Commentary: Foreclosure fix ideas so far lack teeth

Lou Barnes
Inman News

Mortgages struggled to stay as low as 5.75 percent (more below on the stubborn refusal of mortgages to follow the Fed down).

The biggest news of the week: the off-the-table January ISM survey (the ineptly renamed purchasing managers’ association), one of the very best real-time indicators, the 54-to-41 plunge the worst monthly result ever. A general intake of breath followed, not yet released. January retail sales were the worst in five years; credit cards declined in use and increased in distress; and Wal-Mart reported, sadly, that shoppers are using holiday gift cards to buy necessities — diapers, pasta sauce, and detergent.

The only questions remaining: how deep and how long the recession?

This one is different in pattern from others (save perhaps ’91-’92 affair, a micro-mini crunch). By summer ’07 consumers were stressed by energy and housing, but the economy was still rolling along when the August Crunch began to tip it over. Standard recessions are consumer-first, then financial and credit trouble; this is vice-versa. Caught by atypical surprise, policymakers have floundered and flinched.

The problem: the August revelation of some $4 trillion in troubled assets. They had accumulated for years under the pretense of performance, but deteriorated steadily since ’05. Each banker knew his own trouble, and in flash chain reaction each stopped dealing with his peers for fear that they were in as bad shape as he. Crunch.

That crunch was symptom, not cause. Since August we have been in an episode of “House”: While the Fed medicated the interbank symptom, the actual disease worsened, the crunch broadened, the economy deteriorated, and new symptoms forced the Fed into an undignified rate cut. Four times the Fed has cycled this way, patient sinking.

Enter Congress. Treasury Secretary Henry Paulson set up Fed Chair Ben Bernanke as messenger boy to plead for spending stimulus. New medication, wrong disease. There’s a lot we could do with $160 billion (one-fifth would have re-capitalized the bond and mortgage insurers, preventing perhaps hundreds of billions in write-downs ahead). This package will do nothing for the underlying problem, and was unnecessary: the Federal deficit has suddenly exploded from $150 billion to $400 billion, stimulus aplenty.

Bad ideas are pouring from politicians and regulators, trying to get foreclosure toothpaste back into the tube instead of working on the real problem ($4 trillion…). There is no solution to foreclosures; most of these households were bad credits to begin with.

Brand new from energetic but dim Sheila Bair at FDIC: forgive loan balances (Whose? Mine? Please?). Increase the speed of workouts (From zero and pretending, to what?). Sen. Dodd: intercept foreclosures by Treasury purchase of bad loans (Why just those?). Hillary Clinton: freeze rates (ARMs began in 1980; rates fell for 25 years; and the first time rates go up, cancel the contracts?). Freeze foreclosures for 90 days (What to do on day 91?). James Lockhart, regulator of Fannie and Freddie, working overtime to disrupt their mission (Mr. Power-Freak, we created them for this moment!).

Fellas … look: What are you going to do with the $4 trillion in bad paper? The “plan” seems to be to leave most of it in the banking system, financed by central bank credit. Hapless investors hold an unknown fraction, paralyzed as new buyers of securitized credit. The Fed-reduced cost of money will widen banks’ investment spreads, increase earnings and over time generate new capital. Over time. Meanwhile — years — the financial system cannot provide new credit because of the rotting mess in its belly.

Why are mortgage rates stuck up high, at just the moment that housing is desperate for cheap, well-underwritten credit? Banks cannot buy new Fannies, Freddies and Ginnies because they are short of capital. Rather worse, they face new losses, balance sheets crowded with bad assets. So, they are sellers of the only good stuff they have. Sellers of our stuff. Sellers.

I would very much like to be proven wrong, but the word is “bailout”: Extract the rot from the system and put it into a nouveau RTC. Then markets can function.

Copyright 2008 Lou Barnes

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