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Saturday, March 22, 2008

Are Central Banks Planning to Make Coordinated Purchases of Mortgage Backed Securities?

I've proposed that central banks purchase mortgage backed securities to remove risk from financial markets a couple of times as one part of a package of measures to free up credit markets, but it's received a cold reception each time (the second link has the most details - I used the term "Risk Absorber of Last Resort" to describe this type of policy, and I could have stressed the last resort aspect more than I did). It's not hard to understand why these proposals find little support since they are viewed as bailing out the very people who created the problems we are experiencing, thereby creating a moral hazard problem going forward and the perception that rich people get help while the typical household is left to fend for itself against the wave of foreclosures sweeping across housing markets. It is also viewed as putting taxpayer money at excessive risk. Even so, central banks appear to be considering such proposals, though it's not clear to what degree and which banks are involved. I'm glad that central banks are at least thinking along these lines even if it is only a last resort option - it's an indication they are doing their best to explore the full range of policy options, which is one of the reasons I initially pushed in this direction:

Central banks float rescue ideas, by Chris Giles and Krishna Guha, Financial Times: Central banks on both sides of the Atlantic are actively engaged in discussions about the feasibility of mass purchases of mortgage-backed securities as a possible solution to the credit crisis.

Such a move would involve the use of public funds to shore up the market in a key financial instrument and restore confidence by ending the current vicious circle of forced sales, falling prices and weakening balance sheets.

The conversations, part of a broader exchange as to possible future steps in battling financial turmoil, are at an early stage. However, the fact that such a move is being discussed at all indicates the depth of concern that exists over the health of the banking system. ...

The Bank of England appears most enthusiastic to explore the idea. The Federal Reserve is open in principle to the possibility that intervention in the MBS market might be justified in certain scenarios, but only as a last resort. The European Central Bank appears least enthusiastic.

Any move to buy mortgage-backed securities would require government involvement because taxpayers would be assuming credit risk. There is no indication as yet that the US administration would favour such moves. In the eurozone it would require agreement from 15 separate governments. ...

[A] strongly held view at one European central bank is that it is not “mark-to-market” accounting that is to blame for severe weaknesses in banks’ balance sheets but that prices of MBS securities have fallen to levels that imply unrealistically high rates of default.

If public authorities were to buy and hold sufficient mortgage-backed securities – rather than simply lend against them as they have until now – at prices well below face value but above current prices, they would set a floor in the MBS market.

The Fed does not believe that the point has yet been reached when such drastic action is necessary and considers the discussions it has had with its counterparts to represent “blue-sky thinking” rather than the formulation of a definitive policy proposal. ...

Analysts say the US government also has plenty of scope to boost support for the markets indirectly through the Federal Housing Administration or Fannie Mae and Freddie Mac.

The UK lacks these institutions, which could be one reason why the Bank of England is keenest to explore outright intervention. ...

I think the difference in institutions is one of the reasons for the different responses in the US and UK. In the US, using existing institutions such as the FHA to help homeowners by purchasing mortgages, and then reissuing them on better terms has much broader, but by no means universal, support - much more than intervening to purchase non-government securities. But as noted in the article, that option is not available in the UK.

But on the plans to purchase mortgage backed securities, there's this from the WSJ's economics blog:

Fed Says Not Discussing Coordinated MBS Buying, by Greg IP: The U.S. Federal Reserve, responding to press reports, said it is not discussing coordinated purchases of mortgage-backed securities with other central banks.

“The Federal Reserve is not involved in discussions with foreign central banks for coordinated buying of MBS,” a senior Fed official said. ...

[Krzysztof Rybinski, former deputy governor of the National Bank of Poland - citing an article in The Economist for support - seems to like the MBS purchase idea.]

It's probably a good time to remember this:

Matthew Yglesias (March 16, 2008) - Sunday Financial Meltdown Blogging: ...I don't, in general, have any opinions about the problems in the financial markets that go beyond the utterly obvious -- bad things seem to be afoot and I'm worried....

But ... I don't necessarily have a problem with the government intervening to bail a bunch of rich guys out when their own bad decisions blow up in their faces if that's what's needed for the health of the overall economy, but this sort of thing is one of several reasons why I think the very rich should pay high tax rates and we shouldn't be happy about the prospect of ever-growing inequality. At a certain level, the game is rigged and you're not really bearing any risk...

This is part of a more general point. One of many justifications for a progressive tax is to reduce inequities that arise because the economy departs from our ideal, textbook model. These departures from ideal conditions, and things like moral hazard and regulatory capture are certainly departures, allow income to be earned that is hard to justify. Using taxes to reduce the inequities that arise because some groups are unfairly advantaged by an imperfect system is a reasonable response to this problem.

One final note. I think there are two places to attack the financial market problems, cause (bad loans and foreclosures) and effect (falling asset values due to bad loans and foreclosures). On the cause side there are the mortgage purchase proposals (the plans from Alan Blinder and Barney Frank for example), and on the effect side there are the proposals to purchase the assets directly (or intervene in some other way, e.g. provide insurance or temporary shelter through lending facilities) in order to remove the risk from the market.

Dealing with the cause is best, but there is the question of timeliness - can we get it done in time? - and effectivieness - will it work - and my point all along has been that if we cannot solve the foreclosure problem using a Blinder/Frank type approach, we had better have other options waiting in the wings. Direct purchases of mortgage backed securities is one such option.

    Posted by on Saturday, March 22, 2008 at 12:33 AM in Economics, Financial System, Monetary Policy | Permalink  TrackBack (0)  Comments (19)


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