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.

rates.tiff

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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Comments
23 comments so far

In a low interest rate environment it’s suicidal to lend to any but the highest quality credits. This is a surprise?

When the only device one has at one’s disposal is a printing press – one prints. And keeps printing whether or not it does any good. And even if it does plausible harm, one always contrives some rationalization that purports to make a virtue of printing still more. This is a surprise?

Am I the only person on this board who is troubled by the fact the debasement of the currency is seen as acceptable “collateral damage” in the pursuit of an effort to do something that is itself pointless and ineffective?

Posted by MrRFox | Report as abusive

@MrRFox, you care more about the value of the currency than I do. If you step back and look at the “real economy”, people work, people produce, people consume. Different policies result in different patterns of work, produce, consume. A currency is essential to lubricate the gears, but it isn’t the primary good.

I’m plenty troubled by the fact that our present economic course is increasingly unhealthy and unsustainable. I’d suggest that things are worse today than they were in 2007, except that today people are at least AWARE that things are bad. Five years ago everybody was blissfully ignorant.

The first step: “We admitted we were powerless over our borrowing – that our lives had become unmanageable.”

So what is step two?

Posted by TFF | Report as abusive

What do you think of the idea Konczal of having the Fed by muni and state debt?

http://www.nextnewdeal.net/rortybomb/sho uld-federal-reserve-go-muni-market

Posted by Zdneal | Report as abusive

I meant idea Konczal touched on. He credits Richard Clayton, the Research Director of Change To Win.

Posted by Zdneal | Report as abusive

So far the Fed has only been willing to accept market and/or interest rate risk (except for Bear’s Maiden Lane). If the Fed took credit risk, then they could stimulate the economy by either a) increasing demand for lenders to originate higher risk loans, or b) forcing the existing debt to be restructured favorably for the borrower.

This taking of risk would require the Fed to buy assets outside of Treasuries, Fannie, and Freddie because the gov’t takes the credit risk there. One avenue would be for the Fed to commit to buying new private label securities of re-performing, restructured mortgages (regardless of who currently owns or guarantees the mortgage). With a liquid buyer willing to pay up for workouts, current investors would jump at getting the junk off their books.

Unfortunately such action would require the Fed to take the political risk of intervention and the reputational risk of bearing credit losses, even though the Fed is the one entity that can afford to take losses. Bernanke has the power to save the US economy, but I can’t imagine him having the guts.

Posted by kentwillard | Report as abusive

Fuk it – the Fed should just buy out the whole mortgage market for primary residences and offer refis to all. That’s pretty much what Fannie and Freddie were mandated to do, but they got stuck with mostly loser loans and none of the high-roller loans. It’d be like universal healthcare for the mortgage market. How much is the primary residence market worth in America? Maybe $10T? (150k avg home price X 65m households), and it gets Uncle Sam off the hook for Frannie. THAT would be some serious stimulus, and would give banks massive balance sheet relief.

I’m sure this could never happen, but makes for an interesting thought-experiment…

Posted by CDN_Rebel | Report as abusive

Does anyone have a source for what that chart looks like over a substantially longer period of time, say 20 or 30 years? Echoing Felix’s point that perhaps “the clogs look like rational market pricing more than crisis-related market inefficiency”, it’s abundantly clear with hindsight that in 2007 the mortgage market included a lot of loans that never should have been made. I’m more interested in how current numbers compare relative to 1980 – 1999.

Posted by realist50 | Report as abusive

“we’ve more or less reached the limits of what the Fed can do”.

That was at least 3 years ago. People still believe that businesses and individuals will invest if only interest rates are low, and ignore the reality that zero percent loans are not enough incentives to invest in the absence of a likely return. And some still believe that if only taxes were reduced, there would be more investments.

That said, stimulus spending is not sustainable. It will not spur businesses and wealthy individuals to invest more of their cash hoard, so it doesn’t spur any growth. And since the government refuses to increase taxes to finance any stimulus spending they can actually agree on, we just keep borrowing, which is an inefficient way to tax hoarders.

But thanks, Felix, for trying to keep this issue alive.

Posted by KenG_CA | Report as abusive

So we’ve discovered that banks are targeting their lending to people who can pay them back…

…that almost sounds like progress.

Posted by y2kurtus | Report as abusive

It may be suicidal to lend to all but the best risks, but it is also suicidal to not have your deposits lent out enough. A relative works for a enough of your deposits in performing loans. Financial institutions have gone too far when they won’t even make well collateralized loans to people with poor credit who simply stopped paying unsecured credit card debt.

A relative works for a small credit union that is rollign in deposits but doesn’t have enough money lent out to retain their current work force.

Even loans to low risk customers can quickly become bad loans when the terms of the borrower’s retirement or work have changed as well as when major health problems cause extraordinary expenses.

A lending institution that denies too many loans is on its way out of business, and I even have noticed banks I deal with generally having fewer and fewer branch employees, while spendign unreasonable amounts of resources trying to collect debts from those with only exempt income.

Posted by SeniorMoment | Report as abusive

more bank employees are just filling chairs–decisions are no longer based on your credit history, community connections–overall reputation for repayment and even your ability to repay. Decisions are two cities away by people who look at charts and not the borrower.
The Fed has some responsibility here–first an open spicket and then just a wet spot on the ground.

My bank–and I say that very loosely-recently raised interest on a 7 figure loan based on my deposits and great history of paying. Said that they had so many not paying on time in the area, they felt I could afford more. Banker who told me that got fired. They reduced my ability to grow and my ability to take advantage of cash discounts. So I now take my deposits down and don’t tell the bank or show them the actual income. Screw them.

Recently had banks come into see me and ask for business-deposits- but, said in the same breath, they were not making commercial loans. Are these banks? I will find a way around these dunderheads and hope they go under. Maker a conservative hard working responsible man sick.

Posted by kkurtt | Report as abusive

2/3 of the home mortgage tax deduction goes to families that make more than $100,000 a year and it costs taxpayers around 100 billion a year in lost revenue. Essentially, the tax deduction reduces the interest rate paid on the mortgage by around 1%.

Instead of the home mortgage deduction, the Fed could offer all Americans who qualify for a conforming load for their primary residence a loan at the interest rate the Fed currently pays plus the costs of administration.

The Fed would be using it’s power to borrow cheaply to directly benefit the American people, raise a hundred billion in taxes per year and stabilize the housing market and long term interest rates.

Posted by RobertSalzberg | Report as abusive

Why not force a reduction in consumer credit interest rates. credit card interest remains significantly north of 10%. reduce that APR (screw banksters’ profits for the nonce!) and let installment payments go against principal balances. The banksters themselves make this plain when the bills show the come-on that if a small percentage increment is added to current monthly payment, the average life of the balance will drop from 12 years to 3. That is a ridiculous differential! The one issue in our present economy no one seems willing to attack is usury.

Posted by midasw | Report as abusive

@MrRFox

Principal reductions actually do help people who own property but have no mortgages. It puts a floor under the housing market. You can’t begin to regain lost equity until real estate prices stop falling.

Posted by breezinthru | Report as abusive

@RobertS – Out-of-the-box thinking, guy. Maybe it works conceptually. The Fed would capture a giant share of the mortgage business; which means a giant share would be lost to the existing mortgage industry. Easy to foresee a lot of resistance from that side and from small-government-types – probably including me. Government sponsoring below-market rates on housing – do we want to go back there, big?

@Breez – I get principal reds reducing the supply of foreclosures on the market, and thus decreasing the downward pressure on prices to some extent. I don’t get how that “puts a floor under the housing market”. Enlighten us all, please – where exactly is the floor?

The vexing problem with principal reds is the hit banks have to take to balance sheets – they can’t cover it, though TFF et.al. believe otherwise. IMO – they can’t. Fix that then reds become easy.

Posted by MrRFox | Report as abusive

@MrRFox, I agree with you that SOME banks can’t cover the hit from principal reductions. We disagree on whether ANY of the big banks are able to do so. But that is a relatively minor point…

As for the housing market, principal reductions would reduce foreclosures but it could also spur sales that are presently an economic impossibility. Prices are still well above their historic norm (according to Case-Shiller), which makes talk of a “floor” at the present levels kind of silly. Even if they could be supported at the present levels, they probably shouldn’t be.

Bringing back a meme from the files, our best bet at this point might be “Faith and Hope”. We’ll ultimately be disappointed, of course, but such an attitude can slow the process and soften the blow. A “long grind down” can be better than a sharp collapse.

Then again, MrRFox’ suggestion of proletariat revolution sounds more tempting daily.

Posted by TFF | Report as abusive

Why lend when they can make money the easy way

Dirk van Dijk, writing for the investor website Zacks.com, explains what a good deal this is for the banks:
“Keeping short-term rates low . . . is particularly helpful to the big banks like Bank of America (BAC) and JPMorgan (JPM). Their raw material is short-term money, which is effectively free right now. They can borrow at 0.25% or less, and then turn around and invest those funds in, say, a 5-year T-note at 2.50%, locking in an almost risk-free profit of 2.25%. On big enough sums of money, this can be very profitable, and will help to recapitalize the banking system (provided they don’t drain capital by paying it out in dividends or frittering it away in outrageous bonuses to their top executives).”

This can be very profitable indeed for the big Wall Street banks, but the purpose of the near-zero interest rates was supposed to be to get the banks to lend again. Instead, they are investing this virtually interest-free money in risk-free government bonds, on which we the taxpayers are paying 2.5% interest;

via http://www.webofdebt.com/articles/banks_ near.php

Posted by UselessEater | Report as abusive

@UE -

You got it – Wall Street’s got it wired. Why not – they own DC, don’t they?

IMO you’re a million miles off the mark if you think that promoting general business was/is the motive for ultra-low rates, rather than pouring net income onto bank balance sheets. The real economy doesn’t need or want rates this low – financial services and government need them like you need oxygen.

Posted by MrRFox | Report as abusive

The trick, that the government seems to be missing, is that you need to live within your means and not over extend. That’s what gets people in trouble. The iPhone app, Purchases Tracker, has helped my family take control of our spending and cash flow. It helped us to cut out those purchases that we did not realize we were making and we have moved that money over to our retirement accounts. We are now back on track for our retirement, thanks to the iPhone app, Purchases Tracker by Suburbia Apps.

Posted by DaveSr | Report as abusive

It’s nice to have some straight-talk once in a while. Where has it been the past five years when all we got was B—S— Artist (BSA)-speak hyping the “positive” effects of “Quantitative Easing” (creating gobs of Cyber Dollars) on stock market prices and the returns of the One Percenters?

“So-called recovery…” Maybe Catfish will be willing to accept Paul Krugman’s (Nobel Laureate in Economics) assessment that we’re in the Third Depression. Maybe a few people will read his book, “How to Get Out of This Depression”. Maybe pigs will learn to fly. I still dream that truth will out.

Posted by ptiffany | Report as abusive

Considering that there is growing risk that housing prices will continue to decline, loaning to even the best borrowers is risky. We should be happy that banks are even willing to loan any money against assets of declining value.

Posted by 2contango | Report as abusive

Felix, you are missing the point. The main reason the FOMC is concerned about more QE is “FINANCIAL STABILITY” and for the first time I heard Bernanke say it outright. Finally it has gotten to him.
The economy can be modeled as an infinite number of recursive loops, some with + feedback, some with negative, they all interact. Keeping a system like this stable is no easy feat. Increasing liquidity, increases the gain of most of the feedback loops. When that happens only a miracle can preempt whole systems from going haywire or taking an oscillatory behavior. That behavior can trigger “resonances” in the physical sense (obviously the financial equivalent, but the behavioral equations are the same).
Once that type of behavior takes hold on the system, there is NO withdrawal of policy that will stop it. The loops become self sustained.
I have modeled this long ago and sent Bernanke an open letter before QE1 to try to entice somebody close to him to run the number and see the behavior in their models.
After the last press conference I am sleeping more quietly, since at from his words, at least somebody of his trust is aware of the risk.

Until next time,
Engineer

Posted by spine001 | Report as abusive

And what reason do we have to think that any politically, legally, and administratively practical fiscal measure will be LESS broken as a channel for stimulus????

You want stimulus? Print up $x per living person in the US and send it to them, as paper currency, exempt from all income taxes.

Whether people retire debt, increase most forms of savings, or consume with it, it will help work off the hang over.

ANY mechanism that depends on “channels” will be of very limited effect in the current environment. Because the channels will defend themselves one way or another.

You have to go direct.

Posted by BryanWillman | Report as abusive
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