Don't Count on the Fed to Bail You Out?

The Fed has now gone on record in no uncertain terms as saying that it has no intention of protecting the recent gains in housing price values should markets collapse. There you have it folks. (This shouldn't be too surprising given the warnings Greenspan has made but it is rather ironic given that Greenspan also encouraged the heavy use of ARMs.)

Or, is this just the sowing of doubt required if a "Lender of Last Resort" (LLR) is to hope to be successful? A LLR is a body that has access to massive amounts of liquidity and which will apply that liquidity during the collapse following a speculative frenzy so as to "bail out" the large number of investors who would otherwise suffer huge financial losses. To be effective, the LLR must both provide that liquidity when needed and also make investors believe that it is extremely unlikely to provide that liquidity when needed; the mere knowledge that the LLR will "come to the rescue" has the counterproductive effect of spurring on the frenzy.

Only time will tell.

Some choice quotes:

The Federal Reserve has no intention of preserving all of the recent gains in home price values, said Federal Reserve board governor Donald Kohn on Thursday.

"If real estate prices begin to erode, homeowners should not expect to see all the gains of recent years preserved by monetary policy actions,' Kohn said in a speech prepared for delivery to a European Central Bank forum in Frankfurt, Germany.

In his remarks, Kohn attacked the popular 'Greenspan put' theory that Fed policy would always protect investors from sharp asset market drops while doing nothing to restrain these markets when prices rise.

"The same consideration apply to homeowners: All else being equal, interest rates are higher now than they would be were real estate valuations less lofty; and if real estate prices begin to erode. Homeowners should not expect to see all the gains of recent years preserved by monetary policy actions," Kohn said.

Here is the actual text of Kohn's remarks.