Monday, September 17, 2007

Weak Hand At Fed Compounds Mortgage Crisis

Back in July, Tom Petruno, a writer for the L.A. Times Business section, had a strong Page 1 article warning that the sub-prime mortgage crisis was metastasizing into other parts of the economy and would only get worse.

That has certainly come true, and as the crisis has spread, popping up in unexpected places like, this past week, Britain's Northern Rock mortgage lender, the fifth largest in that country, with multi-billion dollar runs on its deposits and a catastrophic decline in its stock price, the crisis is only being compounded by the uncertainty in regulatory quarters as to how to deal with it.

It is a crisis that is not easily containable, as this blog said on July 23. If anything, the outlook since then has certainly grown more somber.

One of the problems, very frankly, is weakness, continued temporizing, at the Federal Reserve Board by its new chairman, Ben S. Bernanke. It could well be that Bernanke's predecessor, Alan Greenspan, bears a share of the responsibility for letting sub-prime mortgages get out of hand years ago, going to borrowers who would never be able to repay them. But at least Greenspan was decisive. When economic trouble reared its ugly head, he took strong and definite action to squelch it and to reassure the markets.

Bernanke has not, thus far, been so decisive. He reminds me of the Carter Administration economists who allowed inflation to soar as high as 20%, while saying all the time that any proposed step to lessen it would only spin the economy into greater difficulties. Their uncertainty as to what to do contributed to the unraveling of the Carter Administration and helped bring Ronald Reagan to the Presidency. Reagan was a figure who inspired more confidence, and as soon as he took over, the inflation rate began dropping.

Bernanke first downgraded the mortgage crisis as not having critical importance. Then, when he realized it did, he resisted lowering the discount rate on grounds partially that this might further weaken the dollar abroad and encourage inflation. Then, he lowered one rate and now is caught up in the issue as to whether to lower the discount rate by one quarter or one-half a point. His uncertainty has roiled the stock market and, in fact, made a bad situation worse.

In a situation like this, those in authority have to choose, often between bad alternatives. If they let the situation drift, it becomes even more of a crisis.

One of the most difficult things about the situation is continued uncertainty as to just who is exposed to the weakness in the housing markets both here and abroad. There have been so many strange investments in exotic securities, borrowings between banks, involvement of less-than-stable hedge funds and so on that not even the experts can be sure about what is happening or what will happen next.

But in the background is the failure of the regulatory authorities to exert their control early enough to be sure that things don't run off the tracks. That was true in the events leading up to the great depression, it was true with the savings and loan crisis, assorted currency crises in Asia and South America, and it is certainly true with the sub-prime mortgages. There has, historically, not been enough control, and it is apt to take a stronger hand than Bernanke's to aright matters.

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Ron Brownstein is the latest well-known journalist to leave the L.A. Times, although there are reports this morning his column will continue to run in the paper. His departure, however, as a full time employee cannot be much of a surprise, because Brownstein was forced by the editors to leave regular political writing by his wife's employment in the McCain presidential campaign, and his subsequent Op Ed page and Opinion columns in the Times have been serviceable at best. Clearly, he had been placed in a difficult situation, and has now decided to move on.
He will now write principally for the National Journal, its allied publications, and the Atlantic magazine.

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