RTTNews - Economic conditions that could lead to a recession were festering for some time before the housing crisis, the Federal Reserve Bank of Cleveland said in a report released Thursday. In addition the Fed branch, which has studied the difference in foreclosure rates in similar communities across state lines, proposed a groundbreaking effort to break the housing crisis cycle that continues to perpetuate the foreclosure crisis in areas around the country.

The Fed argues with the common perception that the housing slowdown caused the subprime mortgage crisis, which in turn sparked the economic crisis.

Many people in fact blame the slowdown in the housing market for causing the subprime mortgage meltdown and subsequent crisis, Yuliya Demyanyk, Senior Research Economist at the Fed branch said. We show though that the crisis or the problems were building up for about 6 consecutive years before the crisis and the housing prices declines in fact revealed those problems, not caused them.

In addition, the housing crisis has affected many areas of the country differently depending on the economic make-up of the region and the role of housing before the crisis.

Often, the housing crisis is referred to only as the collapse of a bubble that was inflated especially high in areas like Arizona, California, and Florida, states that have the highest foreclosure rates in the nation. However, areas that did not see a bubble the size of those states, including Ohio, eastern Kentucky, western Pennsylvania, and the northern panhandle of West Virginia, are still suffering from a high rate of foreclosures as a result of the deep-set recession.

According to the Cleveland Fed's research, those areas of the country were already facing economic challenges long before the recession set in. Therefore, its residents took out loans they could just afford in already challenging times. However, when the economy took a nosedive and unemployment spiked, foreclosures rose as people were unable to make their payments.

The underlying problem was over-lending to people in a region that was under stiff economic pressure long before the recession set in, researchers said.

The more people were forced into foreclosure, the larger the supply of houses. With supply outweighing demand, home prices were forced lower, resulting in a loss of wealth for people invested in real estate and potentially to more foreclosures as people face underwater mortgages.

Underwater mortgages refer to a situation where people owe more on the house than it is worth, a result of price depreciation.

Mark S. Sniderman, Executive Vice President, Federal Reserve Bank of Cleveland, called for a multi-faceted approach to break the negative feedback loop associated with the current economic crisis.

We need a multi-faceted approach to this because there is so many different parties that are all wrapped up in this, he said. There's homeowners, there's financial institutions, there's people in the neighborhood who are affected by this.

Continuing, Sniderman warned that too narrow a focus opens up the rest of the problem for continued losses.

If we focus on just trying to fix one aspect of this problem we're going to find that other pieces and parts of this are still going to be subject to this downward spiral and reinforcing negative feedback loop that we are trying to break, he said.

To break the cycle, researches at the Cleveland Fed suggest several steps, many of them borrower focused. Preventing foreclosures is an important step, and they suggest that providing financial incentives to mortgage lenders to modify loans, possibly lowering interest rates, allowing borrowers to stay in their homes.

If modification is not an option, lenders could help cut down on the abandoned property problem by allowing borrowers to stay in the home by converting them from owners to renters.

In addition, policy action may be needed to beef up code enforcement and clear legislation for managing vacant properties, the Fed branch suggested.

Attacking the financial crisis through re-capitalization of banks is essential to boosting lending, which will allow the demand to catch up with the overhang in the housing market.

For comments and feedback: contact editorial@rttnews.com