Ten Days That Changed Capitalism
Ten Days That Changed Capitalism
(From THE WALL STREET JOURNAL)
The past 10 days will be remembered as the time the U.S. government discarded
a half-century of rules to save American financial capitalism from collapse.
On the Richter scale of government activism, the government's recent actions
don't (yet) register at FDR levels. They are shrouded in technicalities and
buried in a pile of new acronyms.
But something big just happened. It happened without an explicit vote by
Congress. And, though the Treasury hasn't cut any checks for housing or Wall
Street rescues, billions of dollars of taxpayer money were put at risk. A
Republican administration, not eager to be viewed as the second coming of the
Hoover administration, showed it no longer believes the market can sort out the
"The Government of Last Resort is working with the Lender of Last Resort to
shore up the housing and credit markets to avoid Great Depression II,"
economist Ed Yardeni wrote to clients.
First, over St. Patrick's Day weekend, the Fed (aka the Lender of Last
Resort) and the Treasury forced the sale of Bear Stearns, the fifth-largest
U.S. investment bank, to J.P. Morgan Chase at a price so low that a shareholder
rebellion prompted J.P. Morgan to raise the price. To induce J.P. Morgan to do
the deal, the Fed agreed to take losses or gains, if any, on up to $29 billion
of securities in Bear Stearns's portfolio. The outcome will influence the sum
the Fed turns over to the Treasury, so this is taxpayer money; that's why the
Fed sought Treasury Secretary Henry Paulson's OK.
Then the Fed lent directly to Wall Street securities firms for the first
time. Until now, the Fed has lent directly only to Main Street banks, those
that take deposits from ordinary folks. That's because banks were viewed as
playing a unique economic role and, supposedly, were more closely regulated
than other types of lenders. In the first three days of this new era,
securities firms borrowed an average of $31.3 billion a day from the Fed.
That's not small change, and it's why Mr. Paulson, after the fact, is endorsing
changes to give the Fed more access to these firms' books.
In the days that followed, the Republican Treasury secretary leaned on two
shareholder-owned, though government-chartered, companies -- Fannie Mae and
Freddie Mac -- to raise capital that their boards didn't want to raise. In
exchange, their government regulator allowed them to increase their leverage so
they can buy about $200 billion more in mortgage-backed securities.
So Fannie and Freddie will get bigger, a welcome development when mortgage
markets are in trouble. Already, they have regained lost market share. They
accounted for 76% of new mortgages in the fourth quarter of last year, up from
46% in the second quarter, Mr. Paulson said Wednesday. But everyone knows that
if Fannie or Freddie stumbles, taxpayers will get stuck with the tab.
And then, the federal regulator of the low-profile Federal Home Loan Banks,
which are even less well capitalized than Fannie and Freddie, said they could
buy twice as many Fannie and Freddie-blessed mortgage-backed securities as
previously permitted -- more than $100 billion worth.
Was this necessary? It's messy, uncomfortable and undoubtedly flawed in many
details. Like firefighters rushing to a five-alarm fire, policy makers are
making mistakes that will be apparent only in retrospect.
But, regardless of how we got here, the clear and present danger that the
virus in the housing, mortgage and credit markets is infecting the overall
economy is too great to ignore. The Great Depression was worsened because the
initial government reaction was wrongheaded. Federal Reserve Chairman Ben
Bernanke spent an academic career learning how to avoid repeating those
Is it working? It is helping. One key measure is the gap between interest
rates on mortgages and safe Treasury securities. A wide gap means high mortgage
rates, which hurt an already sickly housing market. A lot of recent activity,
including Wednesday's previously planned auction in which the Fed is trading
Treasurys for mortgage-backed securities, is aimed at increasing demand for
those securities to drive down mortgage rates.
The gap remains enormous by historical standards, but has narrowed. On March
6, according to FTN Financial, 30-year fixed-rate mortgages were trading at
2.92 percentage points above the relevant Treasury rates; Wednesday the gap was
down to 2.22. Normal is about 1.5 percentage points. Money markets are still
under stress, as banks and others hoard cash and super-safe short-term
Is it enough? Probably not. Although it's hard to know, the downward tug on
the overall economy from falling house prices persists. The next step, if one
proves necessary, is almost sure to require the explicit use of taxpayer money.
The case for doing more is twofold. One is to cushion the blow to families
and communities, even if some are culpable. The other is to disrupt a dangerous
downward spiral in which falling prices of houses and mortgage-backed
securities lead lenders to pull back, hurting the economy and dragging asset
prices down further, and so on.
In ordinary times, a capitalist economy lets prices -- such as those of
homes, mortgage-backed securities and stocks -- fall to the point where the
big-bucks crowd rushes in, hoping to make a killing. But if the big money
remains on the sidelines, unpersuaded that a bottom is near, the wait for
bargain hunters to take the plunge could be very long and very painful.
So the next step, no matter how it is dressed up, is likely to involve the
government's moving in ways that put a floor under prices, hoping that will
limit the downside risks enough so more Americans are willing to buy homes and
deeper-pocketed investors are willing, in effect, to lend them the money to do