Last week, while Congress and the nation were preoccupied with the holidays, the Treasury made a Christmas eve announcement that it would be providing Fannie Mae and Freddie Mac unlimited financial support for the next three years. The Treasury's press release notes:
“At the time the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship in September 2008, Treasury established Preferred Stock Purchase Agreements (PSPAs) to ensure that each firm maintained a positive net worth. Treasury is now amending the PSPAs to allow the cap on Treasury's funding commitment under these agreements to increase as necessary to accommodate any cumulative reduction in net worth over the next three years.”
Put simply, in a single, coordinated stroke, the Treasury and the Federal Reserve have encroached on spending powers that are enumerated for the Congress alone. Under the Housing and Economic Recovery Act of 2008 (HERA), the Treasury has no such open-ended authority.
As I wrote several weeks ago, “The Federal Reserve has expanded the
The Treasury's action last week completes this circle. It provides a surprise pledge of public resources to make these mortgage loans whole, and an unlegislated commitment to make the “implicit” backing of Fannie Mae and Freddie Mac explicit. All without debate, and without the force of public will. Even as the homeowners underlying these mortgages lose their property to foreclosure.
Or worse, perhaps homeowners who have been diligently making their payments will keep their homes, and homeowners who took out mortgages they couldn't afford will keep their homes as well with no adverse consequence to the lenders – since the underlying loans are now owned largely by the Fed, and the Treasury has pledged its unlimited support. Why pay one's debts if it becomes optional, and the Treasury stands to absorb unlimited losses at public expense?
This policy is likely to lead to far more delinquencies. Whether it will lead to far more foreclosures depends on the nations' capacity and willingness to shoulder multiple insolvencies in order to protect bondholders, mortgage our national wealth to
What is likely, in my view, is that we will observe far greater issuance of government liabilities, which will predictably create a near doubling of the consumer price index in the coming decade (though probably not for a few years due to credit concerns, which dampen monetary velocity). It is notable that the massive expansion of government liabilities beginning in the late-1960's eventually exploded into uncontrollable inflation by the late 1970's. There are lags between the creation of government liabilities and their inflationary effects. But to expand these liabilities as recklessly as the Fed and Treasury are now doing is to undermine the long-term foundations of the economy.
It is commonly argued that we cannot observe inflation with unemployment so high. In my view, this is a misinterpretation of A.W. Phillips (1958) analysis. While the famed “Phillips Curve” was described as a relationship between (nominal) “money” wages and unemployment, the British data Phillips used was from a period when