On August 9, the Federal Reserve announced the inconceivable. It’s going to keep the federal funds rate at a microscopic zero percent to 0.25 percent… for at least another two years!

And in the wake of the news, mortgage rates plumbed historic and yearly lows at 4.32 percent.

Now under normal conditions, access to such cheap money would undoubtedly increase demand for new home and refinancing loans. But we’re not living through normal conditions.

[ad#Google Adsense 336×280-IA]Heck, this is probably going to end up being the worst downturn for the residential real estate market in history.

And the truth is, artificially tamping down mortgage rates is the worst possible solution to the current crisis.

Let me explain why. And then I’ll offer up an alternative, yet difficult, three-step plan certain to usher in a long-overdue real estate recovery.

Say It Three Times: There’s No Place Like Home

Whether Americans have access to cheap financing or not, an increasing amount can’t buy a house if they wanted to.

Why? Either they’re not credit worthy. Or they’re underwater. Their current houses are worth less than they owe on the mortgage.

In fact, CoreLogic estimates roughly one in every four homeowners is currently underwater.

Break it down by state, and the situation is even more depressing…

  • In Nevada, 63 percent of homeowners are underwater.
  • In Arizona, the figure rests at about 50 percent.
  • And in my home state of Florida, it’s about 45 percent (present company included).

As Edward Leamer, an economist at the University of California at Los Angeles, says, “An underwater home is a new version of a debtor’s prison.”

So even the cheapest mortgage rates in the world won’t spring the millions of Americans from the pokey and reinvigorate the real estate market.

I mean, cheap money is what got us into this mess in the first place. It’s foolish to think it’s also going to get us out of it.

A Three-Step Real Estate Recovery Plan

What the Fed and Congress really need to do to usher in a recovery in real estate is take these three steps:

  • Real Estate Recovery Step #1: Let Mortgage Rates Rise

By keeping interest rates at historic lows, all the Fed is doing is providing a glut of homeowners, who purchased a house they could never afford in the first place, with an adjustable rate loan to keep rolling over their bad debt.

Or as Bloomberg Businessweek says, “It’s dangerously close to zombie economics.”

Instead of propping up all these bad debts, what we really need to do is let free market forces go to work. Let mortgage rates rise and squeeze out all the homeowners who are in a home they could never afford.

  • Real Estate Recovery Step #2: Speed Up the Foreclosure Process

At the end of the first quarter, 12.84 percent mortgage loans were either one payment delinquent or in the foreclosure process. Yet it’s taking banks an average of roughly 400 days (and up to 738 days in some markets) to finally evict delinquent borrowers.

That’s unacceptable.

“If you were in foreclosure four years ago, you were biting your nails, asking yourself, ‘When is the sheriff going to show up and put me on the street?’” said Herb Blecher of LPS Applied Analytics, a prominent real estate data firm. “Now you’re probably not losing any sleep.”

What we need to do is speed up the foreclosure process. I know. I’m the mean man. But if you haven’t been paying your mortgage for over a year, you’re never going to pay it.

So let’s get the inevitable over with: Hit the road Jack!

Sounds harsh, I know. But my next step will make sure these evicted homeowners all have a place to go…

  • Real Estate Recovery Step # 3: Turn Bank Foreclosures into Rental Properties

CoreLogic estimates banks are sitting on a shadow inventory of 1.7 million homes, equivalent to a five-month supply based on the current sales rate.

Banks aren’t putting these properties up for sale for one simple reason. They don’t want to flood the market with even more supply and depress home prices further.

But we shouldn’t let banks wait it out and drag out the suffering. Instead, we should force banks to turn their foreclosed properties into rentals.

After all, the rental market is suffering from too much demand and not enough supply. So we can solve two problems – too many homes for sale and not enough homes for rent – in one fell swoop.

Granted, banks would balk about being forced into the property management business. But you know what? They clearly shouldn’t have been in the real estate lending business given all the loans they underwrote that turned sour.

So consider the slight change in business operations their penance and more importantly, a way to eliminate a glut of supply and thereby, hasten a recovery.

The Correlation Between The Housing Market and Unemployment

In the end, I realize my three-step proposal involves a significant amount of pain before the healing begins. But a compelling reason exists to rip off the band-aid quickly.

[ad#article-bottom]If we don’t, there’s no chance our dismal unemployment rate is going to improve.

As this chart from Calculated Risk reveals, a strong correlation exists between the housing market and the unemployment rate.

Put simply, the housing market is a major employer in the United States. And until it’s out of the crapper, we might as well get used eight- to nine-percent unemployment as the new normal.

So again, let’s stop believing the Fed’s pipe dream that cheap money is going to get us out of this real estate mess. The only path to a recovery involves pain. So let’s get it over with already!

Ahead of the tape,

— Louis Basenese

[ad#jack p.s.]

Source:  Investment U