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Government Widens Support for Home Loans, Credit

November 25, 2008 at 6:10 PM EDT
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In an effort to boost economic activity, the Fed and the Treasury announced new plans to boost consumer spending and aid the housing market. Economic analysts examine the Fed's expanding role in managing the crisis.

JUDY WOODRUFF: We begin with the economic crisis and with the Federal Reserve’s latest infusion of money and credit to ease the financial crunch. Jeffrey Brown has the story.

JEFFREY BROWN: The $800 billion from the Fed is aimed at jump-starting mortgage lending amid the continuing housing correction and consumer spending, which declined precipitously over the summer.

The Fed will act in two ways. It will buy up to $600 billion in debt and mortgage-backed securities issued by Fannie Mae, Freddie Mac, and other government-sponsored finance agencies. This is aimed at helping the housing market.

And it will loan up to $200 billion to holders of securities backed by debt from credit card, auto and student loans. The intention is to make new lending possible.

The Treasury will provide some protection for the consumer debt initiative by pledging $20 billion in funds from the so-called TARP program.

Treasury Secretary Henry Paulson described the thinking behind the moves this morning.

HENRY PAULSON, U.S. Treasury Secretary: Millions of Americans cannot find affordable financing for their basic credit needs. And credit card rates are climbing, making it more expensive for families to finance everyday purchases.

This lack of affordable consumer credit undermines consumer spending and, as a result, weakens our economy. Nothing is more important to getting through this housing correction than the availability of affordable mortgage finance. It will take time to work through the difficulties in our market and our economy, and new challenges will continue to arise.

JEFFREY BROWN: Perhaps in anticipation of those new challenges, Paulson said that the $200 billion consumer debt program was just a starting point.

As the Fed and Treasury continue to work in tandem, Paulson also said they’re working closely with the Obama team, particularly Treasury Secretary-designate Tim Geithner. He’s currently president of the New York Federal Reserve Bank and a key player in the ongoing government response.

HENRY PAULSON: We’ve all worked together. And this is an important part of what we do.

Now, in looking at Tim’s new job as Treasury secretary and incoming Treasury secretary, we will obviously work seamlessly with the next administration on a first-rate transition.

And we will discuss with them very, very carefully any programs that we are developing and any programs that we implement, because it’s very important that the next team understand everything we have in place and to be able to carry them out effectively.

The Fed and Treasury's proposals

James Galbraith
University of Texas
[I]t's clearly better to have the Federal Reserve in the business of buying assets than to have the Treasury doing it, which was the original idea.

JEFFREY BROWN: The Fed hopes to have the consumer debt program in place and running by February.

With us now to discuss these latest government measures and their implications, James Galbraith is a professor of economics at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin and the author of "Predator State."

Kenneth Rogoff is a former chief economist at the IMF. He's now a professor of public policy and economics at Harvard University.

And John Cassidy covers economics and finance for the New Yorker magazine. He profiled Federal Reserve Chairman Ben Bernanke in this week's edition.

Well, John Cassidy, help us first understand some of these proposals. How would they work? And what are they aimed at?

JOHN CASSIDY, The New Yorker/Portfolio Magazine:  Well, they're aimed at freeing up the credit markets. What we've had in the last couple of months since the collapse of Lehman Brothers is basically a seizing up of the credit system.

The Fed and the Treasury have already announced a series of measures. This is the latest of them. One of them is aimed at the mortgage market. They would be buying up securities issued by Fannie Mae and Freddie Mac, which are now government-run companies, basically. The aim would be to try and get mortgage rates down, and they've put $600 billion into that effort.

They've also set aside another $200 billion to buy up securities, which back things like credit card loans, student loans, and auto loans. Because of this securitization industry, which has grown enormously in the last 10 years, lots of these loans are dependent on being bundled into securities which are then sold to investors, but that market has completely seized up in the last couple of months.

And the Fed and the Treasury are worried that, you know, people just won't -- people in businesses can no longer get credit, so they're trying to jump-start that market. That's what the thinking behind this.

JEFFREY BROWN: So, Ken Rogoff, does this sound like a good approach?

KENNETH ROGOFF, Harvard University: Yes, I think what they're doing today is a good approach. They're building on what works.

They've actually done this already in the short-term corporate debt market so that people could meet their payrolls. And now they're trying to extend it to mortgages and to consumer credit.

On the other hand, if you look at the larger policy scheme, I mean, I think there are more questions with what they did yesterday with Citicorp and going forward, that there's not really a holistic plan for jump-starting the economy. That seems like it's going to have to wait until the next president.

JEFFREY BROWN: All right, we'll try to come back to the larger picture, but, James Galbraith, first weigh in with the proposals today. What do you think? Does this sound like a fair way of tackling the problem?

JAMES GALBRAITH, University of Texas: Well, it's clearly better to have the Federal Reserve in the business of buying assets than to have the Treasury doing it, which was the original idea. This gets this off of the Treasury's budget.

JEFFREY BROWN: Why is it a better idea?

JAMES GALBRAITH: Because it's a purchase of assets. It's not government spending in the same sense that a new public works project would be and shouldn't be accounted for the same way.

And I think they are doing the best they can with the tools they have to get interest rates down.

But, frankly, I do not think it will work. The problem in the housing market is fundamentally, as we heard today, a collapse in the price of houses. And people who are in the market to buy a house know that the bottom has not been reached.

And so I think it's very unlikely that simply lowering the rate on mortgages is going to induce people who can wait in principle to buy a house to buy one now. That's a big risk, and you're setting yourself up for a substantial capital loss.

Dealing with that problem is going to take time. And in the meanwhile, the fate of the economy rests very much on the fiscal side, on getting enough new spending in place to stabilize state and local governments, to start public capital investment, to begin to deal with the housing problem. Very much on the future agenda, not what's being done today.

Stabilizing the housing market

Kenneth Rogoff
Harvard University
[T]he housing market has not seen the bottom, so this is maybe going to cushion the fall, but it's not going to really prevent the collapse.

JEFFREY BROWN: Well, let me come back to Ken Rogoff then, because you think that this does have chance of boosting the -- stay on the mortgage side, on the home lending -- you think this does have chance at working?

KENNETH ROGOFF: Yes, I mean, it's a good move. Mortgage rates dropped today. The big mortgage agencies have been paying a premium on their debt, because even though the government says it backs it, nobody quite believes them.

So this is just outright buying it. It's not quite having the Treasury call it Treasury debt, and it's bringing down mortgage rates.

But I completely agree with Jamie Galbraith that the housing market has not seen the bottom, so this is maybe going to cushion the fall, but it's not going to really prevent the collapse. A lot more needs to be done.

JEFFREY BROWN: Now, John Cassidy, we're all kind of used to talking about the Fed using its interest rate lever as way to impact the -- impact Main Street. This is -- help us understand. This is another tool that it has. And what sort of implications are there in going this route, as opposed to the one we're used to?

JOHN CASSIDY: Well, as you say, this is a new tool which has been invented more or less over the last year, part of something I wrote about in the New Yorker. It's called the Bernanke doctrine.

And the doctrine is that one thing you use is interest rates to try and revive the economy, but that's not enough. Because of the credit crisis, you also have to lend to banks, which are having liquidity problems, and lend to all other sorts of markets where things have seized up.

So the Fed, without very much publicity, has invented a whole series of lending programs over the last year, which now have built up to enormous sums. We're talking several trillion dollars worth of loans and loan guarantees that they've issued.

And it's basically an attempt to sort of keep the system working, albeit on a limited basis, until the housing market can somehow be stabilized.

Your other commentators are right, of course. We won't solve this problem until the housing market stabilizes. But I think what the Fed would say is, that's not really their job. That's up to Congress and the administration, either this one or the next one, to come up with a plan to rescue the housing market.

Meanwhile, their job is to prevent a wholesale collapse, and that's what all these lending programs are there for, to try and keep things going.

A new role for the Fed

James Galbraith
University of Texas
[E]ven when fiscal policy does its job, the supervision and regulation of the banking system is going to have to be overhauled.

JEFFREY BROWN: Well, James Galbraith, what do you think about the implications of the Fed? First, do you accept that it is stepping into a kind of larger new role here, as we just heard? And if so, what are the implications? What are the risks?

JAMES GALBRAITH: It is certainly absorbing some of the functions that are usually in the private credit markets. It's taken a whole lot of collateral onto its balance sheet, the nature of which we do not know because they've been completely un-transparent about it.

It's also, in fact, supporting much of the rest of the world through swap agreements, which have basically been used to shore up the euro and the currencies of a number of other countries. And there's about $600 billion of that, in addition, I believe, to the $2 trillion that John just mentioned.

So the Fed has greatly expanded its balance sheet. It's playing a very active role.

But, again, the problem here is that the whole financial system has seized up. The result is a collapse in asset values, what economists call a debt deflation. And monetary policy is not very effective when basically the only asset that people want to hold are those rock-solid United States Treasury bonds and bills.

To get the economy going and to solve the problem is, in fact, going to be take direct action on the fiscal sides.

JEFFREY BROWN: So, therefore, you're saying that the Fed, even though it may have taken on a new role, it has to, you're suggesting?

JAMES GALBRAITH: Yes, this is not a problem that's going to be solved by monetary policy. And even when fiscal policy does its job, the supervision and regulation of the banking system is going to have to be overhauled.

The practices which got us into this mess, as the president-elect said today, are going to have to be substantially altered and limited, greatly limited, so that we don't get back into the same mess.

There's a whole problem of the opacity of these credit markets, their -- the inability to set prices on these instruments, the failure of trust from bank to bank.

And that problem is going to take a massive regulatory intervention, which, again, is going to be a time-consuming and, one hopes, cautious and prudent process to make it work over the next few years.

JEFFREY BROWN: All right, Ken Rogoff, go ahead. Weigh in on this new role of the Fed and especially how it fits in with the larger picture you were talking about earlier.

KENNETH ROGOFF: Well, the whole financial system's still imploding, and it's really on life support, and we're seeing the Fed have to step in to do basic functions for this financial system.

They're giving money to the banks, but the banks aren't really actively lending, so they're having to get out and support the credit markets tremendously.

There are tremendous questions to be solved going forward, because they've taken a lot of funky assets onto their balance sheet. And who knows what the end game to this looks like? But they have to do it, because the system's just imploding.

I think that going forward that we really need -- this is a step, but we really need more than this. We need some fiscal stimulus. We need probably even more aggressive monetary policy -- I'd even say inflation -- to help reduce the costs of servicing all these debts.

So this is really keeping the system on life support. This isn't suddenly going to get everything working, but it has worked. They did this with corporate debt, and they said, "You know, we've tried a lot of different things. They haven't all worked." They don't say that publicly, but they haven't all worked.

This has worked. Let's do it with mortgages; let's do it with consumer debt. And I suspect they'll expand it from here.

Ben Bernanke's 'evolution'

John Cassidy
The New Yorker/Portfolio Magazine
[H]e's essentially a very pragmatic man, Ben Bernanke, and, you know, he's willing to try anything to keep things afloat.

JEFFREY BROWN: Well, John Cassidy, come back to your article, because you were able to talk to Ben Bernanke, I guess, a little bit more about his -- what is his thinking about the evolution of -- his own evolution, I guess, in looking at the system and the role of the Fed at this point?

JOHN CASSIDY: Well, I think Bernanke -- there are two Bernankes, really. There's the early Bernanke, which was until the end of last year or so, when he didn't really get the scale of the problem, and he actually told me, looking back, that he made a mistake underestimating the scale of the subprime crisis and how it would impact the entire financial system.

But once the start of the year came around and he really got that this was a major crisis, not just for certain banks, but for the overall economy, I think he threw the old rulebook out the window and said, "We'll try anything."

I mean, he said to me he looks for inspiration to Roosevelt, for example, during the Great Depression. When you think about Roosevelt, he tried all sorts of things in his first 100 days. Some of them worked; some of them didn't. The ones that worked, he kept on; the ones that didn't, he jumped.

And Bernanke very much has followed that model. They've got, I think, 10 or 12 lending programs now. Some of them have proved effective. They'll probably stay part of the toolkit. Some of them haven't.

But he's essentially a very pragmatic man, Ben Bernanke, and, you know, he's willing to try anything to keep things afloat.

JEFFREY BROWN: And James Galbraith, we just have about a minute here, but what -- respond to that. Do you see a toolbox that is being opened in all directions? Or do you see some method to the madness at this point?

JAMES GALBRAITH: Well, I think that's exactly right. Ben Bernanke is a very smart guy. He came into this job with a vision of the role of the Federal Reserve as the nation's guardian against inflation, sort of the legacy of decades of monetarism.

That vision of the Federal Reserve does is out the window; it is not applicable; it is defunct. And the Federal Reserve is in the trenches trying to restart a credit mechanism.

But as I say, the problem here is that the wells of the financial system have been poisoned, and cleaning them up is going to be a slow and deliberate process.

The system is going to have to shrink and the insolvent institutions, which are out there, are going to have to be kept under control so that they don't explode the system in various ways. And the regulatory system is going to have to be recreated in a way that is functional and stable.

All that work is immensely difficult, and only part of it is something that the Federal Reserve can do, leaving aside the job that faces the rest of the government, which is to get the economy going, and to stabilize again the states and localities, the housing sector, the earnings of the elderly, whose pension funds have been contracting. All of that still lies ahead.

JEFFREY BROWN: OK, James Galbraith, Ken Rogoff, and John Cassidy, thank you all three very much.



JOHN CASSIDY: Thank you.