The Federal Reserve's policy of keeping interest rates low to spur lending hit a barrier in the recovery with home prices falling and underwriting guidelines keeping borrowers from refinancing, said Eric Rosengren, president of the Federal Reserve Bank of Boston.

With that in mind, the Fed Bank CEO said he supports policies that would allow homeowners who are underwater on their mortgages to refinance their loans. "Clearly getting more money into the hands of homeowners who spend it could help to fuel GDP growth," he said. "This would reduce one of the impediments to a more significant effect from the monetary policy actions taken to date."

Rosengren's Wednesday speech at the Economic Outlook Seminar in Stockholm, Sweden, focused entirely on housing and how its failure to robustly return in the wake of the recession led to an anemic recovery not experienced in previous downturns.

While low interest rates are forced deeper to spur lending, Rosengren explained this scenario is not working in an economy where many borrowers have fixed rates and homes underwater are keeping them from refinancing.

"The characteristics of a country’s mortgage finance market determine the impact that will come from a change in the rates directly influenced by monetary policy," Rosengren said. "In the U.S., most homes are financed by 30-year fixed-rate mortgages, so a fall in long-term interest rates really only affects existing homeowners to the extent they refinance. As a result, the U.S. gets less effect from the movement of short-term, monetary policy interest rates compared to countries where the primary mortgage financing instruments are floating-rate loans."

Rosengren said real estate is hitting all sectors of the economy since many financial firms have exposure to the sluggish real estate sector through direct lending mechanisms or the acquisition of mortgage-backed securities.

"As a result, declines in real estate prices can have a substantial impact on the capital of financial institutions, which impacts their ability to finance not only the housing sector, but also other sectors of the economy," Rosengren said.

The inability to refinance existing loans paradigm is reinforced by tighter underwriting guidelines that are keeping borrowers from taking advantage of lower interest rates.

Rosengren stressed that no recovery can be fueled without restoration of the housing market. Residential investment grew more than 30% in the first years of past recoveries, while in the recent recovery, residential investment actually fell in the first two years following the end of the recession.

"More than one observer has commented that we are seeing a different pattern this time that equates almost to a “negative feedback loop," said Rosengren. "High unemployment leads to risk aversion, which decreases demand for new housing. But without construction activity we are not seeing the typical uptick in housing-related jobs."

Write to Kerri Panchuk.