How housing weakness may change the Fed's game

When Federal Reserve Chair Janet Yellen testified before the Joint Economic Committee of Congress last week, she added a new variable to the Fed's policy mix — weakness in the housing market.

While in recent weeks, and months, the Fed has focused on two economic variables that are being most closely watched — unemployment and inflation — the mention of housing was significant. Not since the immediate aftermath of the bursting of the real-estate bubble has the Fed focused on the foundation of the American economy as a significant factor is guiding decisions on interest rates and quantitative easing.

Tune in to CNBC's "Closing Bell" Tuesday, May 13 between 3 and 5 pm to see Ron Insana discuss his thoughts on how the weak housing market may impact the Fed's next move.

Federal Reserve Bank Chair Janet Yellen delivers her opening remarks to the Joint Economic Committee during a hearing entitled "The Economic Outlook," on Capitol Hill, May 7, 2014.
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Federal Reserve Bank Chair Janet Yellen delivers her opening remarks to the Joint Economic Committee during a hearing entitled "The Economic Outlook," on Capitol Hill, May 7, 2014.

It has been a winter of discontent for the economy, as a whole, but even more so for sales of new and existing homes, housing starts, mortgage applications and refinancings. Home-price appreciation has slowed in certain parts of the country, as well, but that hasn't yet sparked a pick-up in demand.

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Even with long-term Treasury rates falling to 2.6 percent, pushing mortgage rates back down toward historic lows, the flow of credit to potential home buyers has been choked off, creating a headwind in housing, and for the overall economy, from what was a tailwind a year ago.

If the spring fails to deliver any new "green shoots" to residential real estate, the Fed may do one of several things.

It could "taper the taper," taking a couple months off and then re-start the taper if real estate picks up, or stop for a protracted period.

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But with the cost of credit still quite low by historic standards, the Fed may have to reach into its toolbox and try some other unconventional means of reigniting the home fires in residential real estate. It could stop paying banks the quarter point interest for deposits held at the Fed, potentially forcing banks to take that money and make loans.

Such a move would likely be opposed by banks, that are earning a tidy risk-free sum from the central bank, but the net effect could be quite forceful. It would force nearly $3 trillion of bank reserves held at the Fed into the economy.

Since banks would be earning zero, or even less than zero, on their deposits at the Fed, their incentives to lend could change quickly, particularly if the Fed were to adopt a negative deposit-rate policy — something no one is currently expecting. With that dramatic step, the Fed could actually charge a fee for holding those deposits. The Fed has written about such a maneuver in its myriad studies on how to get a deflationary economy moving again.

The Fed, FDIC and Comptroller's Office, could also begin to relax credit standards so that qualified U.S. buyers can gain access to cheap money from banks.

Mortgage credit remains as tight and unavailable to most buyers today as it was at the depths of the credit crisis in 2009.

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I am not suggesting that regulators relax credit to the extent they did in the years leading up to the real-estate bubble and bust. However, allowing bankers to make traditional 10-percent down mortgage loans to people with decent, but not perfect, credit should get the looky-loos buying again.

I am betting that the Fed has a few more tricks up its sleeve to take a more targeted approach to getting the economy to fire on all cylinders.

If it doesn't "taper the taper," I still expect the Fed will continue unconventional efforts to get the economy, and more specifically, real estate, rising again.

The economy needs all tailwinds, and virtually no headwinds, if the Fed expects the economy to return to its fullest potential and allow it, ultimately, to restore policy to normal — whatever normal means in a post-crisis environment.

Commentary by Ron Insana, a CNBC and MSNBC contributor and the author of four books on Wall Street. He also delivers a daily podcast, "Insana Insights," and a long-form weekly version, both available on iTunes and at Follow him on Twitter @rinsana.