The Federal Reserve as Housing’s Savior?

On March 11, the Federal Reserve stepped into the marketplace by pledging to swap $200 billion in Treasury securities for mortgage-backed securities that have been difficult to trade in the current credit mess.

Specifically, the Fed will lend dealers Treasury securities for up to 28 days, with the mortgage-backed securities used as collateral. But only those mortgage vehicles issued or backed by Fannie or Freddie, or triple A rated.

The hope is that this will boost liquidity and confidence. The markets initially loved this idea. The Dow jumped 3.6% on Tuesday, with the Nasdaq up 4% and the S&P 500 up 3.7%. But there’s been much talk about this being short covering. And in fact, the markets declined on March 12.

To get your head around this and previous Fed actions, and what they mean for housing and the economy, read Wall Street Journal columnist Holman Jenkins’ March 12 piece titled “The Fed Can’t Fix Home Prices.”

Jenkins noted:

Is a housing bailout the solution for clogged-up credit markets and a faltering economy? What the Fed has been doing and did again yesterday hasn't really worked, notwithstanding the pops it produces in the stock market every time it shovels liquidity into the system. The Fed's latest move provides financial institutions another $200 billion in direct short-term lending against their unsaleable housing collateral. The Dow Jones jumped 416 points. But it won't restart markets for the underlying collateral.

Where are the speculators, vultures and hedge funds? Where are the big money players willing to buy the exotic but still substantial mortgage-backed securities for which markets have ceased? The Fed's liquidity rush seems only to have convinced them the time is ripe for staying on the sidelines.

To get to a real solution, speculators and investors need to believe that home prices are hitting bottom, that any mortgage debt they might buy today for 80 cents on the dollar today won't be worth 30 cents tomorrow…

The Fed is pushing on a string -- it can't bring back confidence in specific assets by flooding the market with generalized liquidity, though it can certainly undermine confidence in the dollar and its own anti-inflation credibility. On all sides, meanwhile, the call for a housing bailout is becoming deafening, nigh irresistible. But the seized-up credit markets won't be unseized by trying to induce debtors to cling to houses they now see as throwing good money after bad.

Jenkins’ analysis and worries are right on the mark.