EVEN AS THE U.S. housing market was at the top of what we now know was a disastrously unsustainable boom, top officials of the Federal Reserve had no clue about the looming bust, according to newly released transcripts of internal Fed deliberations. “I think we are unlikely to see growth being derailed by the housing market,” newly installed Chairman Ben S. Bernanke said in March 2006, precisely the moment at which home prices were peaking. As late as December 2006, Mr. Bernanke was still predicting “a soft landing.” Timothy F. Geithner, then-president of the New York Fed and now Treasury secretary, voiced general agreement.
There’s a lesson here. It’s not that Mr. Bernanke and Mr. Geithner are a couple of incompetents. Rather, the point is that even brilliant and conscientious public officials are susceptible to inertia and conventional wisdom or incomplete information. As a result, there will always be a limit to government’s ability to foresee “systemic risk,” let alone act against it in a timely manner.
The Dodd-Frank regulatory reform bill set up a Financial Stability Oversight Council to spot the next catastrophic threat. The group has issued its first report, and, while it’s a perfectly sound work, there’s not much you couldn’t find in any number of think-tank pieces. Sample sentence: “The impact on the U.S. financial system of events in Europe depends on how the peripheral European sovereign debt crisis evolves and on the resilience of U.S. financial institutions and markets.”
It is a little surprising, in this light, to see the Federal Reserve wading into the policy debate over how to fix the housing market now. On Jan. 4, Mr. Bernanke sent an unsolicited memorandum to the relevant Senate and House committees, outlining a series of measures. The Fed is no doubt right to worry that bottlenecks in housing credit have limited the stimulative impact of the Fed’s low-interest policy. The question is whether the benefits of the options it described to Congress necessarily outweigh the risks.
In particular, the Fed memo calls on Fannie Mae and Freddie Mac to do still more to subsidize housing finance by relaxing conditions for refinancing and speeding the conversion of foreclosed homes in its possession to rental properties. The problem, as the memo recognizes, is that this would add to Fannie and Freddie’s potential losses at a time when they are in government receivership, dependent on taxpayer funding and, as such, legally bound to minimize their losses.
The Fed memo suggests that its recommendations would, in a sense, pay for themselves — that “greater losses to be sustained by the . . . [government-sponsored enterprises] in the near term might be in the interest of taxpayers to pursue if those actions result in a quicker and more vigorous economic recovery.” But obviously there’s no guarantee of that.
Congress ought to weigh the Fed’s ideas seriously, with due skepticism. Housing needs help, but most government attempts to fix the market so far have underperformed or failed outright. If this crisis has taught us anything, it’s that risks might be hiding anywhere — and even the Fed doesn’t necessarily know what it doesn’t know.
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