Op/Ed: Fed Reserve Risks Moral Hazard & Now Faces Crisis

Discussion in 'Economics' started by ByLoSellHi, Mar 30, 2007.

  1. This is not necessarily my opinion, but it is well written, and efficiently espouses a point of view many here may enjoy reading and even share.

    Fed Risks Moral Hazard as Housing Market Melts: Mark Gilbert


    By Mark Gilbert

    March 30 (Bloomberg) --
    ``Interest-Only Mortgage Payments and Payment-Option ARMs -- Are They for You?'' asks the U.S. Federal Reserve in a November brochure on its Web site.

    The answer should have been a resounding ``No.'' Instead, cash-strapped Americans embraced loans offering low initial payments, praying that rising house prices would build a refinancing buffer before the monthly rates become unaffordable.

    The hangover from that borrowing binge is beginning to hurt. Evidence is building that the U.S. economy is slowing sufficiently to warrant a soothing reduction in interest rates from the Federal Reserve. That poses an interesting dilemma for Fed Chairman Ben Bernanke.

    Cut too soon, and he will stand accused of ignoring inflation in an attempt to rescue the housing market. Leave it too late, and he risks tainting his second anniversary at the helm of the world's biggest economy by overseeing a recession.

    All four legs of the U.S. housing market are wobbling precariously. The mortgage lenders who funded the boom are going bust or shutting up shop. The homebuilders who slapped together the bricks and mortar are seeing their earnings plummet. The financial alchemy used to repackage home loans into tradable securities is starting to unravel.

    American Nightmare?

    And the consumers seduced into what the Fed pamphlet calls the ``American dream'' of home ownership are becoming more fearful about the future as real-estate values start to stumble.

    Mortgage Lenders Network USA Inc., Ownit Mortgage Solutions LLC, People's Choice Financial Corp. and ResMae Mortgage Corp. have all gone bankrupt in recent months. Lennar Corp., the largest U.S. homebuilder, this week abandoned its 2007 profit goal after fiscal first-quarter earnings plummeted 73 percent. The Federal Bureau of Investigation is checking Beazer Homes USA Inc. for possible mortgage fraud.

    About 45 percent of the $179 billion of structured finance collateralized debt obligations sold last year had subprime mortgage bonds in their collateral pools and could face ``severe rating cuts,'' according to Moody's Investors Service. The securities may become the ``worst-performing in recent history,'' Standard & Poor's said earlier this week.

    The housing market's woes are beginning to infect the U.S. economy. The New York-based Conference Board's consumer confidence index declined to 107.2 from February's five-year high of 111.2, figures this week showed. The S&P/Case-Shiller index showed home prices dropped in January for the first time in at least six years.

    Slashing Forecasts

    U.S. orders for durable goods, excluding transportation, fell for a second month in February, suggesting U.S. executives aren't willing to invest in new equipment and machinery. After that report, Morgan Stanley cut its growth forecast for the first quarter to 1.6 percent from 2 percent, while HSBC Securities USA revised its estimate to 1.5 percent from 1.8 percent.

    In testimony to the Joint Economic Committee of Congress in Washington this week, Bernanke hinted at why the Fed dropped its reference to ``additional firming that may be needed'' on March 21 after including the phrase in its previous five monetary- policy statements.

    ``The uncertainties about the outlook have increased somewhat in recent weeks,'' Bernanke told Congress. ``The correction in the housing market could turn out to be more severe than we currently expect. We could yet see greater spillover from the weakness in housing to employment and consumer spending than has occurred thus far.''

    Numbers, Not Nuances

    ``Fed watchers need to concentrate on fundamentals at times such as these, not on the nuances in Fed statements,'' Brian Reading, an economist at London-based Lombard Street Research, wrote in a research note yesterday. ``The chances of early, then deep, interest-rate cuts are increasing daily. When push comes to shove, forget inflation fears.''

    Economists have been pushing back the date when they expect the Fed to lower borrowing costs. The Fed won't cut rates until the final quarter of this year, according to the median forecast of 74 economists polled by Bloomberg News at the beginning of this month.

    In December, the consensus was for lower borrowing costs to come in the second quarter. A year ago, economists were expecting the key overnight rate to be half a point lower than its current 5.25 percent level.

    ``Our main point of reference should be the experience of the years 2000 to 2001,'' says Nick Parsons, head of market strategy at National Australia Bank Ltd.'s NabCapital unit in London.

    The Fed raised interest rates by three-quarters of a point to 6.5 percent between February and May 2000, and then put monetary policy on ice. On Jan. 2, 2001, the National Association of Purchasing Management (now called the Institute for Supply Management) published its services index showing a decline to 43.7 from 47.7.

    Emergency Move

    The following day, U.S. policy makers held an emergency conference call and agreed to cut the rate to 6 percent -- ``exactly 50 days after the November Fed statement which had warned of inflationary pressure,'' Parsons says. ``A data- dependent Fed could become a very active Fed if the economic numbers turn sour.''

    Prices in the futures and options market suggest traders and investors see a 16 percent chance of the Fed cutting its key rate to 5 percent at its June 28 meeting, rising to 28 percent for the Aug. 7 meeting, according to Bloomberg calculations. There's only a 3.3 percent chance that rates will be unchanged by the end of October, and zero likelihood that the Fed will stand pat through December, based on March 28 closing prices.

    Moral Hazard

    Targeting asset prices is anathema to the current generation of monetary-policy guardians, who invoke the risk of moral hazard -- the danger that investors will throw caution to the wind in the belief that central banks will always bail out their risky adventures by making money cheaper.

    ``I do want to emphasize that we have not shifted away from an inflation bias,'' Bernanke told Congress. As the crisis engulfing the subprime mortgage market worsens and the contagion threatens the wider U.S. economy, though, the Fed chief may find he's damned if he does cut, damned if he doesn't.

    (Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)
  2. blast19


    Bloomberg is somehow the only news source that's covering the topic in detail. They must be perma-bears I guess! :p