A Perspective Behind The FED's Plan To Lower Mortgage Rates, aka The MBS Bailout

In his most recent post, Brad Setser doesn't specifically address the FED's recent action in the Agency MBS market (remember the FED's $500b MBS purchase program?), but he does provide some great analysis of the numbers that are behind the FED's move.

From one of my new favorites, Brad's Follow The Money blog:

This is what a crisis looks like in the balance of payments data, 12/15/08

[Agency - Fannie, Freddie, Ginnie Mae]

"So much for talk that central banks are always a stabilizing presence the market. They clearly have destabilized the Agency market. The fall in demand for Agencies over the past three months — and most Agency demand has come from central banks until recently — has been sharper than than the fall in demand for US corporate bonds (think securitized subprime mortgages, the category “corporate bonds” in the BoP data includes asset-backed securities) after the crisis of last August."

"The Agency market is a rather important market. Increased lending by the Agencies offset the fall in demand for “private” mortgage-backed securities after the crisis last August. More recently, the absence of a “central bank bid” has kept
Agency spreads wide even after the US Treasury bailout of Freddie and Fannie. And that in turn has pushed the US to adopt other measures to bring down long-term mortgage rates. The Fed and the Treasury are literally now buying the Agencies that foreign central banks are selling. Action, reaction …"

Earlier in the same post, Brad points out "[foreign investors added] $400 billion in demand for safe dollar denominated assets [T-bills, T-bonds]. If that kind of monthly inflow is annualized it is a shockingly large number. It allowed foreigners to reduce their holdings of Agencies by close to $75 billion (including a $25 billion fall in short-term Agencies), their holdings of long-term corporate bonds by $13 billion and their holdings of US equities by $6 billion without causing any strain on the dollar."

According to Brad, that's $75b just in October. I'm sure numbers like these make the FED and Treasury nervous.

On to Bailout #2 - Is the Hubbard Plan next?

Earlier this month The $700b Bailout was passed into law. Labeled the Emergency Economic Stabilization Act of 2008, it provides Paulson & Co. $700b with which to purchase any type asset from any investor it deems worthy of its favor (among other things).

Not only did it receive a considerable backlash from the general public and quite a few government representatives, but it also drew criticism from a significant number of economists around the country. One of those economists was Jeff Miron of Harvard, who suggested that the banks and investors who purchased all of these risky, non-performing assets bear the responsibility and file for bankruptcy if need be and the American taxpayer should not bail them out.

Another such economist (though not on the list linked above) is Glenn Hubbard, current dean of the Columbia University Graduate School of Business and former chair of the Council of Econimic Advisors. Mr. Hubbard has come up with his own plan which he presented in an editorial in the Wall Street Journal on October 2nd:

First, Let's Stabilize Home Prices

"We propose that the Bush administration and Congress allow all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25% (matching the lowest mortgage rate in the past 30 years), and place those mortgages with Fannie Mae and Freddie Mac. Investors and speculators should not be allowed to qualify."

In addition to focusing on the very real problem in the housing market, the plan could be implemented immediately. As a result of the U.S. government's conservatorship of Fannie Mae and Freddie Mac, origination of new mortgages can be financed quickly. Congress would have to raise the overall borrowing limit and approve the new federal purchases of negative equity loans. But it will likely take the Treasury much longer to buy troubled assets than Fannie and Freddie, and it would have to seek the involvement of many additional private actors, as opposed to using vehicles already in place. The decline in housing prices remains the elephant in the room in the discussion of the credit market deterioration. Let's start there."

The Hubbard plan was also covered by NPR:
Bailout Critics Say It Won't Fix Underlying Problem, NPR Morning Edition 10/3

Is this a viable and/or appropriate solution for our ailing economy? Or is Hubbard just trying to score a few points on Bernanke (the guy who took his spot at the Fed)?