Bryan from Houston, who’s been asking a lot of good questions lately, wonders apropos of the Frannie bailout:
Why don’t we just allow the market to work? In my mind, this will bring everything back into equilibrium.
But what if there isn’t just one possible equilibrium? Then the choice becomes, Do you want the equilibrium with house prices down 30% nationwide, incomes flat, and unemployment at about 7% (which is where I think we’ll end up sometime next year)? Or do you want the one with house prices down 60%, incomes way down, and unemployment at 14%? The first one sure sounds better to me.
The lesson that most economists (certainly not all, but definitely most) have taken from the Great Depression is that more aggressive Fed policy and more, earlier bailouts of financial institutions could have dramatically reduced its severity.
Bring this forward to the current situation. We’ve seen lots of aggressive Fed policy, and lots of bailouts. And so far we haven’t landed in another Great Depression. We’re still getting a sharp reduction in asset prices (not just houses) and an economic downturn as markets move toward a new, more sustainable equilibrium. But we’re not getting a complete economic breakdown.
Now I would agree there are all sorts of risks to this course of action, from rewarding bad behavior with taxpayer money to preventing a necessary adjustment in asset prices. But house prices are falling pretty danged dramatically already (adjust for inflation and the S&P/Case-Shiller 20-city composite is down 25% since mid-2006). So it doesn’t seem entirely unreasonable for our Treasury Secretary to be looking for ways to minimize the collateral damage.