There’s a seeming paradox at the heart of the housing crisis: housing is more affordable than ever, but potential homebuyers remain skittish and banks have dramatically tightened their lending standards. It’s this paradox, combined with the huge overhang of vacant and foreclosed properties, that’s prevented the Federal Reserve’s rock-bottom interest rates from having much of a stimulative effect and the economy from recovering faster, according to a new paper presented Friday at a monetary policy event in New York. As a result, the housing market has continued to lag and has held back the entire recovery, affecting everything from auto loans to local property tax receipts, the authors explain.

The paper lays out the big disconnect that’s impeding the recovery: “When households are asked about homes as an investment—is this a good time to buy because either prices are going higher or it is a good investment— the combined response is at a record low and has shown no sign of recovery,” says the paper, authored by JP Morgan’s Michael Feroli, Bank of America Merrill Lynch’s Ethan Harris, the Chicago Booth School’s Amir Sufi, and the University of Wisconsin’s Kenneth West. “On the other hand, housing affordability—the median servicing costs of a new loan relative to median income—is at a record high.”


Typically, the Fed has been able to step in to address such problems by lowering interest rates, among other stimulative measures. But the magnitude and nature of this particular crisis has weakened that link: One of the main ways the Fed’s lower interest rates boost the economy is by making it cheap for consumers to buy new homes. Since consumers don’t want to buy new homes right now, those lower interest rates aren’t doing much.

Instead, to counter these trends, the paper’s authors have a couple of policy recommendations -- principally to convert foreclosed homes into rentals, most likely through government financing for bulk purchases. In fact, the Obama administration launched a pilot program to do this through Fannie Mae in early February, and a controversial Fed white paper recently recommended as much.