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Fed’s liquidity moves not enough

By Holman W Jenkins Jr
Is a housing bailout the solution for clogged-up credit markets and a faltering economy? What the Fed has been doing and did again on Tuesday hasn’t really worked, notwithstanding the pops it produces in the stock market every time it shovels liquidity into the system.

The Fed’s latest move provides financial institutions with another $200 billion (Dh735bn) in direct short-term lending against their unsaleable housing collateral. The Dow Jones jumped 416 points. But it won’t restart markets for the underlying collateral.


Where are the speculators, vultures and hedge funds? Where are the big money players willing to buy the exotic, but still substantial mortgage-backed securities for which markets have ceased? The Fed’s liquidity rush seems only to have convinced them the time is ripe for staying on the sidelines.


To get to a real solution, speculators and investors need to believe that home prices are hitting bottom, that any mortgage debt they might buy today for 80 cents on the dollar today won’t be worth 30 cents tomorrow. Then the vultures will pile in: the transfer of wealth from the overleveraged banks and hedge funds to those who kept cash handy will be shocking, ugly and cathartic – but it will also be quick. Credit markets will begin to function and the economy will grow.


“When all else fails, builders cut prices,” read a Los Angeles Times headline last week. We need more headlines like that. Buyers showed up in droves once sellers knocked 35 per cent or so off the asking price. All the Fed can do, meantime, is to make it a tad less painful for banks to hold onto the unmarketable mortgage securities that have been burning down their books.


In this sense, government policy is working against itself. The Fed is pushing on a string – it can’t bring back confidence in specific assets by flooding the market with generalised liquidity, though it can certainly undermine confidence in the dollar and its own anti-inflation credibility. On all sides, meanwhile, the call for a housing bailout is becoming deafening.


But the seized-up credit markets won’t be unseized by trying to induce debtors to cling to houses they now see as throwing good money after bad.


Not much better are bailout plans that try to keep borrowers in their homes by shifting some of their equity losses to the taxpayer. The market has utterly changed from the market in which these recent purchasers made their purchase decisions. But we now have another problem.

Nobody in his right mind would recommend having a financial crisis in the middle of a presidential campaign, but here we are. Warren Buffett, appearing at a Hillary Clinton event in December, spoke soothing words to the investor class on CNBC, saying no Democrat would be so foolish as to “kill the golden goose” of the US economy. He quickly amended his statement: most were not so foolish.


Yes, exactly. It behooves us to recognise that bad economic times are not always uncongenial to every kind of political career. Bad times can be useful to those whose path to power is paved with demagoguery. Bad times can allow the aggregation of bureaucratic power at the expense of the private sector in ways that are not possible in good times.


Millions of Americans have negative equity in their homes, but did not bite off more mortgage than their incomes could support. These people are still paying their mortgages and never imagined doing anything else. Millions of others have positive equity in their homes despite seeing painful declines in their home value. Now all these homeowners are to be taxed to benefit more irresponsible borrowers?


This could be a nastier political fight than now foreseen, especially as Democrats try to soften up a big swath of the homeowning middle class for higher taxes by anathematising them as the “rich”.


And that’s just the start. To the goal of forestalling foreclosure and keeping marginal borrowers in their homes at any cost, politicians are turning the full investigative heat of the states and FBI on the mortgage-lending and home-selling industries. This will not help the liquidity of the housing market and the $11trn in securities derived from it.


Harder to calculate is how our politics will respond when the wish-list arrives on a wave “us versus them” demagoguery aimed at voters demoralised over economic setbacks and a crash in home prices.
That’s another reason Washington’s real goal should be to accelerate foreclosures, making them cheaper and less onerous for all concerned, so the market can hit bottom and buyers and sellers can have confidence in prices. Otherwise, look out below.
(Holman W Jenkins Jr is a member of The Wall Street Journal’s Editorial Board and author of the weekly Business World column).