Flying Pink Unicorns

The latest federal efforts to restart our financial system

Another day, another record breaking, unprecedented, potentially insanely expensive, federal rescue.

Earlier in the week, while we were all making travel plans for Thanksgiving, the federal government announced that it was purportedly pumping up to $800 billion into credit markets, with the goal of making it easier and cheaper to get a mortgage, as well as student loans, small business loans, and, incredibly, credit card loans.

The closer I look at this seemingly breathtaking program, the less I see.

The government isn't getting into the lending business. Instead, the federal reserve "plans to purchase in coming months up to $600 billion of debt issued or backed by Fannie Mae, Freddie Mac and other mortgage finance businesses. The idea is that with this debt off of the balance sheet of these financial entities, they could more readily make mortgage loans.

I'm not opposed to this happening in a vacuum per se, but I think its hugely overblown. Are there really masses of people with reasonably good credit itching to buy a home but unable to because they can't get a mortgage? I'm willing to be persuaded, but based on what I know (which is very little) I find that really hard to believe. Perhaps the reason that home prices have plummeted is, um, because they rose so far so fast and people aren't rushing out to buy houses about now? Or because a lot of people that might have bought a house in 2008 bought it in 2006? Or because with a deep recession upon us people are waiting to make such big purchases?

By purchasing these securities, the government is hoping to lower mortgage rates as paid by would-be homeowners. That's a fine goal generally, but one thing our economy does not need about now is any incentives for additional housing stock. We already have a pretty significant overbuilding of residential real estate. Politicians are obsessed with helping homeowners, because homeowners vote, but in terms of our nation's problems, sadly, helping people buy new homes, or stay in the ones they have is actually pretty low on the list. That sounds creul, and it is, but if more houses by far were bought and sold and built that fundamental demand would require, as is 100% certainly the case, why encourage a return to the merry-go-round? Traditionally, recovery begins with a housing market revival. Happened in 2002-03, 1992-94, 1984-5, etc. That's not going to happen this time, at least I hope not. If the recovery of 2009-10 is housing led, god help us all. I say that becuase it would represent the building of another bubble rather than an expansion on solid footing.

As I have said before, Paul Krugman has said, and now Obama and many democrats, government spending, primarily on infrastructure, should lead us out of the recession. Then private investment and perhaps international trade can follow. Housing should still be a drag on the economy for at least another year and a half, and when it recovers it is highly unlikely to be a robust housing recovery.

Back to the debt securities the government is set to buy. Now this debt was implicitly backed by the government anyway. Everyone assumed it. So if the federal reserve can put it explicitly on the federal balance sheet without losing the ability to spend huge amounts of additional money if that proves necessary (and it will) that's fine by me. But for the reasons I have outlined above, this just will not be a panacea of any sort whatsoever. Where it may do some good is because mortgage rates have been dramatically lowered (they have in the last week) a new refinancing boom is underway. This will put cash in people's pockets, some of which will be saved (which is a good thing in and of itself!) and some spent, which is, right this instant, an even better thing.

The other part of the new announced program from this past week is that "the Fed will provide up to $200 billion in financing to investors buying securities tied to student loans, car loans, credit-card debt and small-business loans." (emphasis added) This part of the package I approve of, for the most part, although lending money to investors to buy these securities, as opposed to the government buying them itself, seems like a needless step. Now the government is a lender, rather than an asset purchaser. Someone explain to me why this is radically better?

Anyway, this country probably needs more student loans and small-business loans. Car loans are trickier. Car sales were quite high until recently, but have fallen off the cliff, to their lowest levels since the early 1990s. This profound shock, coupled with the myriad other problems they already had, have, as you all know, driven the big 3 to the wall (no pun intended). So a case can be made for subsidizing car loans about now. A case could be made against it, but again, I'm comfortable. The government won't lose anything like $200 billion buying these securities. Even assuming rising defaults, which seem certain, the fed will be able to recover some-most of the money it is spending, perhaps even make a profit.

Financing the purchase of securities linked to credit card receivables is a whole other matter. I'm ignorant right now, and willing to be persuaded, but at first blush that seems just nuts. Does America need more credit card lending, or does it need less? Isn't that a drug we need to wean ourselves off of? Cold turkey if necessary?

Next, I note that, "The central bank is taking several steps to avoid [certain risks]. The Treasury has agreed to absorb the first $20 billion of losses on the new $200 billion lending program for car loans, student loans, and other consumer credit." The central bank is to lend money to investors via various banks. Investors can then use the money to buy AAA rated securities tied to consumer debt.

http://online.wsj.com/article/SB122761978389056335.html?mod=todays_us_page_one

So even though it isn't purchasing the securities for its own account, the government is guaranteeing the first $20 billion of losses (the losses most likely to occur!) I wonder what interest rate the federal reserve will receive on the loans it makes to investors. This seems like a crazy, unnecessary step. What value are these investors adding, exactly, above and beyond the purchase of the securities, which the fed could do all by itself?

Finally, it is highly noteworthy that the federal reserve is paying for these new announced facilities by simply increasing the money supply! Actually printing more $20 bills is so 1980s. Now the fed will simply issue electronic credits. But the effect is absolutely identical to running the printing presses and simply printing hundreds of billions of additional dollars. It is a sign of the times that this critical fact is barely remarked upon by the press. I note that I am not too concerned about it right now. The big risk to printing more money, obviously, is inflation. And higher inflation is a real risk down the road, and we'll need to be mindful of it. But right now, not so much. A mass deflation is a bigger and vastly scarier risk. So let it be said that I approve of printing additional money as the means to pay for all this, but even I'm seriously concerned about the precedent, and about the direct harm which could come. Team Obama is going to have a hell of a job on its hands for a long long time. Even if, happy happy joy joy, the economy recovers towards the end of next year and recovers strongly, there is still going to be a massive financial mess to clean up. Bush 43 has left a terrible pile of steaming brown stuff in his wake.