The Breakdown | Explaining Southern California's economy

Can the Federal Reserve end the foreclosure crisis?

The Federal Reserve Building in Washington, DC.
The Federal Reserve Building in Washington, DC.
AP Photo / J. Scott Applewhite

The economist Peter Morici, who has been extremely critical of the Obama adminstration's economic policies of late, has taken a look at the housing crisis and doesn't see much hope. He does see one way out, however. But it's an exceptionally unlikely way out:

Currently, the rate on five-year adjustable rate mortgages is about 3.2 percent. If the Fed could get the investors who buy Fannie and Freddie bonds to accept interest rates of minus 3 percent, then young folks could be offered mortgages with appropriately negative interest rates. To accomplish that feat, the Fed would have to buy all those bonds itself-that's right the Fed would finance all federally guaranteed mortgages and write off 3 percent a year. I can just hear Ron Paul now.

Morici makes this argument in the context of discussing why it makes little sense for young people to buy houses right now (unfortunately, I can't link to his piece, as it isn't on his website yet). He refers to Ron Paul, a Texas congressman and noted libertarian, because Paul is no fan of the Fed

However, Morici is getting at something here, while setting up a preposterous option for Ben Bernanke. The real problem of the cheap money that the Fed has been unleashing by cutting interest rates to nearly zero, promising to keep them there, and then trying to drive rates even lower by doing two rounds of "quantitative easing" plus "Operation Twist" is...that cheap money isn't good enough! Right now we money!

That's what negative interest rates would deliver. It's an idea that's been put out there — by no less an authority than Harvard economist N. Gregory Mankiw — against the obvious intellectual resistance: Who would loan money at a negative rate of return? 

Well, the Fed, that's who. 

The outcome could be disturbing, as the government would be assuming responsibility for backstopping the entire mortgage market, at least until the oversupply created by foreclosures has cleared. But you can file this one next to the idea that banks should allow principal writedowns on loans that are underwater; or use "mark-to-market" accounting to correctly assess the value of loans on their books. Both ideas have merit, but they also have consequences, not least being that they could initiate a spiral of declining prices for homes that could theoretically drive values to zero. 

Not pretty.

Maybe the Fed is our last chance. We may just have to put up with Ron Paul's protests after all.

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