Tuesday, March 11, 2008

The Federal Reserves $200 Billion Mortgage Solution

I saw this peice in Saturday's Washington Post that the Federal Reserved plans to make $200 Billion available to lenders. The plan is designed to head off a credit crunch that may make it hard for homeowners and lenders to get future loans.
The world's financial plumbing is so clogged that the central bank sees a need for new steps to clean it out to prevent severe damage. Mounting panic in the credit markets is making it harder for Americans to get mortgages and is increasing the rates they must pay on credit cards and auto loans. Even solid businesses are finding it difficult to raise money to expand.

The Fed said it will make $200 billion available to financial institutions in an effort to ease a crisis of confidence that is making it harder for families and businesses to borrow money.
Fine, I don't like the idea, but fine if that is going to be the policy of the Fed.

But there were some quotes, from people who really should know better, that the need for the Fed's action is predicated upon something in the market not working.
"They're recognizing that financial markets aren't functioning well, and that that creates risks to the real economy," said Vincent Reinhart, a resident scholar at the American Enterprise Institute and a former senior Fed official.
Actually, if credit lenders are making it more difficult to get loans, they are responding to concerns about the risks of such loans. Thus the market is working EXACTLY as it should. Thus there is nothing wrong with the credit market, other than we don't like how it is responding.

For years, the govnerment has encouraged either explicitly or implicitly the growth in subprime lending. Subprime lending is riskier and when it goes bad, the natural and correct reaction is to cut back on subprime lending. That has spill-over effect into lending for not sub-prime transactions as banks become a little more risk adverse, but again that is a natural reaction.

So even with the new funds, there is no guarantee that the lenders will suddenly loosen up their standards (they are still businesses after all) unless the Fed tells them to. If the Fed tells lenders to get a little looser with their lending guidelines, what may actually be happening is simply a delay in the crisis.

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