Fiscal versus Monetary Solutions to the Subprime Crisis

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link http://www.rgemonitor.com/blog/roubini/212479

Es un post del 27 de agosto. Espero que no este repetido

Fiscal versus Monetary Solutions to the Subprime Crisis
Nouriel Roubini | Aug 27, 2007

There is now a growing realization that the turmoil in financial markets in the last few weeks is not just due to a liquidity crunch but it is more importantly related to serious credit problems: bankrupt and/or distressed homeowners, bankrupt mortgage lenders, distressed homebuilders, some distressed highly leveraged financial institutions and even some over-leveraged parts of the corporate sector. Liquidity problems and crunches can be solved with liquidity injections by central banks. But more severe credit problems of borrowers cannot be resolved with monetary policy. Rather if the distress of borrowers need to be addressed sometimes fiscal solutions – like financial support of distressed mortgage borrowers – needs to be considered.

Once you consider fiscal solutions to credit problems, the same conceptual issue of whether lender of last resort support by central bank will lead to jovenlandesal hazard (i.e. bailout of reckless lenders and borrowers) is relevant to the issue of a fiscal solution to credit problems. Were homeowners innocent victims of predatory lenders or reckless borrowers and "condo flippers" who should have known better? If we implement fiscal policies that are going to help distressed home owners aren’t we also rescuing the reckless lenders? Will forbearance and attempts to reduce the rate of foreclosures – various mitigation measures - solve credit problems or exacerbate them and only postpone more severe defaults down the line? Should caps on the portfolio of the GSEs (Fannie Mae and Freddie Mac) to be loosened to allow them to provide liquidity to seized mortgage markets or will this lead to greater jovenlandesal hazard for institutions that – while formally private – are assumed to be protected by some implicit public bailout guarantees? And is greater portfolio exposure by GSE a form of fiscal policy or monetary policy?




These are some of the complex and difficult issues that analysts and policy makers are starting to address. Bill Gross of Pimco is now proposing the creation of a fiscal institution like the RTC (that resolved the S&L banking crisis of the late 1980s and early 1990s) – what he called the Reconstruction Mortgage Corporation – to resolve the subprime credit problems. While this may sound as a fiscal bailout of borrowers (and by default of lenders) the alternative in his view is destructive home price deflation (as much as 10% fall in home prices in his view) and million of homeowners ending up in foreclosure. Folks at Goldman Sachs are actually predicting that home prices will fall as much as 15% in the next few years before they bottom out.


Larry Summers – former secretary of the Treasury – is concerned about the size and activities of the GSEs; but he correctly argues today in the FT that in situations of severe credit distress it is important to be pragmatic rather than religious on issues of jovenlandesal hazard:

“what is the role for public authorities in supporting the flow of credit to the housing sector? The lesson learnt during the S&L debacle was that it was catastrophic to finance home ownership through insured banking institutions that borrowed short term and then offered long-term fixed-rate home mortgages. Now a system reliant on securitisation, adjustable rate mortgages and non-insured financial institutions has broken down.

I am among the many with serious doubts about the wisdom of the government quasi-guarantees that supported the government-sponsored entities, Fannie Mae, the Federal National Mortgage Association, and Freddie Mac, the Federal Home Loan Mortgage Corp , as they have operated in the mortgage market. But surely if there is ever a moment when they should expand their activities it is now, when mortgage liquidity is drying up. No doubt, credit standards in the subprime market were too low for too long. Now, as borrowers face higher costs as their adjustable rate mortgages are reset, is not the time for the authorities to get religion and discourage the provision of credit.”

Dean Baker wants to help the victims (the subprime borrowers in his view) rather than the reckless lenders (the “bloated bankers); so he is suggesting changes in foreclosure rules to allow moderate and low-income homeowners to remain in their homes indefinitely as renters.


A number of authors - including analysts at BNP – have argued a fiscal solution is needed and that government sponsored agencies should be allowed to purchase more conforming loans.


Even the Bush Administration, that has opposed suggestions to have Fannie and Freddie expand their mortgage portfolios, is now suggesting that Federal Home Administration could help distressed borrowers. Whether this specific proposal is only a minor Band-Aid -that is aimed at stemming more incisive Congressional action - or not is an open issue.


The main point is that – leaving aside important issues of jovenlandesal hazard from fiscal bailouts – there is now a new and increasing recognition that severe credit and financial distress problems cannot be resolved with monetary policy alone. Thus, if a political consensus were to emerge that some financial support of distressed mortgage borrowers is fair and necessary then fiscal – as opposed to monetary alone - solutions may have to be discussed and implemented. The prospect of home prices falling 10 to 15% and two million plus home owners losing their homes is – rightly – becoming a political issue. And political issues lead to fiscal solutions when there is a political consensus that the consequences of no action can be a severe economic and social fallout from the worst U.S. housing recession in decades.

 

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"The main point is that – leaving aside important issues of jovenlandesal hazard from fiscal bailouts – there is now a new and increasing recognition that severe credit and financial distress problems cannot be resolved with monetary policy alone. Thus, if a political consensus were to emerge that some financial support of distressed mortgage borrowers is fair and necessary then fiscal – as opposed to monetary alone - solutions may have to be discussed and implemented. The prospect of home prices falling 10 to 15% and two million plus home owners losing their homes is – rightly – becoming a political issue. And political issues lead to fiscal solutions when there is a political consensus that the consequences of no action can lead to severe economic and social fallout from the worst U.S. housing recession in decades."

This is the problem with economists who don't know anything about the law. Anyone with a law degree will ask you instantly: what new rights are you creating in housing possessors if you go down this path? In fact, you can't NOT be creating new rights by doing this, because you are insuring a possessory right which can be enforced by the possessor.

OK fine. What about those who have unsecured debt? There is no clear reason they should not have the same protection as those with secured debt. And what is the extent of these rights? And what about education, medical care? If you are currently being educated, if you are currently receiving medical care, why should that be allowed to be terminated when possession of housing cannot be termined? What in law is the difference?

As I have said all along, what is really going on is that we are in the process of elevating the facts mentioned in the New Bill of Rights, to the level of protection stated in the New Bill of Rights.

But will this happen in the case of housing, in the way which has been suggested? Not at all. Why not? Because not one of them--including Roubini--discusses the implications for individually enforceable rights. There is NO consensus on removing housing from the political system. Those who might benefit from it either oppose it or do not have the power to enforce it.

What is more, the legal establishment has ALWAYS counseled, not only the U.S. Government, but also every other government, NOT to grant increased rights in housing. Why not? Because it decreases the discretion of the political system with respect to these facts.

Thus, the absurd ignorance of economists, who bat these ideas around without ever answering the question: what does this do to the existence of rights, the extent of the rights, and those affected by the rights?

Which is why these discussions are all silly nonsense and will go nowhere. Ask any lawyer what a proposed jovenlandesatorium on housing evictions will do to the entire legal system. It would completely upend the scrutiny regime established by West Coast Hotel v. Parrish. The political system does not have the mandate to do that. If anything, its mandate is to circle the wagons around the Capital and to hell with the population. The greater the degree of deterioration, the stronger the remaining strong political forces, and the more strongly they will insist that whatever powers of government remain, be used in THEIR interest. What is peculiar to America is that the suburban mentality will provide EXTRA support for this draconian point of view.

Do the polling: I doubt there is much support for more than cosmetic assistance to homeowners.

And by the way, what relief, by analogy, do renters have from the supposed new protection for homeowners? Would you like to be the judge who decides that?

No no, let the revolution take its course.