NEW CALL FOR FED SPUR HOUSING / BARRON´S MAGAZINE ( HIGHLY RECOMMENDED READING )

Up and Down Wall Street

FRIDAY, OCTOBER 21, 2011

New Call for Fed to Spur Housing

By RANDALL W. FORSYTH

But stepped-up buying of mortgage securities could backfire if food and fuel prices jump.


The Federal Reserve may be mulling a new twist on its monetary policy.


The central bank should consider resume expansion of its holdings of mortgage-backed securities to reduce further the cost of home loans, which already hover just above record lows reached earlier this month, says Daniel Tarullo, a member of the Fed's Board of Governors.


Tarullo's call adds his voice among Fed officials calling for further unconventional policy moves to try to get the stagnant U.S. economy moving. It comes just a month after the Federal Open Market Committee approved the so-called Operation Twist, in which the central bank will buy $400 billion of long-term Treasury securities to attempt to bring down longer-term interest rates, while offsetting the purchases with the sale of an equivalent amount of shorter-dated notes. In addition, the FOMC decided to reinvest principal payments on its agency securities into agency mortgage-backed securities instead of Treasuries with the aim of making home loans cheaper and more readily available.


This latest effort at increased monetary-policy accommodation was opposed by three voting members of the FOMC, Richard W. Fischer, Narayana Kocherlakota and Charles I. Plosser, respectively the presidents of the Dallas, Minneapolis and Philadelphia Reserve banks. Since the Sept. 20-21 meeting of the policy-setting panel, Chicago Fed President Charles L. Evans, a voting member of the FOMC this year, and Boston Fed President Eric Rosengren, a non-voter, have called for still more accommodation. Now, they've been joined by Tarullo, so there are three dissident "doves" to counter an equal number "hawks" among Fed officials.


That leaves the most deeply divided Fed in decades. At various times, there has been a dissenting faction in favor of greater policy ease or one urging more tightening. Never in my recollection have there been dissents on both sides. Fed Chairman Ben Bernanke has to steer a policy through this unprecedented (to my knowledge) tension. And it's complicated further by two vacancies on the Board of Governors. Recall that the FOMC consists of the Fed governors, who normally number seven but now total just five, plus five Fed of the 12 district bank presidents who rotate with the exception of the New York Fed president, who serves continually because of New York City's role as the world's financial capital.


Bernanke's experience as head of Princeton University's economics department should serve him well in dealing with the dissenting factions. Academic politics are so vicious because the stakes are so low, according to the quote widely attributed Henry Kissinger. Given the FOMC's focus on the vital matter of the nation's economy, it can be safely assumed the Committee's members don't share the pettiness of academe.


For his part, Tarullo contends additional, large-scale purchases of mortgage-backed securities would boost mortgage lending and therefore the housing market. The resulting to spur to aggregate demand would ultimately lead to lower unemployment. That is how monetary policy's transmission has worked in the past, and while he acknowledged how the transmission is slipping -- particularly because of the difficulty in getting a home loan—he argued this is all we have in the absence of fiscal initiatives.


In essence, Tarullo is saying the Fed has to do something, anything to get the economy and employment growing. But in urging the Fed to increase its securities purchases, he is ignoring the recent experience that should be painfully apparent.


As I've written on several occasions, most recently in this week's print edition of this column ("Preoccupied with Wall Street"), the Fed's policies have backfired to produce precisely the opposite impact that the monetary authorities desire.


While the liquidity injection from the expansion of the Fed's balance sheet has boosted financial asset prices, it has reduced real, disposable income for the average American household. With unemployment high and incomes stagnant, real purchasing power is being reduced by higher food and energy costs. That squeeze on middle- and lower-income families is constraining their spending. Any pickup in spending during the third quarter was the result of a reduction of their savings rate, which assures the gains will be short-lived in the absence of income or credit growth.


Let's make it clearer: Fed policies to boost the economy benefit the so-called top 1% and hurt the other 99%, to use the nomenclature of Occupy Wall Street. In every cycle since World War II, monetary policy has worked by stimulating housing; lower interest rates induced renters to buy houses and homeowners to trade up or to refinance and leverage up. But even with record-low mortgage rates, would-be buyers are holding back in anticipation of further house-price declines. Even at zero interest rates, who wants to buy a home that could fall another 10% or more in the next year? And so, starts of single-family homes fall while rental building expands to satisfy demand from those for whom the American dream no longer is a house with a picket fence.


History shows monetary policy in the U.S. worked largely by turning on housing by lowering interest rates, and vice versa. That housing has failed to respond to record-low mortgage rates shows something is amiss. Yet, Tarullo proposes the Fed should buy mortgage-backed securities even the record shows the money goes to raise commodity and stock prices; the latter hurts consumers even as it helps investors.


Albert Einstein defined insanity as doing the same thing over and over and expecting a different outcome. With $1.6 trillion of excess reserves sloshing around the banking system, it is difficult to say what still more would accomplish. That is, other than to lower the dollar's value and boost commodity prices, which would make leave consumers with less to spend after paying higher prices for fuel and food.


So, to those who are pushing further Fed monetary stimulation, be careful about what you wish for.
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