The Fed’s credit problem

By Felix Salmon
June 19, 2012

Jon Hilsenrath, the Fed Whisperer, has a very good piece this morning on a key worry facing monetary policymakers as we go into the latest FOMC meeting: the Fed might be able to push long-term interest rates down, but as any fixed-income professional knows, there’s a huge difference between rates and credit. And something worrying is clearly happening in the mortgage market: rates are low, but credit is very, very hard to come by. Or, as millionaire homeowner Chris Hordan put it to Hilsenrath, “If you don’t need the money, you can get it all day long. Thank you, Ben Bernanke.”

This is a long-term trend, which has only been getting worse in the so-called recovery: fewer and fewer homeowners who could really use the savings are finding it possible to refinance their homes.

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This is not entirely irrational on the part of banks. As Mary Umberger reports:

In recent years, when facing financial pressure, homeowners have been more likely to let the mortgage slide before they would fall behind on their credit card bills, researchers have found.

But it turns out that the mortgage is even less sacred than we thought: When times are tight, consumers put paying for their cars first. Then the credit cards will be paid.

The once-mighty mortgage has slipped to No. 3.

In other words, even as interest rates have fallen, default risk on mortgages continues to be high, especially for borrowers with less-than-stellar credit. According to Hilsenrath, mortgage rates for a household with a credit score of 650 are now just 4.04%; while that’s higher than the rates available to households with a score of 750, it’s still so incredibly low that banks will reasonably decide that it’s just not worth taking the credit risk, if all they’re getting is 4% in interest. Once upon a time, banks basically ignored credit risk on mortgages; now, they’re hyper-sensitive to it. And insofar as there’s a broadly-based societal trend whereby mortgage debt is moving from senior to junior status, then that’s all the more reason to stay on the sidelines for the time being.

Here’s how Hilsenrath puts it:

Credit is the most important and most direct channel through which Fed policies affect the economy. The problem for the Fed is that the pipes in the financial system through which its easy money travels are clogged.

It seems we don’t need Ben Bernanke any more, we need Super Mario to come in and unclog those pipes. It’s a hugely important job, but the problem is that no one knows how to do it, especially insofar as the clogs look like rational market pricing more than crisis-related market inefficiency. (Remember, the prepayable fixed-rate 30-year mortgage itself is something which is never found in a laissez-faire capitalist system: only government intervention can ever persuade banks to issue such things.)

All of which helps underscore my belief that we’ve more or less reached the limits of what the Fed can do. In order to get this economy back on track, what we need is fiscal, not monetary, stimulus. Don’t hold your breath.

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