Thursday, March 16, 2006

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.


Blogger Matt Norris said...

My opinion:

If prices are going to correct to the point where they should have been, the Fed needs to stay completely out of it. There is a "natural" curb to home prices as a result of local earnings by the population, interest rates, etc.

Unfortunately, for some reason (and I know what it is), houses prices broke through that barrier.

The Federal Government would be stupid to bail people out of this. The only reason we're in this situation is because of bad decisions by uninformed consumers and bad loan programs designed by lenders to take advantage of uninformed consumers.

Mar 16, 2006, 11:11:00 AM  
Blogger Marinite said...

I think what this statement by Kohn really means is that the Fed is far more concerned with keeping foreigners buying our debt than trying to preserve the values of people's houses.

Mar 16, 2006, 11:34:00 AM  
Blogger Matt Norris said...

You make a good point about that. The approval the other day of what is essentially a 9 trillion dollar debt for the Federal Government is absurd. I've never really been a doomsday type of person when it came to national debt, but even my levels of tolerance on that matter have been exceeded.

I am not, of course, an expert in the field of national debt, but in most publications from experts about the situation, they have nothing good to say about it.

Mar 21, 2006, 8:36:00 AM  

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