from the Lincoln Institute of Land Policy that separates the price of housing into the price of structures and the price of land. The data were originally constructed by Davis and Heathcote (2005, 2007), and are derived from the Case-Shiller housing price index. These data indicate that the price of housing structures rose by less than 100% in nominal terms from 1996 to 2006, and has fallen by less than 10% since that date. 

[H]omeownership is only good for families and communities if it can be sustained. Home purchases that are very highly leveraged or unaffordable subject the borrower and lender to a great deal of risk.

We have seen some stability over the last couple of quarters in real estate... Nonetheless, it’s something we have to worry about.

As reported by Dow Jones.  The associated Powerpoint presentation can be found here.

But suppose for a moment that we do accept the claim that housing is somehow critical for an economic turnaround. I’m not sure how, if at all, it would affect my thinking as a monetary policymaker. The Federal Reserve can only influence the housing market by manipulating interest rates. But there is little evidence that interest rates have a big influence on housing starts. For example, in a 2007 National Bureau of Economic Research paper on housing and the business cycle, UCLA professor Edward Leamer estimated a relationship between current housing starts, past housing starts, and interest rates. The Minneapolis Fed banking studies group has used Leamer’s estimates to calculate the impact of a 100-basis-point permanent decrease in 10-year Treasury yields on housing starts one year from now. The group has found that housing starts would be 11 percent higher with the rate cut than without it. This effect would be barely noticeable, given that housing starts need to nearly triple to get back to their normal level.

[W]ith the exception of housing, lending over the current downturn does not appear particularly weak or subdued relative to other downturns. Indeed, for all categories of lending other than home mortgage lending...there are at least two other downturns for which the paths of lending after the business cycle peak lie below that following 2007:Q4

I am not particularly concerned about the possibility of persistent deflation. When oil and commodity prices stabilize, the negative rates of inflation we have seen in the CPI are likely to disappear. Moreover, I am confident that the FOMC is committed to maintaining price stability. Nonetheless, we must act to ensure that expectations of deflation do not take root, just as we must act to ensure that expectations of higher inflation do not emerge. The failure to maintain well-anchored inflation expectations can wreak havoc with the real economy, foster unnecessary volatility, and make it more difficult for the Fed to deliver on its dual mandate to keep the economy growing with maximum employment and price stability.

I and others have long proposed establishing an explicit inflation target as one way to signal the FOMC's commitment to price stability and help anchor expectations. Such a commitment not only helps prevent inflation expectations from rising to undesirable levels, but it can also help prevent expectations from falling to undesirable levels.

On the fiscal side, it is possible that Fannie Mae and Freddie Mac could play a more significant role in restoring liquidity and providing a secondary market for mortgages that reflect the lower cost of funds in many credit markets. Further exploration of the GSEs’ options for pricing and programs may result in additional support to the mortgage market.

On the monetary policy side, the Federal Reserve announced on November 25 that it would be buying up to $100 billion in GSE direct obligations, and up to $500 billion in mortgage-backed securities.[Footnote 9] A subsequent announcement on December 30 provided more details.[Footnote 10] Since the announcement of the program, designed to reduce the recently widening rate spreads on GSE debt and on GSE-guaranteed mortgages, mortgage rates have declined (see Figure 8). Some mortgages in Boston are now available for under 5 percent.

...

Since stabilizing the housing market is critical, expanded use of policies that address the cost of housing finance may give further impetus for new home buyers and existing mortgage holders to take advantage of what are very low rates by historical standards.

(A) proposal developed by several Federal Reserve economists, and available on our website,[Footnote 13] suggests that the U.S. government could pay a significant portion of monthly payments for borrowers who are facing severe but temporary financial setbacks. There are two variants to the proposal. One way in which such a plan might work is for the government to offer these borrowers temporary loans that must be paid back once the borrower returns to financial health. Another version of this plan calls for the government to offer grants, not loans, to borrowers who have adverse life events, such as job loss.

The paucity and inaccessibility of data about the underlying home loans was, in my opinion, one of the reasons that private-label MBS was able to expand so rapidly in 2005 and 2006 despite a deterioration in underwriting and prospective credit performance. That is not to say that better data would necessarily have led investors to completely sidestep the private-label MBS that have caused them so much difficulty. But I do think it was a significant hindrance that the information needed to infer, in real time, the extent to which subprime and alt-A mortgage underwriting was sliding simply did not exist in a form that allowed the widespread scrutiny or objective analyses needed to bring these risks more clearly into focus.

Thus, I believe that markets for private-label MBS are unlikely to recover unless comprehensive and standardized data for home mortgage pools are made widely available to market participants.

Looking ahead, uncertainty about the outlook is greater than usual, though probably not greater than is typical for this phase of a business slowdown. It strikes me as reasonable to expect the U.S. economy to regain positive momentum sometime in 2009, for several reasons. First, monetary policy is now quite stimulative. Second, the energy and commodity price shocks that dampened economic activity earlier this year have subsided already or are in the process of doing so. And as I’ve mentioned, the drag from housing seems likely to lessen in the next year, and in fact, I would be surprised if we don’t see a bottom in housing construction sometime in 2009. This is the third straight year, however, that I’ve been expecting a bottom in the housing market in the middle of next year, so my outlook is tempered by more than the usual amount of humility.

The Boston Fed’s position has long been — despite some determined mischaracterizations — that some flexibility in underwriting criteria may be appropriate if the borrower’s willingness and ability to handle the debt can be affirmed, and such flexibility is considered in a consistent and fair manner across applicants.

We have not, and do not, advocate for irresponsible or poorly underwritten lending. That perspective, however, is not at odds with advocating that the various participants in housing markets continue to strive for fair access to credit, appropriately extended. Nor is it at odds with our belief that responsibly underwritten loans to borrowers in low- and moderate-income areas — including those whose credit situation is considered “subprime” but can document their ability to afford the loan — are welcome and indeed crucial.

Any stabilization in the housing sector should provide a sizable stimulus to overall growth, all else equal...By the first half of 2009, homebuilders will probably have worked off the bulk of their excess inventories of unsold new homes, and, after three years, we will finally see an end to the drag from this sector.