In threatening economic times, government policy may help to avoid a recession or to reduce the impact of slowing growth. While markets have focused on Fed policy, the issues are not all within the scope of Fed powers.
Ben Bernanke has been meeting with Administration officials and Congressional leaders. Tomorrow he will testify before the House Budget Committee. He is expected to endorse some kind of fiscal stimulus package to accompany the Fed's interest rate reductions.
It is important that public officials restore confidence in economic leadership. Otherwise, the worry about a recession could become a self-fulfilling prophecy. Here is a review of action so far and what else might be on the menu.
The Fed has attacked the problem in the traditional way, by cutting interest rates. While many question the pace of the cuts, it has been a pretty rapid series of moves, beginning while data still showed solid growth. This is earlier action than in past recession threats.
The Fed has also instituted the TAF facility, accepting a wider range of securities as collateral from a broader range of financial institutions. Both David Merkel and Greg Ip, while observing some eventual risks, note the success of the policy in reducing LIBOR and the TED spread.
In our view the biggest problem with this policy is that many people never really understood it, complaining that the new form of lending did not provide permanent liquidity. We originally gave the Fed a "B-" on this plan, but the expanded auctions have done the job well. It is too bad the Fed did not introduce and explain the plan more effectively. It should have been part of the December rate policy announcement. The market lost confidence in the Fed at exactly this point.
Finally, Congress and the Administration cooperated in fixing the tax code so that homeowners getting mortgage forgiveness of various sorts would not be taxed on the adjustments.
There is now plenty of support for some sort of fiscal stimulus package. There are various plans, but nearly everyone agrees on the need for action. We think that a compromise will emerge. An excellent report from the Congressional Budget Office provides a scorecard for considering the impact of various proposals. The CBO provides non-partisan policy research for Congress. It does excellent work, and the report covers a wide range of alternatives.
Among other items, it considers the possible impact of broad proposals like those we cited in our "fantasy State of the Union Address." These include government purchase of distressed securities to restore the normal market function.
One highly-politicized issue is the role of Fannie and Freddie in restoring normalcy to the mortgage market. These Government Sponsored Entities (GSE's) have been a GOP target for years, especially after the accounting issues of a few years ago. The GSE's are seen as unfairly competing with private enterprise.
We believe that housing progress requires an increase in the conforming loan limit from the current $417,000. This would reflect actual pricing in much of the country. The House has passed such a bill. A temporary increase has been endorsed by both Bernanke and Treasury Secretary Paulson. Despite this, a story from the Treasury Department on Thursday stated that any increase in the limits must be part of a comprehensive reform package. This insistence would probably kill the change. Stocks sold off sharply after this story hit the wires.
How this issue is treated will be a good early indicator of whether bipartisan action is possible. While we expect and hope for the best, there is the possibility that election-year posturing could scuttle any plan.
Governments are better at using existing tools rather than building new ones. That is why we expect an expanded role for Fannie Mae (FNM) as part of any solution. We wrote about this last November, establishing a position at 29 (which we still hold).