What Can The Fed Do Now About The Housing Crisis?

The housing crisis that is plaguing the United States seems only to be getting worse. Does Bernanke, or any other government official for that matter, have the answer? Toni Straka at The Prudent Investor looks more closely at the situation in his post below.

Halloween started early this year with a televised speech by the Fed's bearded chairmen Ben Bernanke. Recognizing that the problems in the biggest debt bubble of all times are far from over, Bernanke appeared helpless when offering several options for the future of the government sponsored entities (GSE) Fannie Mae and Freddie Mac.

The reorganization of the two mortgage giants, saddled with so many debts in default that no one can quantify reliably due to a lack of proper accounting, can take several ways.

Obviously addressing US policymakers, Bernanke presented four possibilities for the future role and organization of Frannie. The first one is rather wishful thinking: Returning the two GSEs to their pre-conservatorship status quo.

According to a Reuters dispatch from Friday, one in five homeowners sits on negative equity and it is going to get worse:

Nearly one in five U.S. mortgage borrowers owe more to lenders than their homes are worth, and the rate may soon approach one in four as housing prices fall and the economy weakens, a report on Friday shows.

About 7.63 million properties, or 18 percent, had negative equity in September, and another 2.1 million will follow if home prices fall another 5 percent, according to a report by First American CoreLogic.

The data, covering 43 states and Washington, D.C., includes borrowers nationwide, even those who took out mortgages before housing prices began to soar early this decade.

Seven hard-hit states -- Arizona, California, Florida, Georgia, Michigan, Nevada and Ohio -- had 64 percent of all "underwater" borrowers, but just 41 percent of U.S. mortgages.

As if this was not enough, Marketwatch raised concerns that nothing influences people's investments more than the change of value of their house.

Consumers react more to changes in their home values than changes in their investment portfolios, according to a recent study.

In fact, real estate economists at UCLA and the University of Southern California found that a 10% decline in housing wealth from the 2005 highs would result in a $105 billion, or 1.2%, drop in personal consumption expenditures. That 10% decline in home values translates to roughly a 1 percentage-point reduction in real GDP growth, researchers said. Read the report.

One of Bernanke's other options looks DOA when checking the state of markets. A true privatization is simply not in the cards after a 99% decline in the share price of Fannie and Freddie.

Elaborations about copycatting the European system of covered mortgage bonds may bring its problems too at a time when trust between lenders has reached an all-time low as it is demonstrated by the essential seize-up of interbank markets for more than a year by now.

This leaves Bernanke's last option: Bringing the GSEs under Uncle Sams rule, with or without additional shareholders. Taking it from the recent past where the former champion of free market ideology has made a bizarre U-turn with several acts of Fedization I would not wonder if this will also be the future of Frannie.

Seeing that Bernanke offers options without favoring one of them I am afraid that it is not Bernanke who will solve the mess that Greenspan made. Thinking about Treasury secretary Hank Paulson's recent moves that cost the taxpayers basically another $70 billion in bonuses for his friends on Wall Street and had them pay almost double the price for some bank shares it is most likely we will see another round of more government in everything.

Somehow the American economy reminds me of the twists in the life of Joseph A. Schumpeter, an economist who coined the term "creative destruction" 90 years ago, favoring a laissez-faire capitalism over any government intervention. Schumpeter did not fail to recognize the signs of his times. In a speech held in Tokyo in 1932 Schumpeter had already shifted his perception towards permissible protectionism.

10 years later, in 1942, Schumpeter had morphed into a socialist. In his late work "Capitalism, Socialism and Democracy" Schumpeter declared that capitalism had no chance of survival, praising Karl Marx' theory on socialism which offered a more flexible approach to the headwinds any system will encounter. Will the same happen to the USA?

This article has been reposted from The Prudent Investor. The full post can also be viewed on The Prudent Investor.