Sept. 13 (Bloomberg) -- Even the most casual observer of the events of the last five years -- the housing bubble, the bust and the digging-out process -- would be struck by the similarities between the policies that got us into this mess and the prescriptions for getting us out.
Whether it’s ultra-low interest rates, borrowing and spending (too much then, too little now), or artificially inflated home prices, the cure bears an uncanny resemblance to the cause.
I’ve identified five areas where policy makers need to reexamine their recommendations or do a better job of explaining why yesterday’s mistakes will be tomorrow’s remedies.
1. Easy Come, Easy Go
The Federal Reserve kept short-term interest rates too low for too long in 2003-2005. No one at the Fed has acknowledged the role the 1 percent funds rate played in ballooning the volume and variety of adjustable-rate mortgages and inflating the housing bubble. For some reason, policy makers would rather be seen as regulators asleep at the wheel than forecasters groping in the dark.
The bubble burst, the residential real estate market tanked, and the funds rate settled at 0 percent to 0.25 percent. With the economy’s recent turn for the worse, the Fed is considering additional quantitative easing.
Both zero percent interest rates and a bloated balance sheet may be necessary for the moment, but they aren’t without costs.
2. Lend ‘n Spend
President Barack Obama’s economic team has diagnosed the U.S. economy as suffering from a lack of aggregate demand. Businesses and consumers aren’t spending enough. Banks aren’t lending to make more spending possible.
Our casual observer might wonder how it is that more borrowing and spending can fix a case of excess leverage and overspending.
Banks made loans to anyone who could sign on the dotted line. People bought homes they couldn’t afford with no money down. Household debt as a share of disposable personal income rose to a record of 130 percent in the third quarter of 2007. It fell to 119 percent by the second quarter of 2010.
Periods of loose credit beget periods of tight credit. Regulators aren’t happy with either.
In his opening remarks at the Kansas City Fed’s annual Jackson Hole symposium on Aug. 27, Fed chief Ben Bernanke said bank regulators were “working to help banks strike a good balance between appropriate prudence and reasonable willingness to make loans to creditworthy borrowers.”
It sure sounds as if regulators want banks to take a second look at that loan they nixed. Maybe it will look better with a little regulatory coaxing.
3. A House Without a Home
For decades, house prices rose in line with the rate of inflation. That changed in 1997, when the rise in home prices galloped ahead of the consumer price index.
Nationwide, home prices fell 31 percent from their peak in the first quarter of 2006 to the trough (to date) in the first quarter of 2009, according to the S&P/Case-Shiller Home Price Index. Although it’s a great time to be a renter, record low mortgage rates have done little to spur housing demand.
Consumers did perk up when the government introduced a homebuyer’s tax credit of up to $8,000 last year, but new and existing home sales are lower now than before.
What’s the solution? Prices need to fall now as they did four years ago, just not as much.
The Obama administration’s various mortgage modification programs all have underperformed expectations. The latest is a “short refinance” program. The Federal Housing Administration will offer underwater homeowners current on their mortgage payments new FHA-insured low-interest loans if the lender writes down at least 10 percent of the unpaid mortgage balance.
The FHA insures the mortgage. The taxpayer assumes the risk.
The U.S. economy was brought to its knees by dodgy loans on the books of banks deemed too big to fail. Never again would depository institutions be allowed to get so large that their failure would imperil the nation, regulators said.
Fast forward from the second quarter of 2008 to the second quarter of 2010, and the four biggest banks are even larger as a result of government-orchestrated mergers. Wells Fargo & Co. with assets of $1.23 trillion, is more than two times larger.
New financial regulations aim to address the issue of TBTF by giving regulators new resolution authority for failing banks. That presumes regulators will identify the problem and elect to pull the plug. Good luck.
5. Extend and Pretend
After the housing bubble burst, regulators were shocked to learn there was gambling, and gaming, going on at the banks. New accounting rules forced financial institutions to bring shaky assets back onto their balance sheets and take losses.
While the government is using monetary incentives to encourage lenders to modify home mortgages, banks are taking the initiative on their own when it comes to commercial real estate loans. Such forbearance may be in the lender’s self-interest, but critics refer to it as “extend and pretend.” Extend the life of the loan and pretend that the borrower will pay it back in full.
The phrase has broader implications. Extend past policies that created the bubble and pretend it won’t happen again.
(Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)
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