Fed Rate Cuts Are Helping Economy, Not Credit Crisis

The size of the Federal Reserve’s expected interest rate cut this afternoon may help stimulate a sluggish economy. But like the several cuts before, it is unlikely to unfreeze the credit markets, especially the mortgage one.

And as the Fed continues to use its conventional fire-fighting equipment,there’s a growing sense that extraordinary--and somewhat controversial--measures may be needed.

“The Fed by itself will not get us out of it," says John Irons, research director at the Economic Policy Institute. “We need to combine fiscal stimulus with monetary stimulus.”

Among the ideas now emerging are a new fiscal stimulus measures, specifically targeting the mortgage market, and the possibility that a bailout of both business and consumers may be inevitable.

“The bulls eye of this crisis is the mortgage market,” Sen. Charles Schumer, chairman of the Economic Policy Subcommittee, told CNBC Tuesday. “Everyone knows we need to do more to stabilize housing.”

“It doesn't matter how low rates go, if you are a financial institution, if you think the home is worth the less than the mortgage or if you're worried the homeowner is going to pay back the mortgage,” says Dan Mitchell, a senior fellow at the Cato Institute.

Look at Bear Stearns. It may be no coincidence that the biggest casualty on Wall Street thus far was suffocating under a blanket of mortgage-backed securities.

It may also be no coincidence that the Fed last week took the unusual step of creating its so-called Term Securities Lending Facility, allowing it to take up to $200 billion of non-Treasury securities, including federal agency backed mortgage securities and mortgages, as collateral for up to 28 days.

“It’s probably an admission that federal funds will not be enough," David Resler, chief economist at Nomura International, said at the time. Reseler considers the lending facility, the “most significant policy initiative since the credit crisis began last August.”

But it may be as far as the Fed can go. Federal law prevents the central bank from buying mortgages outright. Congress, of course, could change that, or otherwise, empower another arm of the federal government to do that.

“The most effective way is to create some way so the federal government can force a markdown in some of these mortgages and take them on itself -- say through some sort of bank -- such that the government becomes the holder of mortgages," says Irons.

The 1990-1991 recession was short and shallow. On top of the Fed’s action -- which included a stunning one percent cut in the discount rate -- regulators and legislators hatched a strikingly successful rescue plan for the savings and loan industry, which was suffering its own lending meltdown.

A newly created federal corporation in essence took responsibility of billions of dollars of bad loans and devalued real estate assets, which were then auctioned off to private buyers.

This time, the government’s efforts are arguably ill-conceived and misplaced, say economists. The $172 billion stimulus package is likely to provide little of a boost. It contains one-off tax cuts, which typically lead to consumers saving the money, and lacks traditional measures such as an extension of jobless benefits and infrastructure spending. Most importantly, it does not address the slumping mortgage market.

Bernanke himself has suggested some kind of markdown in mortgage principal--a signal, much like his hearty endorsement of a stimulus package--somewhat unusual for a Fed Chairman -- that he thinks the central bank needs help.

Last Friday, hours after moving to provide emergency funding to Bear Stearns, Bernanke was talking up tougher mortgage lending regulations and explaining how the Fed was “addressing the foreclosure crisis in capacities other than that of a regulator” in a speech to the National Community Reinvestment Coalition, which happens to be urging the government to buy mortgages at a discount through an auction.

On Capitol Hill, House Financial Services Committee Chairman Barney Frank is the latest to push the idea of federal intervention and support, through some sort of loan guarantees.

Other proposals include temporary foreclosure relief and the refinancing of subprime loans. Sen. Schumer Tuesday called for an easing of capital requirements for Freddie Mac and Fannie Mae and floated the idea of tax credits for homebuyers, while repeatedly referring to a “crisis of confidence.”

He is has plenty of comapny in saying that. Lending is all about confidence and trust.

“I think it is an issue of the financial system overwhelming the rest of our U.S. economy,” Vanguard founder John Bogle told CNBC.

Bogle, for one, seems to be worried about the Fed's own balance sheet and sees taxpayer money at stake. “They can't do everything,” he said.

Or as Resler puts it, the Fed “may have enough ammunition, but it’s arsenal may not be big enough.”

In a presidential election year, however, it may be more politically desirable -- as well as easier -- for the Fed than for the Congress to throw good money after bad.

And though bailout may be an usually dirty word at the moment, there were few howls Monday decrying the Fed’s intervention in the Bear Stearns case.

Much like the debate over the Fed’s role and the idea of moral hazard, an argument whose intensity has waned as fear of the credit crunch has heightened, hand wringing over an outright government bailout may turn into an open-hands expression of helpless inevitability.

At this point, the moral hazard issue may be solely “theoretical,” as Irons puts it, because we are “stuck” with the credit crunch and a bailout. “This is a once in a generation thing,”

The economy we have today is a mere shell of what it use to be. When we purchase almost any product we are not putting money in American pockets. For the past 10 years we used rising stock prices and rising home prices to fuel our economy. We also accumulated record amounts of debt during that time. What happens to a service and credit based economy when there's no more credit and no more asset appreciation?

Well low and middle income people can just live off debt, the system we have now would marginally benefit that decision. People who aren’t in debt yet living paycheck to paycheck will get hurt a lot, and people who live within their means and invest conservatively in cash, CDs, and bonds will get hurt.

No system has sustained long term growth by punishing conservative savings and encouraging debt. Its like trying to re-write the laws of nature to benefit bad behavior.

Look at Bear Stearns. It may be no coincidence that the biggest casualty on Wall Street thus far was suffocating under a blanket of mortgage-backed securities.

And the blanket's woven material?

I'm guessing that once the mortgages were bundled and securitized the bits and pieces from that process were bundled and securitized, then the bits and pieces from that process were bundled and securitized . . . .

Whatever happened, I've heard the term "financial innovator" used to described the architects of what did happen.

Isn't that just an euphemism for con man? Didn't Michael Milken serve time for an earlier round of "financial innovation." And what about Charles Ponzi, it seems that these "financial innovators" today created a kind of nuclear fission-fusion pyramid?

And for that.. the taxpayer may have to support "government interference" (in sunnier days, hated "government interference") which will likely be needed to bail out the con men, dust 'em off, hand 'em their 100-million dollar salaries, and send 'em back into the ring to do.. what? What's next?

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