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Letting the Markets Work: St. Louis Fed Analyzes the Mortgage Crisis


ST. LOUIS — When it comes to the current mortgage crises, large-scale government interventions directly in housing or mortgage markets are not necessarily the best policy responses. By allowing markets to sort themselves out quickly, a foundation for sustainable homeownership and responsible mortgage lending can be re-established.

Economist William R. Emmons offers that perspective in a review of the current mortgage crisis for the July issue of The Regional Economist, the quarterly journal of business and economic issues published by the Federal Reserve Bank of St. Louis. The publication is also available online at:

While house prices in many parts of the country may fall from their peak levels in 2006 or 2007 by the largest amount in several decades, from an economic standpoint this decline of overvalued properties is necessary. If house prices are allowed to remain artificially high, homebuilders will make the eventual correction even worse by supplying more unneeded houses and driving prices down even further.

The second unpleasant, but essential aspect of the mortgage market is foreclosure. In order to ensure the mortgage market functions effectively, the lender must have the ability to seize the borrowers property as collateral. Without the possibility of foreclosure, mortgage rates would be more on par with those of credit cards, said Emmons.

Moving forward, Emmons argues that oversight in the mortgage market should be strengthened and abuses eliminated. And because the private market for nonprime mortgages is not likely to recover quickly, he said there is a case to be made for bolstering government agencies and programs that facilitate widespread access to decent housing and mortgage credit.

"It is important to keep in mind that there will be those individuals who are truly harmed by the crisis, said Emmons. The financial distress to borrowers and communities caused by foreclosure should be addressed directly. A stronger social safety netincluding measures such as income support, vouchers to guarantee access to decent housing, and assistance in re-establishing household financial stabilityis the most direct way to deal with the fallout from mortgage foreclosures. Local communities can be supported through direct grants from the federal government to replace tax revenue lost as a result of slumping local housing markets.

Emmons notes that the underlying cause of the recent mortgage crisis is best dealt with directly through economically efficient public policy and a laissez-faire approach to the housing and mortgage markets. "By treating the cause and not the symptoms," he said, "the true root of the problem can be addressed."

With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, and provides payment services to financial institutions and the U.S. government.

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