From the howl of the press you might well think that the real estate and economic story of the moment is about AIG, and how they wanted to pay huge bonuses to retain the very people who insured collateralized debt without the means to pay off, thus costing American tax payers many billions of dollars. That’s been a pretty good distraction.
But the real story this week is about the new efforts to extend credit. The Federal Reserve, in its March 18th press release, committed to purchase an additional $750 billion of Agency mortgage backed securities (high quality mortgage backed securities issued by Fannie Mae and Freddie Mac), purchase an additional $100 billion in agency debt, and, to improve conditions in private credit markets, to purchase up to $300 billion in longer term treasury securities over the next 6 months. This brings the total investment in Agency mortgage backed securities to $1.25 trillion and Agency debt to $200 billion. These are examples of quantitative easing (see primer here from the Financial Times), used when the Federal Funds Target Rate is near zero and has a limited effect on the economy. In a sense the Fed has decided to “print money” (increase its credit limits) and buy assets, thus raising the price and lowering the interest rate on those assets. In this case they have focused their purchases on the housing market. The Fed’s purchase of $300 billion in longer term Treasury debt drove the 10 year Treasury Note interest rate down about half a percent, while also causing the value of the dollar to fall and the price of precious metals to soar. 30 year fixed rate mortgages have fallen as low as 4.75%. Some think rates are near the bottom.
The coming week brings more details on the bank bail out. The program for “stress tests” of the 19 largest banks will continue through April and determine which banks will require additional capital later this year to survive. The irony is that having already used a silver bullet on the Stimulus package and now with a populist backlash against the banks, the government cannot really afford to take on the bank’s toxic debt with more government spending. It hopes to use public private partnerships to purchase the toxic bank debt. The government will provide the financing and share the risk of loss while the private investors will manage the government’s money along with their own to determine the best purchase price and hopefully earn a profit.
University of California Economist Brad DeLong provides a useful frequently asked questions article about today's bank bailout program announcement.
