Washington had little choice but to deal with the mortgage-backed securities that nearly brought down the financial system. But is the Fed saving the financial system or creating another dangerous credit bubble?
At first glance, the Fed’s effort to clean up mortgage-backed securities is a winner. As Heidi Moore writes for Slate’s The Big Money, the “banks get to dump some bad assets and gain fees for selling them to the Fed. The Fed gets to enact a stimulus that helps the banks and gets the mortgage markets moving. Politicians can be delighted that Fannie and Freddie are getting some love, because they lend to consumers and that in turn wins votes.”
But, Moore says, the Fed is actually creating a bubble similar to the one it’s trying to do damage control on. By eagerly trying to save banks and stabilise the housing market, Washington is taking on too much: $1.25 trillion of mortgaged-backed securities, including both the original toxic assets and products of foreclosures to come. Writes Moore:
Both types of assets are creating a shadow boom in unworthy debt, based on the same excessive leverage and questionable financial judgment of the last credit bubble. Plus the Fed is making some of the same mistakes as banks did in 2005-07. The banks forgot they were in the “moving” business-of underwriting mortgage-backed securities—and got into the “storage” business of keeping those securities on their books. That’s where the Fed is now. It has not yet articulated an exit strategy to dump up to $800 billion of mortgages from its balance sheet.
The question is, if this mortgage-backed security bubble bursts, who’s going to bail the Fed out?
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