Fed study suggests mortgage agencies taking losses would support housing market

According to a Bloomberg article, Fed Chairman Ben Bernanke provided Congress with a Fed study that suggests that having the mortgage agencies take losses would support the housing market.

It is really nice to have the Fed confirm a fundamental assumption underlying your humble blogger's blueprint for saving the financial system.

Regular readers will recall that under the blueprint, banks act as a safety valve by being a circuit breaker between the excesses of the financial market and the real economy.  Specifically, banks are suppose to recognize the losses from the financial excesses.

The Fed study confirms that banks can act as a safety valve and the result of their action will be to protect the real economy.

Please re-read this conclusion!

The Fed study talks about mortgage agencies, how do we know this also applies to banks?

The mortgage agencies are the functional equivalent of large banks.

Like banks, their assets are a mixture of loans and securities backed by loans.  Like banks, they offer credit enhancements (in their case, it is guarantees on the performance of mortgage backed bonds).  Like banks, they rely on a government guarantee to attract funding .... Like banks, they can operate for years with significant negative book equity.

Needless to say, it is very exciting to have the Fed saying that banks acting as a safety valve by aggressively recognizing losses is good for the real economy.

A report from Federal Reserve Chairman Ben S. Bernanke called the weakness in the housing market a “significant barrier” to U.S. economic health and said Fannie Mae (FNMA) and Freddie Mac might have to bear greater losses to stoke a broader recovery.

The study, delivered today to leaders of the Senate Banking and House Financial Services committees, noted “tension” between aiding the economy and minimizing losses of the failed government-sponsored enterprises, which depend on taxpayer aid for survival. 

“Some actions that cause greater losses to be sustained by the GSEs in the near term might be in the interest of taxpayers to pursue if those actions result in a quicker and more vigorous economic recovery,” according to the study.

That tension was a theme throughout the 26-page report, which examined ways to clear the glut of foreclosed (FORLTOST) properties, protect homeowners from default (DLQTDLQT), and help more borrowers take advantage of record-low mortgage rates. Doing nothing would chill an already-tepid expansion, according to the report. 

A policy of no action will lengthen the housing slump, generate higher costs to the economy, push home prices lower and prolong “downward pressure on the wealth of current homeowners and the resultant drag on the economy at large,” the paper found.

This is exactly what the global economy is experiencing as a result of the policy of no action with regards to the banks.

The study was meant to provide a framework for “thinking about certain issues and tradeoffs,” Bernanke said in a letter accompanying the report. “Restoring the health of the housing market is a necessary part of a broader strategy for economic recovery.”...