A Ray of Mortgage Market Sunshine

Economics maven John Rutledge finds good news: His March 24 blog posting hails a decision by the Federal Housing Finance Board to allow regional banks in the Federal Home Loan Bank system to add up to $150 billion in Freddie Mac & Fannie Mae mortgage-baked securities (MBS).  Rutledge explains that this doubles the amount such banks can buy, and thus adds much-needed liquidity to the$4.5 trillion MBS market.

Rutledge then gives another of his classic mini-seminars on economics.  The stimulus package, which aims to boost demand, does no good in a situation where the problem is the supply of credit.  It is a demand-side solution to a supply-side problem.   Good remedies are to increase transparency, so investors can better price securities and thus assess risks.  Bad things include empowering lawyers to sue, which reduces transparency and will freeze capital markets, empowering bankruptcy judges to amend contracts, which reduces predictability and hence transparency, and letting Congress grandstand.  Above all, he counsels against quick, temporary fixes, such as raising the mortgage lending ceiling for one-year, which would create an "orphan class" of securities hard to price.

Gerard Baker of the Times of London informs us that Fed Chairman Ben Bernanke has made a specialty of studying the causes of the Great Depression, and firmly agrees with the late Milton Friedman that policy errors by the Fed were a prime cause; Bernanke, writes, Baker, is determined to act decisively to prevent a repeat.  The continuing danger is that politics in the short-term, in the person of people like Democratic Congressman Barney Frank, will undermine economic recovery in the longer term, in the person of Treasury Secretary Hank Paulson who, unlike Rep. Frank, really understands the situation, and has a far better guess at what to do to encourage recovery.