The government’s latest effort to help unfreeze credit markets may achieve some success, but it still raises questions about the overall US strategy in the financial crisis, say observers in and out of government.
The move will work “as well as anything else has worked,” says Gerry O’Driscoll, a former vice president of the Federal Reserve Bank of Dallas and Citigroup .
At its most basic level, the Federal Reserve’s $600 billion program to buy mortgage-related debt should lower interest rates somewhat and thus spur lending and support the troubled housing market.
“We see this as a positive step," says Scott Talbott, chief lobbyist for the Financial Services Roundtable, an industry trade group that was among those pushing for the plan. "This is a big help for the housing market,” adding it should also make it easier to refinance and modify troubled mortgages.
There was approval from other quarters as well, although it was clearly muted.
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“I think it helps the housing market,” says Rep. Brad Sherman (D. Calif), a frequent critic of Treasury Secretary Henry Paulson, who voted against the $700 billion bailout legislation. "This should reduce interest rates. If you're underwater with your mortgage, I don't now how this helps.”
Mortgage rates, which did fall sharply Tuesday, have been erratic as well as artificially high lately.
The rate on a 30-year fixed-rate mortgage has bounced between 5.78 percent and 6.46 percent in the past two months. It was as low as 5.58 percent in late January, soon after the Fed began cutting rates aggressively, only to climb sharply. On Tuesday, it touched 4.75 percent.
Under the plan, the Fed will buy up to $500 billion in mortgage-based securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae, all government corporations.
“All things being equal, by bringing down mortgage rates you increase mortgage demand,” says independent bank analyst Bert Ely.” You lower borrowing costs. More people are going to qualify.”
Ely and others agree in theory, but are quick to add that reality may be another issue. Ely notes that weekly Federal Reserve data on bank industry assets and liabilities showed only a 1 percent decline in the Oct. 22-Nov. 12 period.
He and others attribute some of that to good reasons, including an appropriate tightening in lending standards.
“To what extent is the drop off a reduced desire to borrow vs. a reduced desire to lend,” says Ely. “A lot of people feel an overpowering need to de-leverage.”
Others say its partly a reflection of the state of the economy.
“They're forgetting that we are in a recession,” says O’Driscoll, now with the Cato Institute. “Demand for credit falls.” O’Driscoll, for one, doesn’t think the program will help much.
Mixed reviews aside, analysts found fault in the government’s latest move in a bigger context. For one, the proposal to buy such assets has been around for months and could have been implemented sooner.
“They're fumbling through the maze and trying to figure out what to do,” says Robert Brusca, chief economist at Fact & Opinion Economics. “At every turn when things get worse they do something they didn't want to do.”
Others say the mortgage-purchase plan is more of the same and resembles the relentless—and largely ineffective—campaign to cut official interest rates.
“Just flood the system with liquidity,“ says Lawrence White, a former White House economist and regulator, now at NYU’s Stern School of Business. “They're not dealing with the toxic assets and that's a problem.”
Like many aspects of the rescue efforts, critics say the government did a poor job explaining the purpose of the program, which some initially saw as a version of the Troubled Asset Relief Program, TRAP, but without the auction.
Those assets or loans are toxic; these are plain vanilla.
“You're almost talking about an intra-governmental arrangement,” explained Ely, wherein the central bank is essentially assuming the liabilities of Fannie and Freddie, which were nationalized by the federal government in September.
The mortgage program also caused a bit of the stir because it followed high-profile policy reversals by Paulson, as well as what some consider controversial aspects to the latest round of aid to Citigroup, which beg the question of whether TARP “was legally necessary,” says Sherman.
“Just because you're erratic, doesn't mean you're wrong,” says Rep. Sherman.