Ezra Klein at the Washington Post offers a way out of the current mess:
Tomorrow morning, Bernanke could walk in front of a camera and announce that the Federal Reserve intends to begin buying huge numbers of mortgage-backed securities with the simple intention of bringing the interest rate on a 30-year mortgage down to about 2.5 percent and holding it there for one year, and one year only.
The message would be clear: If you have any intention of ever buying a house, the next 12 months is the time to do it. This is Uncle Ben’s Crazy Housing Sale, and you’d be crazy to miss it.
Now, financial markets are not my specialty, and maybe Klein has thought about this more deeply than I have, but there seems to be a little flaw in this plan.
Namely: If the interest rate is currently 2.5 percent, and everyone believes it’s scheduled to go up in a year, where is the lender who willingly locks himself into a 2.5 percent rate for the next 30 years?
I think maybe Klein forgot that the lending market needs lenders, not just borrowers. Back in the old days, we used to call it “supply and demand”.
Edited to add: As Mike H, Morten, Daniel Hewitt and others have pointed out, the Fed itself is the missing lender. I had indeed missed the point.
As Emily Litella used to say: Never mind.
If the Fed is buying mortgage-backed securities like that, aren’t they offering to be the lender?
Sorry, my comment should have been in the subjunctive tense.
So to sum up – Ezra suggests: Let the FED lend
Little flaw: There are no lenders
Amazing.
But I guess you are right, you really do not seem to think very deeply.
The problem you identify is a general one with monetary policy, not limited to Ezra’s crazy plan. The ability of the Fed to affect investment by changing the Fed Funds rate depends on a diversity of opinion about the long term equilibrium rate. Some people will guess right and make money, and others will guess wrong and lose money.
The lender sells the debt to whomever is consolidating and securitizing the mortgages (an investment bank for example). The investment bank then sells the securities to the Fed. Not sure if the Fed is allowed to do this, but they pretty much do what they want anyways.
So if the Fed is aggressively buying these securities, the investment banks would have the incentive to create more of them. Which they do by buying mortgages from the lenders. If the lender knows that they will be able to quickly sell the mortgage, then wouldn’t they have the incentive to lend more?
Mike H:
If the Fed is buying mortgage-backed securities like that, aren’t they offering to be the lender?
Okay. Gotcha. I had indeed missed the point.
Daniel Hewitt (and others): Yes, you’re right. Editing to acknowledge this.
The Fed is the lender.
But I think he’s got it upside down. Housing demand, driven by targeted credit supply, will be artificially pumped for 1 year (and 1 year only). Home prices will push higher than they would have been (or not fall by as much). There will be a whole bunch of buyers getting in for the low interest charges.
Then when the sale is over a year later, rates go back up, demand drops because the next round of buyers aren’t getting fire sale prices, and house prices drop leaving the sale price buyers in negative equity. Good luck if you ever want to/need to move or sell. How is making another round of home buyers upside down on their mortgage supposed to “get us out of this mess”?
It’s like setting a teaser rate on the whole housing market.
Dave: Thanks for rescuing this post from complete irrelevance with your thoughtful comment!
Whether or not the fed is the lender here is somewhat irrelevant. I believe Hayek’s words apply directly to Ezra’s scheme:
“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
… and more to that point, what happens to the values of the homes when the interest rates go back up, potentially to much higher rates, which drastically reduces the number of buyers willing to enter the market? Will everyone be under water on their newfound fire-sale mortgages?
I don’t claim to actually know the answers to these questions, but then again I’m a lot more willing to admit how little I know about what I think I can design than Ezra.
I’d like to add to Daniel Hewitt’s comment (which I think nicely outlines the basic scheme) that Dodd Frank limits what types of mortgages may be securitized by imposing a 5% risk retention requirement on all but the safest mortgages. I’m almost certain that’s going to raise the cost of lending (if securitization is the ultimate goal of the lending at issue, anyway), and depending on the composition of borrowers (quality verses low quality), it may throw a large wrench into the Fed plan. Not really sure. Anyway, it’s a detail.
The message would be clear: If you have any intention of ever buying a house, the next 12 months is definitely not the time to do it. This is Uncle Ben’s Crazy Housing Pump and Dump Scheme, and you’d be crazy to get on board now.
I think Ezra has forgotten that quantitative easing is less effective in a world where the problems are being caused by insolvency, rather than liquidity.
Rent control for the mortgage market?
Steve, there are at least 5 horrible things embedded in Ezra Klein’s proposal. The fact that you pounced on something that wasn’t a problem, is almost impressive.
(That’s supposed to be funny.)
This plan is as stupid as cash for clunkers. Dave number #8 has it nailed.
And as far as the Fed “being the lender,” so what? This still does not create a free lunch. It is just a government agency doing with other people’s money what no sane person would do with his own (that is, lend for 30 years at 2.5%.)
Would randomly burning down houses get prices up and solve the crisis? Or would the subsequent increase of fire insurance premiums negate the benefits?
So, the Fed is going to do the risk assessment and screening process so that they don’t make bad loans? Will they know how much to charge as a risk premium, or will they limit this to super-secure, low loan-to-value loans?
Or do they just loan the banks money (equal to their mortgage dollars lent) at 2.5%, and let the banks mark up for risk as they choose? If so, that wouldn’t do anything about mortgage rates, because current rates *also* have a risk markup (above that of the risk-free rate), and this would have to be applied regardless of who loans them money and on what terms.
Or is Klein really advocating that the Fed deliberately take a loss doing this?
The fact that the Fed fills in the role of lender does not resolve the problem here.
Silas,
The Fed will buy MBS in the secondary market until the rates are 2.5%. The banks will still originate the loans that go into the MBS. The banks do the screening.
Matt
SL: Banks will lend at any nominal rate if they can lock in an appropriate spread to their cost of funds. It doesn’t matter whether the rate is artificially low or is expected to increase. While residential mortgages contain prepayment risk which makes their average lives variable, and hence a bit tricky to lock in that spread, sophisticated banks while not perfect can do a good job of this.
@Matthew — agreed, I was sloppy and should have more carefully distinguished between loaning and buying loans (though they are similar enough in this context).
It still doesn’t explain how this stops the same “pack and sell junk” process that got us into this mess. What stops a bank from making a bunch of loans it knows won’t be paid back, and then selling them the secondary market, which the Fed is reliably draining (purchasing and not selling) of loans? The Fed will be the only net purchaser on that market after a while — the dupe.
(Btw, your posts are auto-signed so you don’t need to put your name at the end.)
No one has mentioned the hidden role of the GSEs. The banks will sell loans quickly to GSEs who will package MBS which Fed Reserve will buy. If loan goes bad, GSE takes it back, loses money which then requires Treasury to give GSE more money. What a scheme
It would trigger a wave of refinancing which would drive the interest payments down for all CURRENT homeowners who choose to refinance (i.e. most people). This would be an incredible short term boost to current homeowner discretionary income.
Sure it would pump house prices up a bit in the short term and then they’d fall. But this would be a wash.
Its the repayment (refinancing) that matters here.
I get the feeling Uncle Ben’s Crazy Housing Sale would be the start of a long running, very unfunny sitcom. What is Crazy Uncle Ben going to do this week to encourage demand? Free makeovers for the entire US? Mandatory yacht racing?
At some point you have to question the basic premise, do these economic antics actually work or even make sense? For example, why should giving money to the people least capable of doing anything productive with it help us the most? (Eg, giving money to people who will immediately spend it in order to “create demand”.)Seems like it’d be better to question these ideas now, rather than halfway through season 18 of Ezra’s World.
I find it remarkable that these sorts of ideas have any traction whatsoever.