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Wednesday, March 12, 2008

Why the Fed Can't Fix Home Prices

If anyone was wondering what the nightmare scenario looks like in real estate, they need to only read this analysis from the Wall Street Journal. The piece makes several points starting with the not so politically correct truth of all of this fed intervention...

Is a housing bailout the solution for clogged-up credit markets and a faltering economy? What the Fed has been doing and did again yesterday 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 another $200 billion 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 relatively quick. Credit markets will begin to function again. The economy will grow.

There will be many politicians and activists that will argue, however the truth of the matter is that the housing market won't be fixed through intervention. It will only be fixed when its players, described as speculators, vultures, and hedge funds, decide that the time is right to get back into it. In fact, the article makes the intuitive point that all of this fed intervention is possibly counter productive. If speculators see a fed ready to do anything to artificially bring liquidity to the market, then clearly we haven't seen the bottom yet. The irony is that the bottom will hit once the Fed stops interfering. That will be the signal for the market players to get back into the market.

While we have a credit, mortgage and housing bailout from the Fed, the article points out another problem...

But we now have another problem. Nobody in their 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 U.S. economy.He quickly amended his statement: Most were not so foolish.

Yes, exactly. It behooves us to recognize 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.

This mortgage crisis will lead to mortgage "solutions". Those solutions will involve saving borrowers at all costs. They will involve government intervention that we would never see during good times. All of this adds up to two things: the first is that good solid borrower will have to pay to bail out the bad ones, and the second is that there will be bigger more intrusive government. Beyond the bailout, the article points out, is new zest of aggressive prosecutors looking to punish banks and securitizers for real and perceived fraud, predatory lending, and anything else. Of course, a plethora of banks and securitizers facing billions of dollars in new lawsuits isn't exactly what we need when we want to create liquidity. Such is the consequence of opportunistic politicians...good politics is not always the same as good policy.

There are other things looming on the horizon that will only make things even worse: the tax cuts are set to expire, expanded health care, and new taxes on energy products. All of these things will be nothing less than a big match set up next to a big flame. The article finishes with a thought I have been saying for a while...

Harder to calculate is how our politics will respond when the wish-list arrives on a wave of "us versus them" demagoguery aimed at voters demoralized 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.

That is the truth of the matter. If we really want to end this mortgage crisis as quickly as possible the only thing we can do is remove all of those bad borrowers from their properties ASAP. That is of course the exact opposite of the policies currently being discussed, which is why I pointed out that this is the nightmare scenario.

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