How to Fix the Economy and Avoid a Bubble

International Builders Show 2012 recap

bernanke-speech-at-international-builders-show-ibs-2012

 

Recently, I had the opportunity to attend the 2012 International Builders’ Show in Orlando for a couple of days. 

I’ve attended the IBS a few times prior, but this year the National Association of Home Builders (NAHB) arranged for Federal Reserve Chairman Ben Bernanke to address the members regarding the state of the economy, the state of housing, and the correlation between the two.     

After listening to Chairman Bernanke’s speech, I felt very confident in his grasp of the underlying issues holding down the economy and housing. 

As a historian of economic and financial crisis and recoveries, Chairman Bernanke is well aware of the contributions to GDP and to the overall economic recovery that the new home construction industry is capable of.  

 

As he outlined the issues holding down the economy, he suggested certain solutions, but reading between the lines, it was clear to me that he was basically saying that many of these solutions were not within his control.  To implement the solutions that Chairman Bernanke suggests, a multi-faceted, governmental effort would be required, including efforts by the Federal Reserve, the FDIC, the Office of the Controller of the Currency, the GSEs, and Congress.

From a basic economic standpoint, the prices of homes have gone down because the supply of houses for purchase is higher than the demand of qualified purchasers – end of story.  In that vain, I was most pleased to hear Chairman Bernanke discuss the “REO to Rental” program and the GSE Pilot Program.  The “REO to Rental” program would be a program focused on banks that (1) own a large number of foreclosed homes and (2) have sufficient capital to hold these homes on their books for a number of years.  The basic premise is that the banks would get more value (on a discounted basis) from the houses by renting them than by selling them out right at today’s prices.  The GSE Pilot Program provides for a structure for the Government Sponsored Enterprises (“GSEs”), like Fannie and Freddie, to sell foreclosed houses in bulk to large investors, who will rent the houses for an extended period of time.  

The benefit of these programs is that the houses are rented to fill the excess demand for rental units rather than listed for sale whereby adding to the excess supply of houses already for sale.  I believe these programs provide the most fundamental support to housing values (which has been shown to have a positive correlation to consumer spending and household wealth) and the economy. 

Although Chairman Bernanke did not discuss multi-family housing and the rental market in depth (other than to say the rental market has strong demand), I feel that his solutions for housing values would also help prevent a real estate bubble that is forming in the multi-family/rental market. 

The demand for houses for rent is high, largely because, many would-be purchasers can not qualify to purchase homes due to lack of credit and financial strength, which were damaged/restrained during the recession; therefore, these purchasers are forced to rent in the short-run.  So, what has been our brilliant answer to the high demand for residential rental properties:  let’s build a ton of multi-family rental units (i.e. apartments) and let the banks finance these projects.  This should work out really well for the banks and apartment owners when those now would-be purchasers improve their credit (in many cases, it takes only about three years after a short sale, foreclosure, or bankruptcy to get a home loan again) and savings and decide to purchase a home and vacate the rental property. 

As you might guess from my sarcasm, I believe there is a bubble growing in the multi-family rental market as I write this post.  Oh, and did I mention that home ownership affordability is at record highs (i.e. the monthly costs of owning a home is very comparable with renting a home – even before tax benefits)?  This should bold well for rental rates and demand for multi-family residential units in the coming years.

Unfortunately, the “REO to Rental” program and the GSE Pilot program alone will not be enough to avoid the bubble in the multi-family/rental market, because if lenders keep financing apartment and developers keep building apartments based on, what I believe to be, a false or temporarily high demand for rental units, than the bubble will still exist.  An effort on the lenders part to recognize the false / temporary demand will be required to avoid over-building in this area. 

At this point, you may be asking:  if there is a false / temporary demand for rentals, why is it any better to rent the excess houses than to build apartments?  First and most importantly, rental houses can quickly be sold as more qualified buyers hit the market whereas apartments can not be sold unless they are converted to condominiums (that’s right, I said condo conversions in the year 2012).  Second, the excess houses are already built and holding down the overall value of housing, so they need to be addressed prior to building new rental units.

In conclusion, the “REO to Rental” program and the GSE Pilot program that Chairman Bernanke discussed is the quintessential “two birds with one stone” solution for drastically improving the state of the housing market and the economy and potentially averting the next real estate bubble, which I believe to be the multi-family residential market.

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* This Post is intended for editorial purposes only.

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