Why the Fed Needs to Talk More About Housing

In this issue of The Institutional Risk Analyst, we argue that the Fed should be talking about housing and doing so more often. But FRBNY President Bill Dudley and Moody's economist Mark Zandi need to give credit in their speeches to former FDIC Chairman Sheila Bair. Chairman Bair years ago described most of the policy steps for which Dudley and others now claim authorship. Does anyone at the Fed understand the term plagiarism?

The lack of progress in dealing with the housing sector is a national scandal and one reason among many that President Barack Obama does not deserve another four years in office. There is a cost to doing nothing about the housing crisis, as Laurie Goodman at Amherst Securities has noted repeatedly. This cost is borne by the tens of millions of American households that are unable to refinance their mortgages.

The Wall Street Journal is badly wrong when they criticize the Fed for speaking up on housing. The real crime is that Dudley, Chairman Ben Bernanke and other Fed officials did not listen to Sheila Bair three years ago, when she and other officials at FDIC were calling for more aggressive policy approaches to dealing with foreclosures. Instead the large banks and their partners in crime in Washington, Fannie Mae and Freddie Mac, have formed a political and financial cartel to prevent American home owners from refinancing their mortgages, effectively thwarting Fed policy efforts to reflate the economy.

Instead of passing the savings afforded by lower interest rates to deflation ravaged consumers, the TBTF banks - BAC, C, JPM and WFC - are instead now using the low cost of funds to do nothing. Zero interest rates allow the zombie banks to sit on bad loans and foreclosed real estate, but this studied inaction also ensures a low or no-growth US economy for years to come. By doing nothing on housing, the White House and Congress are helping America to turn Japanese a la the 1980s to prop up the zombie banks and GSEs. The cost of this deliberate act of criminal indifference is shouldered by the bottom third of American households in the conforming loan sector.

Now you know why last week an article from Bloomberg News set off a media tempest regarding the possibility of a mass refinance proposal from Washington. Such is the pain in the banking and consumer sectors that astute policy analysts know that something eventually will have to be done for the millions of American home owners who are now underwater on their mortgages. The question is will this be a 2012 project or wait until 2013?

Part of the dilemma facing the Fed is that the fiscal situation in Washington has become ridiculous, most recently with Congress imposing a tax on Fannie Mae and Freddie Mac in order to pay for the "emergency" payroll tax holiday. The refusal of Congress to deal directly with the federal debt explosion means that the central bank has no room to let rates rise and thereby force the big banks to unload foreclosed homes, office buildings and other bad assets.

"Our publicly traded debt has increased 100% in the last 5 years alone! What is even worse is that our debt as a percentage of revenue is exploding," writes Mike Pento. "Back in 1971, the national debt was 218% of revenue. Back in the year 2000, that debt as a percentage of revenue had grown to 280%. Today, it has skyrocketed to 700% of revenue. Our government simply cannot survive having that much debt in relation to revenue."

Pento notes that the Fed is now clearly targeting inflation: "Therefore, the real rate of inflation suffered by most Americans will be significantly higher than the rate the Fed is targeting. The reality is that the Fed is now stepping up their easy-money rhetoric, despite the fact that they have conducted a more than four year campaign to produce a higher rate of inflation and lower the value of the dollar." Well, maybe. We see instead low rates and no job growth in the US for years to come.

The sad fact is that neither the Fed nor the WSJ understand that without movement on housing, there will be neither any meaningful inflation or job growth in the US for years. The real estate sector is a millstone around the neck of the US economy with a decided deflationary bias. Without a restructuring of BAC, Ally and some of the other TBTF banks, there will be no sustained credit or job growth in the US and thus no movement in government revenues. After five years of zero rates, all that the Fed has to show for its trouble is a banking industry where the top four institutions representing 70% of total assets remains crippled.

If you think of the US financial sector as three legs of a stool, the markets for government debt and mortgage debt are constrained. In many respects, the US corporate debt sector is the only functioning capital market in the US and the world. We cannot achieve economic recovery in the US or globally without repairing the markets for mortgage and government finance. The housing sector is half of all bank balance sheets and two-thirds of total US bank exposure.

Not only should the Fed be talking about the housing sector but it should do so more often. We note in this regard that the creditors of Ally Financial have begun to organize in preparation for the restructuring we predicted last week. The bottom line message from Fed Chairman Bernanke and other Fed members to Congress and the White House should be this: there will be no economic recovery until we deal with the housing sector. Refinancing for performing borrowers and restructuring for troubled loans is the route to salvation. But once the housing market boil is lanced, then the real fun starts in addressing the parlous US fiscal situation.