WASHINGTON (Reuters) - In mid-2011, with the U.S. economy at risk of a new recession, top Federal Reserve officials began to explore a different way to shore up the recovery: looking for fixes for the battered housing market.
The central bank had just wrapped up $2.3 trillion in bond purchases in an unprecedented attempt to snap the United States out of its economic blues.
But its efforts were being frustrated. With nearly one in four Americans owing more on their mortgages than their homes were worth, millions remained locked out of credit markets and unable to reduce the cost of their loans.
The Fed’s board in Washington gathered a task force of around 30 staff and put them to work far from the public gaze on ways to turn around the worst housing slump in generations.
More than six months later, the central bank surprised lawmakers with a string of proposals, including deploying the firepower of the massive U.S. housing finance agencies Fannie Mae and Freddie Mac to help struggling homeowners.
But rather than spurring fresh debate among decision-makers in Washington on how to fix the housing market, the Fed put itself in the sights of Republicans angry at what they saw as election-year meddling, an intrusion on Congress’ turf and a veiled attempt to further the Obama administration’s agenda.
“I was truly taken aback when just recently, as you know, the Fed issued an unsolicited white paper ... on housing policy where, if you didn’t advocate for, you certainly mirrored much of the positions of this administration,” Republican Representative Scott Garrett told Fed Chairman Ben Bernanke.
“Why would you issue such a paper when we don’t ask for it?”
Bernanke was in an uncomfortable spot, and he issued what amounted to a rare public apology at the February 1 hearing.
“We were trying to provide pros and cons, analysis, background — I’m sorry if you think we went too far,” he said.
Fed officials were taken aback by the hostile reaction. They say they intended their work to be a good-faith effort to pinpoint policy changes that could help the shell-shocked economy. The 33 percent plunge in U.S. house prices since 2006 has wiped out an estimated $7 trillion in wealth.
Their political miscalculation may have undermined one of their main hopes: building bipartisan consensus around ideas that could get the housing market off the ropes.
“It wasn’t that hard to predict that if you put out a white paper with specific housing proposals that are very political, you’re going to get a political reaction and that might in fact not be productive,” said former Fed staffer Julia Coronado, now chief North America economist for BNP Paribas in New York.
The Fed ran headlong into a culture clash between its own cerebral, deliberative norms and the sound-bite driven, polarized election-year political environment on Capitol Hill.
The interest-rate sensitive housing sector usually helps lead economic recoveries, but this time was different.
Two years after the economy bottomed out, even with interest rates around record lows, housing remained in the tank.
As Fed officials studied how long it took for credit to recover after recessions, they were struck by parallels between the residential mortgage markets of today and the commercial mortgage markets that went bust in 1991. Then, it took 10 years to achieve a full recovery.
One former Fed official who spoke on condition of anonymity said central banks have an obligation to think through all the factors that are holding back economic growth.
At the same time, he said, it was unclear why the Fed felt compelled to outline potentially controversial ideas for Congress, especially during an election year when it was highly unlikely any legislative solutions would gain traction.
The Fed has a dual mandate to keep inflation at bay while ensuring the fullest possible employment.
Bernanke, first appointed by Republican President George W. Bush, is acutely aware of the risks to the Fed’s independence from appearing to take political sides. He had already drawn political fire for bailing out banks during the financial crisis, and for courting inflation and veering into fiscal policy with the Fed’s bond buying.
Republicans viewed the housing white paper as another instance of Fed overreach.
Among other ideas, the central bank suggested that Congress and regulators could expand the scope of government-run Fannie Mae and Freddie Mac to help more homeowners refinance.
The firms have already been propped up with $169 billion in taxpayer aid, making them a target of fierce criticism from Republicans angry at the government’s role in the economy.
The agencies would likely have to accept more near-term losses as the cost of fostering a stronger housing recovery but they would eventually benefit, the Fed said.
“The unveiling of your staff’s housing white paper ... treads too far into fiscal policy, and runs the risk of being perceived as advocacy for particular policy options,” Republican Senator Orrin Hatch wrote to Bernanke.
Bernanke stressed that the white paper - one of only a handful the Fed has produced in recent years - was drawn up in response to inquiries from Capitol Hill and elsewhere.
Last October, at a closed-door meeting with Senate Democrats, Bernanke was pressed on housing. He told lawmakers the central bank would likely soon have ideas to share, according to two senators he spoke with.
The release of the report, however, took months as it got caught in the Fed’s internal vetting process. Bernanke paid careful attention to every detail, and penned his own letter to attach to the paper.
Former Fed Governor Mark Olson said the central bank likely felt a duty not only to dig into what was holding back a housing recovery, but also to share its findings.
“When you’ve assembled research like that, it has limited value if you keep it to yourself. The value is putting it out for public discussion and hopefully implementation,” he said.
Fed Governors Elizabeth Duke and Sarah Raskin oversaw the effort. Duke, a Bush appointee, was a former community banker who had seen what could happen when banks became saddled with foreclosed properties. Raskin, appointed by Obama, was a former state banking regulator who had focused on mortgage servicing issues since joining the Fed.
An assistant director of research at the Fed, Karen Pence, led the group of staff which combined economic and regulatory skills. Pence had studied the rise in mortgage defaults and investigated subprime mortgages in two papers published in 2009.
“We as a nation currently have a housing market that is so severely out of balance that it’s hampering our economic recovery,” Duke told a Fed housing conference in September.
In her remarks, which aired some of the proposals eventually included in the white paper, she called for eliminating the obstacles that were preventing millions of homeowners from refinancing into cheaper mortgages, a signal of support for an Obama administration plan to revamp the government’s main refinancing initiative.
She also suggested making it easier for Fannie Mae and Freddie Mac - which along with the Federal Housing Administration own about half of all foreclosed properties in the United States - to convert those units into rentals, an approach the Obama administration was already considering.
Other officials had begun to consider bolder and more controversial steps.
New York Fed President William Dudley was getting an earful from business leaders during trips in the region about how housing was weighing down local economies. After a trip to the Hudson Valley towns of New Paltz and Fishkill, Dudley ordered his staff to mount a full-court press on housing last spring.
Aware the Fed was studying converting bank-owned properties into rental units, Dudley had his researchers focus on other questions, including the more radical possibility of chopping the amount of outstanding debt owed by some homeowners. That idea, which is anathema to many conservatives, has been credited as one of the issues that spawned the Tea Party.
But it was another policymaker, Fed Governor Daniel Tarullo, who revealed the depths of the central bank’s concerns. “Housing continues to hang like an albatross around the necks of homeowners and the economy as a whole,” he said in October.
Tarullo, an Obama appointee and one-time aide to former president Bill Clinton, said it was time for the central bank to consider buying more mortgage-backed bonds to lower mortgage rates as it had done in 2009 and 2010.
When the Fed sent its white paper to Congress on January 4, it identified three key housing market weak spots: far too many vacant homes, tight credit and the often slow process for foreclosing upon borrowers unable to pay their mortgages.
Its panoply of policy options included the idea of renting bank-owned properties that Duke had discussed, as well as the controversial proposal of allowing Fannie Mae and Freddie Mac to refinance loans they had not backed.
“Unlike a research paper this had the full force of the Fed governorship all over it,” said Clifford Rossi, a former banker and Freddie Mac official who teaches at the University of Maryland.
As the white paper’s release roiled the political waters, Dudley went a step further.
Two days after its publication, he went public with a call for Fannie Mae and Freddie Mac to cut the size of loans for homeowners who owed more than their homes are worth but who had kept up with their payments. It was a proposal that was not only deeply opposed by Republicans but one which the regulators of the massive finance firms had already rejected out of concern it would drive up further the cost of their bailout by taxpayers.
Dudley rebutted a central argument of some conservatives: that loan forgiveness would bail out irresponsible borrowers.
“The problem was that these purchases occurred near the peak in the market and now many of the buyers have suffered an adverse life shock such as unemployment or illness ... this is just the bad luck associated with the timing of the purchase and an exceptionally weak jobs market,” he said.
“Punishing such misfortune accomplishes little.”
On the same day, Duke also pressed the case laid out in the white paper, and suggested the regulator for the two government-sponsored enterprises (GSEs), the Federal Housing Finance Agency, was being short-sighted.
“Policymakers should at least consider policies that take into account the role the GSEs could play in hastening the healing of the housing market rather than focusing entirely on minimizing losses to the GSEs,” she said.
The timing of the paper and the calls for action were politically jarring given that the White House, with an eye on November’s elections, was on the verge of launching its own latest efforts to help the housing market escape its morass.
The negative reaction was swift.
“This extraordinary political intrusion ... is a clear attempt to provide intellectual cover for politicians to spend more taxpayer money to support housing prices,” the Wall Street Journal said in an editorial.
Pressed at his congressional hearing on why Duke and Dudley were effectively advocating for specific policy positions, Bernanke distanced the Fed from their remarks, saying they were simply presenting their personal points of view.
However, Bernanke has not given up on pressing the case for action. On February 10, he called again on Congress and regulators to consider steps to help spur a stronger housing recovery, although he offered no specifics and avoided discussing the more politically controversial white paper suggestions.
Some Fed officials have said that if the central bank sees the need to provide further, direct help to the U.S. economy, it might buy more mortgage-backed bonds.
As for the white paper, the Fed may wish it had tested the waters more carefully to avoid any impression of a central bank seeking to take over new turf, said John Dearie, executive vice president for policy at the Financial Services Forum and a former official at the New York Fed.
“Regrettably, the dust-up probably amounts to additional fodder for the Fed’s critics, despite the Fed’s recent efforts toward improving transparency and communication,” he said.
Additional reporting by Pedro Nicolaci da Costa in Washington and Jonathan Spicer in New York; Writing by Mark Felsenthal; Editing by Tim Ahmann and Claudia Parsons