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July 24, 2021, 9:30 a.m. EDT

Washington might have to go to war to fight a housing bubble. Does it have the tools to win?

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By Chris Matthews

A housing bubble burst in 2008 pushing the U.S. into deepest recession since the Great Depression. In the aftermath, many nations developed new tools designed to take the air out of real-estate bubbles before they burst. The U.S. has lagged in some respects, in part because of the deregulatory zeal of the Trump administration.

Some reformers, sensing danger, want the Biden administration and the Federal Reserve to develop new tools and take action to catch up. Others worry that efforts to deflate bubbles will, in the end, only hurt the poor and the middle class.

Developments this year have focused attention on the issue. Home prices are rising at their fastest pace in history , fueling concern that a new real estate bubble has formed.

These double-digit home price increases have led some to call on the Fed to raise interest rates. So far, Federal Reserve Chairman Jerome Powell has resisted those calls, arguing that higher rates damage the entire economy and lead to job losses at a time when the effects of COVID have already left millions of Americans unemployed.

Raising rates “in order to address asset bubbles…[is] not something we would plan to do.” Powell told reporters earlier this year. “We would rely on macroprudential and other tools to deal with financial stability issues.

So far, nothing has been done, despite protest from some Fed officials like Boston Fed President Eric Rosengren, who recently argued that a “boom and bust cycle” in real estate is incompatible with financial stability.

Read more : Fed official says another boom-and-bust housing market is not sustainable

Jeremy Kress, a former attorney in the banking regulation and policy group at the Federal Reserve and professor at Michigan’s Ross School of Business criticized the Fed for not using a tool already in its arsenal — the countercyclical capital buffer.

This rule allows the Fed to require banks to fund themselves with greater amounts of equity in the form of retained earnings or money raised from stockholders and less from debt, he said.

“By raising capital requirements during boom times, that could put a break on runaway asset prices,” Kress said. “The Federal Reserve, in contrast to other countries, has never turned on this discretionary buffer. Perhaps now might be a good time to activate it.”

There are other, more specific, ways the government could target bubbles in the housing market.

Gregg Gelzinis, associate director for economic policy at the Center for American Progress told MarketWatch in an interview that the Financial Stability Oversight Committee, the group of the heads of regulatory agencies created in response to the financial crisis, would be more effective if Congress gave it the power to set nationwide limits on how much money banks can lend to purchasers of real estate.

“The suite of tools regulators have are imperfect, and there are other tools that that Congress could grant them to could bolster the arsenal,” Gelzinis said. Regulators in the UK and some countries in Europe can put limits on loan-to-value ratios that change based on the state of the economy. “You have one cap in normal times and another when the market is overheating,” he said.

See also : An inflation storm is coming for the U.S. housing market

Former Federal Reserve Vice-Chairman Donald Kohn made a similar point in a 2017 speech that Washington regulators “need the power to put limits on loan-to-value and debt-to-income measures, when loosening standards, perhaps occurring outside the banking system, threaten financial and economic stability.”

A loan-to-value ratio measures the size of a mortgage loan relative to the value of the property used to purchase it. High LTV ratios may suggest speculative behavior because the buyer could take out such a risky loan on the expectation that the property would rise in value.

According to the International Monetary Fund , 19 different European countries have instituted loan-to-value caps that range from 30% to 100%, with higher limits on loans for first-time homebuyers and lower caps on those buying second homes and investment properties. The IMF study said the results of these policies often slowed the pace of price growth in a given real estate market, though in some countries with severe constraints on the supply of new homes, those effects were muted.

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