Fed Is Out of Tricks to Jump-Start Housing

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- Federal Reserve officials are flailing about for new tools -- for example, more quantitative easing or a better communications strategy -- to jump-start the economy.

Sadly, the Fed has few arrows left in its quill, most are crooked, and Mr. Bernanke appears to not know where the target is.

The legend on Wall Street is the economy remains dormant because depressed housing values prevent homeowners from refinancing their mortgages to free up disposable income and boost consumer spending.

From November 2008 to this past June, the Fed suppressed mortgage rates and helped put a floor under housing prices by purchasing mortgage-backed securities and long-term Treasuries. More recently, under Operation Twist, it has sold short-term Treasuries to purchase long-term Treasuries -- a maneuver aimed at accomplishing similarly low mortgage rates.

Still, sales of existing and new homes remain depressed, and most of the modest increase in residential construction is in multiunit housing. Young Americans are more frequently renting rather than taking the plunge into home ownership, and many older Americans can't sell their homes for what they paid.

During the boom years, thanks to "creative mortgages" that encouraged individuals to speculate in real estate, more homes were built than were needed, and the resulting oversupply will take years to work off.

The pace of foreclosures and number of homes banks place on the market will pick up through 2012, because banks are working through the legal morass created by robo foreclosures. Though banks face civil penalties or an expensive settlement with the states' attorneys general, most homeowners not able to make payments will have to move out and their homes will hit the market. This extra supply, realtors' hype notwithstanding, will keep housing values depressed for at least the next two years.

A second recession could drive down values, already off about 31% since their July 2006 peak, another 10% to 20%.

Considering the risks, renting and postponing homeownership makes sense for young people not blessed with Wall Street or high-tech jobs, and not working in cities like New York and Washington where the housing recession has passed in upscale neighborhoods.

For most young people, it would only be rational to invest in a home if they could obtain a mortgage at zero or negative interest rates.

Currently, the rate on five-year adjustable rate mortgages is about 3.2%. If the Fed could get the investors who buy Fannie Mae ( FNMA) and Freddie Mac ( FMCC) bonds to accept interest rates of minus 3%, then young folks could be offered mortgages with appropriately negative interest rates. To accomplish that feat, the Fed would have to buy all those bonds itself. That's right, the Fed would finance all federally guaranteed mortgages and write off 3% a year. I can just hear Ron Paul now.

For these reasons, with or without cheerleading from the Fed, a housing recovery is not going to lead the economy out of its current funk.

The U.S. economy does suffer from too little demand, and another popular myth is that this is also caused by households saving too much. Although the personal savings rate did jump from 2.4% in 2007 to 6.2% just before the recovery began in mid-2009, it is now down to 4.5 percent.

The net impact on aggregate demand of the 2.1 percentage point increase in the savings rate is about $275 billion. This pales by comparison to the $550 billion drain on demand imposed by the trade deficit.

Moreover, Americans can only get along without saving a reasonable amount if they expect their government to borrow, forever, large amounts from foreign sources to finance their retirements. Greece has demonstrated how well that model works.

Nope. To jump-start the economy, the trade deficit -- which is almost entirely the deficits with China and on oil -- must be addressed. That requires confronting China's undervalued currency and mercantilism, and developing America's abundant oil and natural gas resources.

Mr. Bernanke is not permitted to communicate those facts, because those issues are the purview of the Treasury and Energy secretaries. But don't look for help from those gentlemen, because their boss "knows" taxing millionaires is the answer.

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Professor Peter Morici, of the Robert H. Smith School of Business at the University of Maryland, is a recognized expert on economic policy and international economics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission. He is the author of 18 books and monographs and has published widely in leading public policy and business journals, including the Harvard Business Review and Foreign Policy. Morici has lectured and offered executive programs at more than 100 institutions, including Columbia University, the Harvard Business School and Oxford University. His views are frequently featured on CNN, CBS, BBC, FOX, ABC, CNBC, NPR, NPB and national broadcast networks around the world.

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