Real Estate Lender Implosion

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Crisis? What Crisis?

Thursday, Jul. 17, 2008
By JUSTIN FOX
Time.com

It's getting to be a familiar ritual. Markets panic. A bunch of G-men in dark suits interrupt their routines for an emergency meeting or a conference call to piece together a rescue plan. They announce the plan. Panic subsides. Then, a week to a couple of months later, it starts all over again.

I count six such episodes since August 2007. In the early days, the Federal Reserve Board did all the work and usually made its big announcement on a Friday. Since then, Treasury Secretary Hank Paulson has moved to the fore, and he picked a Sunday afternoon to float his proposal for bolstering beleaguered mortgage giants Fannie Mae and Freddie Mac. The basic pattern, though, remains the same: Financial tizzy. Dramatic government action. Period of reduced tizzy. Repeat.

Is this cycle ever going to end? It has to someday, although at this point only a fool or a psychic would dare predict when. The more important question may be, What the heck does it all mean for people without Bloomberg terminals and subscriptions to the Financial Times?

For the financial crowd, this may well be--as is oft proclaimed--the worst crisis since the Great Depression. But you don't have to agree with Phil Gramm that this is a "mental recession" to acknowledge that things don't look quite so bleak beyond Wall Street--unless you're struggling to make payments on a house that's worth 30% less than the mortgage. Then you're in crisis. Most Americans aren't. The economy still seems to be growing. Job losses have been manageable. Yes, people are very unhappy about the economy. But day to day, they're more worried about the price of gas than the soundness of the financial system.

In part, that's testimony to the success of those G-men in dark suits. (There are women involved, but they're a distinct minority at Treasury and the Fed; men in light-colored suits are even rarer.) The U.S. government is a far bigger, more activist presence in financial markets than it was in the early 1930s, and this activism has staved off the kind of financial breakdown that sparked the Depression.

You can see this most clearly in the case of Fannie Mae and Freddie Mac, which buy mortgages from banks, thrifts and mortgage brokers and repackage them for sale to investors around the world. The two government-chartered companies have, together with the Federal Housing Administration, been the main factors in keeping mortgage-lending going in the U.S. since the market for private mortgage-backed securities collapsed last summer. They've been able to keep financing mortgages because of the widespread belief that if they faltered, the government would step in to make buyers of their mortgage securities whole. If Paulson and the Fed hadn't stepped in when Fannie and Freddie faltered in early June, the companies might have stopped buying loans and the housing market might have stopped functioning.

All this activism comes at a price. The Fed's rate cuts have fueled inflation and undermined the dollar, now trading at about $1.60 to the euro. The Treasury's willingness to backstop Fannie and Freddie, which together are on the hook for $5.2 trillion in mortgage debt--just slightly less than what the U.S. government owes investors--is already sparking a bit of worry about the soundness of T-bills and bonds. With more bailouts, that worry could snowball.

There are also valid concerns about the fairness and prudence of hitting up taxpayers for the missteps of well-compensated mortgage shills and Wall Street hucksters. "Socializing risk and privatizing reward," Senator Chris Dodd has called it.

Finally, there's the matter of effectiveness. Washington's response has so far shielded the economy from the worst of the catastrophe in financial markets. But it hasn't fixed the problem that started the crisis: the fact that a few million Americans got home loans they can never pay back. The resulting foreclosures have been driving housing prices down and forcing lenders to retrench. The result is less credit for heavily indebted American consumers. In the second quarter of 2008, this credit crunch was counteracted by $78 billion in stimulus checks--yet another of those government interventions. That boost is petering out. The likeliest next step, while not the Great Depression, is a recession that even Gramm will have to concede is more than just mental. Which could lead to a few more emergency meetings of the men in dark suits.

http://www.time.com/time/magazine/article/0,9171,1823931,00.html