Best of the Week
Most Popular
1. US Housing Market House Prices Bull Market Trend Current State - Nadeem_Walayat
2.Gold and Silver End of Week Technical, CoT and Fundamental Status - Gary_Tanashian
3.Stock Market Dow Trend Forecast - April Update - Nadeem_Walayat
4.When Will the Stock Market’s Rally Stop? - Troy_Bombardia
5.Russia and China Intend to Drain the West of Its Gold - MoneyMetals
6.BAIDU (BIDU) - Top 10 Artificial Intelligence Stocks Investing To Profit from AI Mega-trend - Nadeem_Walayat
7.Stop Feeding the Chinese Empire - ‘Belt and Road’ Trojan Horse - Richard_Mills
8.Stock Market US China Trade War Panic! Trend Forecast May 2019 Update - Nadeem_Walayat
9.US China Trade Impasse Threatens US Lithium, Rare Earth Imports - Richard_Mills
10.How to Invest in AI Stocks to Profit from the Machine Intelligence Mega-trend - Nadeem_Walayat
Last 7 days
China Hang Seng Stocks Index Collapses and Commodities - 24th May 19
Costco Corp. (COST): Finding Opportunity in Five Minutes or Less - 24th May 19
How Free Bets Have Impacted the Online Casino Industry - 24th May 19
This Ultimate Formula Will Help You Avoid Dividend Cutting Stocks - 24th May 19
Benefits of a Lottery Online Account - 24th May 19
Technical Analyst: Gold Price Weakness Should Be Short Term - 24th May 19
Silver Price Looking Weaker than Gold - 24th May 19
Nigel Farage's Brexit Party EU Elections Seats Results Forecast - 24th May 19
Powerful Signal from Gold GDX - 24th May 19
Eye Opening Currency Charts – Why Precious Metals Are Falling - 23rd May 19
Netflix Has 175 Days Left to Pull Off a Miracle… or It’s All Over - 23rd May 19
Capitalism Works, Ravenous Capitalism Doesn’t - 23rd May 19
The Euro Is Bidding Its Time: A Reversal at Hand? - 23rd May 19
Gold Demand Rose 7% in Q1 2019. A Launching Pad Higher for Gold? - 23rd May 19
Global Economic Tensions Translate Into Oil Price Volatility - 22nd May 19
The Coming Pension Crisis Is So Big That It’s a Problem for Everyone - 22nd May 19
Crude Oil, Hot Stocks, and Currencies – Markets III - 22nd May 19
The No.1 Energy Stock for 2019 - 22nd May 19
Brexit Party and Lib-Dems Pull Further Away from Labour and Tories in Latest Opinion Polls - 22nd May 19
The Deep State vs Donald Trump - US vs Them Part 2 - 21st May 19
Deep State & Financial Powers Worry about Alternative Currencies - 21st May 19
Gold’s Exciting Boredom - 21st May 19
Trade War Fears Again, Will Stocks Resume the Downtrend? - 21st May 19
Buffett Mistake Costs Him $4.3 Billion This Year—Here’s What Every Investor Can Learn from It - 21st May 19
Dow Stock Market Trend Forecast 2019 May Update - Video - 20th May 19
A Brief History of Financial Entropy - 20th May 19
Gold, MMT, Fiat Money Inflation In France - 20th May 19
WAR - Us versus Them Narrative - 20th May 19
US - Iran War Safe-haven Reasons to Own Gold - 20th May 19
How long does Google have to reference a website? - 20th May 19
Tory Leadership Contest - Will Michael Gove Stab Boris Johnson in the Back Again? - 19th May 19
Stock Market Counter-trend Rally - 19th May 19
Will Stock Market “Sell in May, Go Away” Lead to a Correction… or a Crash? - 19th May 19
US vs. Global Stocks Sector Rotation – What Next? Part 1 - 19th May 19
BrExit Party EarthQuake Could Win it 150 MP's at Next UK General Election! - 18th May 19
Dow Stock Market Trend Forecast 2019 May Update - 18th May 19
US Economy to Die a Traditional Death… Inflation Is Going to Move Higher - 18th May 19
Trump’s Trade War Is Good for These 3 Dividend Stocks - 18th May 19
GDX Gold Mining Stocks Fundamentals Update - 17th May 19
Stock Markets Rally Hard – Is The Volatility Move Over? - 17th May 19
The Use of Technical Analysis for Forex Traders - 17th May 19
Brexit Party Set to Storm EU Parliament Elections - Seats Forecast - 17th May 19
Is the Trade War a Catalyst for Gold? - 17th May 19
This Is a Recession Indicator No One Is Talking About—and It’s Flashing Red - 17th May 19
War! Good or Bad for Stocks? - 17th May 19
How Many Seats Will Brexit Party Win - EU Parliament Elections Forecast 2019 - 16th May 19

Market Oracle FREE Newsletter

U.S. House Prices Analysis and Trend Forecast 2019 to 2021

There’s No Such Thing as a Free Bailout for the US Housing Market

Housing-Market / US Housing Aug 24, 2007 - 08:39 PM GMT

By: Paul_L_Kasriel

Housing-Market PIMCO's William Gross is now calling for a fiscal policy bailout for the U.S. housing market debacle rather than a monetary policy bailout (see “Where's Waldo? Where's W?”). On the surface, Gross's arguments seem to make sense – on the surface . Gross argues that even a cut in the federal funds rate of several hundred basis points might not lower reset rates on adjustable-rate mortgages enough to prevent the massive looming foreclosures. In addition, Gross argues that such an injection of Fed-created credit could be the catalyst for a run on the dollar, which, in turn, would probably prevent 15-year or 30-year fixed rate mortgage yields from falling enough, if at all, to prevent massive foreclosures.

Moreover, Gross argues that a large cut in the federal funds rate would perpetuate Greenspan's moral hazard policy and would encourage further leveraging in the global financial markets. So as an alternative, Gross recommends that some federal government agency, either an existing one such as the Federal Housing Administration (FHA) or a newly-created alphabet soup, bailout those current home“owners” who otherwise are soon-to-be renters.

I believe that Gross makes some valid points about the implications of a Greenspan-magnitude cut in the fed funds rate. But I do not believe that a fiscal policy bailout of prospective defaulting mortgagees would be “free,” economically speaking.

Let's assume that the FHA guarantees the refinancing of the approximately $683 billion of subprime and Alt-A mortgages that are scheduled to reset in the six quarters ended 2008:Q4 (dollar amount according to Merrill Lynch). An FHA guarantee is a full-faith-and-credit guarantee of the federal government. So, the market for these new FHA-guaranteed mortgages would overlap with the one for U.S. Treasury securities. That is, FHA-guaranteed mortgages and U.S .Treasury securities are close substitutes. Thus, all else the same, U.S. Treasury security interest rates would rise as investors shift out of Treasuries into FHA-guaranteed mortgages.

But because the FHA would be guaranteeing massive amounts of subprime and Alt-A mortgages, market participants would anticipate higher defaults on these mortgages going forward, which, in turn, would cause market participants to expect higher Treasury borrowing requirements going forward to make buyers of these FHA-guaranteed mortgages whole after defaults. So, interest rates on Treasury debt would rise not only because of the substitution effect, but because a greater future supply of Treasury debt would be anticipated. In fact, the interest rates on all other fixed-income securities would rise because FHA-guaranteed mortgages are, to varying degrees, substitutes for other fixed-income instruments. 

So, the current federal deficit would rise because of higher interest costs on the public debt. In addition, expected future federal deficits would rise because of higher anticipated defaults on FHA-guaranteed mortgages. Private borrowers would cut back on their borrowing and spending because of the higher interest rates they now have to pay in order to obtain funding. Other private – and perhaps public – spending, then, would be “crowded out” by the increase in FHA guarantees on mortgages.

The cost of funds to private equity syndicates would increase, so the dollar volume of “deals” would decline from what it otherwise would have been. This would reduce the amount of shares being bought from households, which, in turn, would reduce an important source of household deficit spending. (For a discussion of the impact on household spending of private equity buyouts and corporations' stock buybacks, see "Wall Street and Main Street Are Joined at the Hip" ). Again, other spending would be crowded out by the increase in FHA guarantees of mortgages.

It is not even clear that the U.S. dollar would not come under downward pressure with a fiscal policy bailout of subprime and Alt-A borrowers. As alluded to above, private spending on research and development and business capital equipment would be crowded out by the government guarantee of less-than-prime mortgages. Slower growth in these types of private spending implies slower future growth in the U.S. economy. Slower future real growth in the economy implies slower growth in our standard of living, especially if we have to devote part of our future production/income to servicing our foreign debt. With the U.S. already a gargantuan net debtor to the rest of the world and with the bulk of our debt denominated in U.S. dollars, foreign creditors might wonder if political pressure would be brought to bear on the Federal Reserve to crank up the currency “printing press” in order to help make principal and interest payments on the debt owed to these creditors. The anticipation of this, of course, would induce investors – both foreign and domestic – to reduce their exposure to U.S. dollar-denominated financial assets, thus causing the dollar to depreciate vs. other currencies.

For the FHA to guarantee the refinanced mortgages of subprime and Alt-A borrowers, a moral hazard policy still would be perpetuated, just not by the Fed. Subprime and Alt-A lenders would be bailed out by the federal government, thus reinforcing the notion that some form of government safety net would likely be there to mitigate the potential losses of investments in risky assets.

So, there is no free bailout to the predicament we have gotten into as a result of Greenspan's cheap credit and moral hazard policies. For those that think there are free bailouts, I suggest that they read the writings of Frederic Bastiat, a 19 th century French political economist, who preached that in economic analysis, one must take into account not only what is seen, but what is not seen. In other words, employ general equilibrium analysis, not just partial equilibrium analysis.

*Paul Kasriel is the recipient of the 2006 Lawrence R. Klein Award for Blue Chip Forecasting Accuracy

By Paul L. Kasriel
The Northern Trust Company
Economic Research Department - Daily Global Commentary

Copyright © 2007 Paul Kasriel
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

Paul L. Kasriel Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules