Fear Over the Fed

Robert Novak

8/23/2007 12:01:00 AM - Robert Novak

WASHINGTON -- The unexpected, widely praised cut in the discount rate last Friday only momentarily removed pressure from the Federal Reserve. While the Bush administration and conservative economists deplore bailing out improvident investors, leaders of the mortgage finance industry consider it unthinkable that the central bank will not take decisive action.

A cloud of fear will hover over the Federal Open Market Committee (FOMC) when it meets Sept. 18. More than impecunious homebuyers and reckless hedge fund operators are afraid. The failure of reputable lending institutions plants apprehension about a general housing slump that will guarantee an economic slowdown and threaten recession. Republican businessmen look to Washington for help. They want an interest rate cut -- and more.

Secret plans carefully laid by Federal Reserve Chairman Ben S. Bernanke for a gradual, non-inflationary easing are no longer operative. The real world has impinged on desires to cut the federal funds rate by the end of the year. With Congress in its summer recess, Senate Banking Committee Chairman Christopher Dodd (seeking to revive his moribund presidential campaign) summoned Bernanke to his offices Tuesday to demand action now.

Prominent supply-side economists warn against precipitous action with ruinous results for the economy. Last Sunday, consultant (and former Fed governor) Lawrence Lindsey told his clients that monetary policy will be "neutral to restrictive for quite some time." On Monday, Bear Stearns economist David Malpass said "credit market turbulence . . . marks the end of the U.S. and global reflation." In The Wall Street Journal Monday, economist Brian Wesbury wrote that "even very easy money today can't put off the day of reckoning for subprime mortgage holders who bought homes with no money down and thought interest rates would stay low forever."

The private analysis at the upper reaches of the Bush administration has been that the credit crisis was limited to subprime lenders. The frightening developments of the past week reflect a different story -- afflicting jumbo (over $400,000) mortgages, other housing and the broader economy.

-- On Aug. 3, American Home Mortgage, based in Melville, N.Y., closed its windows to borrowers and ceased operations (laying off all but 750 out of more than 7,000 employees). It explained: "Conditions in both the secondary mortgage market as well as the national real estate market have deteriorated to the point that we have no realistic alternative."

-- Last Thursday, Countrywide Financial, Calabasas, Calif., the nation's largest mortgage banker that funds one out of every five U.S. loans, was reported by Merrill Lynch to be facing bankruptcy. On Friday, it disclosed using its entire $11.5 billion line of credit.

-- On Monday, jumbo specialist Thornburg Mortgage Inc., Santa Fe, N.M., announced it would take no new loan applications. Facing a severe cash shortage, Thornburg sold $20.5 billion in securities at discount.

-- On Monday, Capital One Financial Corp., Overland Park, Kan., announced an immediate end to residential mortgage operations at its wholesale mortgage unit, GreenPoint Mortgage. "Current conditions in the secondary mortgage markets create significant near-term profitability challenges," Capital One announced.

A prominent Republican banker in the Midwest (whose firm has not been hurt by the credit crunch) is disturbed by the rhetoric coming out of New York and Washington. "This is not a matter of hedge funds with subprime paper," he told me. "These are solid firms going under."

This banker wants help from Washington, not only the Fed's interest rate cuts but also additional assistance from Freddie Mac (supporting the secondary mortgage market) and Fannie Mae (lending to the primary mortgage market). Although the FOMC's statement last Friday constituted a directive away from neutrality toward easing to prepare for interest rate cuts, Fed-watchers doubt that the FOMC will do more than cut the federal funds rate by 50 basis points (one-half of one percent). The administration and conservative economists oppose raising the caps on Freddie and Fannie.

Sen. Dodd's stunt of summoning Ben Bernanke and Treasury Secretary Henry Paulson to his office Tuesday promises more of the same when Congress reconvenes in September. While Dodd commended Bernanke's attitude toward the credit crunch because he "gets it," he criticized Paulson's caution. Indeed, in failing to perceive this threat to the economy, not for the first time has the Bush administration been behind the curve.