The Housing Chronicles Blog: Analyzing the Fed Bailout

Wednesday, December 12, 2007

Analyzing the Fed Bailout

I think the Federal Reserve should have to obey the same motto taught in medical school: Primum non nocere, or "First do no harm." While this saying is not technically included in the Hippocratic Oath, perhaps the Fed could launch its own "Hypocratic Oath," in which its moves should not be seen as nakedly political maneuvers.

I say this because some analysts believe that the Fed's latest move to shore up global liquidity may actually prolong the mess that has to be cleaned up by allowing the market to mop up its excess inventory. Senior Fortune magazine writer Peter Eavis explains:

The potentially dangerous aspect of the TAF is that it will allow banks with problems to borrow their way out of trouble, rather than by taking measures like issuing large amounts of stock to bolster their balance sheets. Struggling banks are struggling chiefly because they were mismanaged and wrote too many risky loans when credit was cheap. The TAF potentially gives mismanaged banks even more cheap credit, which will delay a much-needed restructuring of the banking sector. Nervousness about banks could then deepen, leading to even fewer loans being made. One of the big lessons of the credit crunch is that overly cheap credit causes massive harm to the economy in the long run. The TAF suggests that the Fed still hasn't learned that.

I remember back in 2005 when I was trying to explain -- at least to those who would listen -- that a housing price bubble was simply a symptom of a worldwide credit bubble. In other words, there was too much money sloshing around looking for the best return -- in this case, subprime, Alt-A and other adjustable mortgages. Around the same time, I noted that Congress had made it much more difficult for individuals to file for Chapter 7 bankruptcy, potentially leaving many on the hook for homes even though they long ago parted with the keys, and minimum payments on credit cards doubled from 2% to 4%.

I guess I'm just surprised at all the surprised looks out there...

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