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How QE Is Impeding the Economic Recovery


The problems that are impeding the economic recovery are not due to the lack of federal agency-backed mortgage loans that wind up in securities, but rather the continued contraction of US bank balance sheets.

MINYANVILLE ORIGINAL Since the 2009 lows and the QE-infused bizarro world market where good news is bad news and fundamentals are irrelevant, investors have had no shortage of juxtapositions with which to add to the confusion. But last week we were provided two that may epitomize the post-credit crisis reality.

On Thursday Federal Reserve Chairman Ben Bernanke gave a speech titled Challenges in Housing and Mortgage Markets where he discussed the obstacles in obtaining credit.
...restrictive mortgage lending conditions do not seem to be linked to any insufficiency of bank capital or to a general unwillingness to lend.

Certainly, some tightening of credit standards was an appropriate response to the lax lending conditions that prevailed in the years leading up to the peak in house prices.

However, it seems likely at this point that the pendulum has swung too far the other way, and that overly tight lending standards may now be preventing creditworthy borrowers from buying homes, thereby slowing the revival in housing and impeding the economic recovery.

On Friday we learned of the results of the FHA's (Federal Housing Administration) annual audit that showed a net worth deficit of $16.3 billion due to rising mortgage delinquencies. The projected losses raise the prospects of a (nother) tax payer bailout. As reported in the Wall Street Journal:

The FHA is required to maintain enough cash to pay for projected losses on the $1.1 trillion in loans that it guarantees. Last year, the independent audit said the FHA would have $2.6 billion after covering estimated losses.

But the latest forecasts show that while the FHA currently has reserves of $30.4 billion, it expects to lose $46.7 billion on the loans it has guaranteed, resulting in a $16.3 billion deficit. Friday's report was released as part of an annual review required by Congress.

Chairman Bernanke was well aware of the FHA's solvency issues when he made that speech so it seems odd that he would complain about tight credit conditions in the mortgage market at a time when tax payers may have again foot the bill for home loans gone bad. Nevertheless Bernanke is missing a very critical variable in the lending process, and in doing so, I think he has exposed a fundamental flaw in current Fed policy.
At the Federal Reserve, we have sought to support the economic recovery and maintain price stability -- the two goals given to us by the Congress -- by keeping both short-term and longer-term interest rates historically low. Low interest rates reduce the cost to households of buying homes, cars, and other consumer durables while increasing the attractiveness of new capital investments by firms. Increased demand in turn leads to faster economic growth and more jobs.

So on the one hand Bernanke argues that lending conditions are too tight, inhibiting growth, but on the other hand he extols the virtues of the Fed's historically low interest rate regime on improving economic activity. Conventional wisdom would have you believe that interest rates are low because credit is tight. I think it could be the opposite. I think at this point in the cycle its possible tight credit is a product of historically low interest rates.
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