The New ‘New Deal’

In the 1930s Franklin Delano Roosevelt saved American capitalism from its own self-inflicted wounds by erecting a new financial infrastructure—often over the vociferous opposition of the bankers and investors whose poor judgment had helped precipitate the Great Depression. During the New Deal the government reacted to a disastrous systemic failure by creating the sort of backstops, insurance, and risk-spreading mechanisms the market had failed to develop on its own, such as deposit insurance, federal securities registration, and federally sponsored entities that would insure mortgages.

Despite sustained efforts to tear down the New Deal—from the repeal of the Glass-Steagall Act in 1999 to President George W. Bush's ill-fated 2005 efforts to dismantle Social Security—the 1930s-vintage infrastructure has proved remarkably durable. And just as the Great Depression did, this crisis has elicited new experiments in policy. The Federal Reserve has been systematically lowering its standards for what it will accept as collateral for loans. This week Hillary Clinton called for a national panel to recommend solutions to the housing morass. (She said the group should include former Federal Reserve chairman Alan Greenspan, which is a little like Chicago appointing a cow to a panel on how to prevent disastrous fires.) But as the nation once again confronts a systemic failure in housing and housing-related credit, the Bush administration is going back to the future, using New Deal-era agencies as the cornerstone of its response.

Although the Tennessee Valley Authority has yet to get involved, four 70-year-old agencies are helping to cushion the blow of the housing bust. Let's count them.

1. The Federal Home Loan Bank system Last year the model of originating and securitizing mortgages began to break down in the wake of the subprime debacle. Mortgage companies that relied on the capital markets (rather than deposits) to raise money to make mortgages suddenly found themselves starved for cash. Many of them turned to the FHLB, which was created in 1932 (so let's give that one to Herbert Hoover) and provides capital to lenders. Indeed, had it not been for the FHLB, it's possible that the nation's largest mortgage lender, Countrywide Financial Corp., might have gone under. Sen. Charles Schumer of New York noted last fall that Countrywide borrowed a whopping $51.4 billion from the Atlanta FHLB as its troubles mounted. On Monday the FHLB pitched in again, relaxing regulations on member banks that will allow them to double the amount of mortgage-backed securities issued by Fannie Mae and Freddie Mac that they can hold on their books for the next two years. The FHLB noted that this measure could allow member banks to purchase more than $100 billion worth of such securities.
 
2. The Federal Housing Authority The FHA, which was created in 1934, insures mortgages made by approved lenders to borrowers who are creditworthy but not particularly affluent. As the mortgage market grew like Topsy and subprime lenders peddled credit to underserved markets, the FHA may have seemed outdated. But in the wake of the subprime debacle the FHA has suddenly become an important part of the effort to stanch the rising tide of foreclosures. Last summer it created FHA Secure, a program that lets certain borrowers switch from adjustable-rate mortgages to fixed-rate mortgages. "From September to December 2007, FHA facilitated more than $38 billion of much-needed mortgage activity in the housing market, more than $15 billion of which was through FHA Secure, FHA's refinancing product." As part of the recently passed stimulus package, the FHA is also temporarily jacking up the size of the mortgages it will insure (in high-cost housing areas) from $362,790 to $729,750.

3. The Federal National Mortgage Association (Fannie Mae), which was created in 1938. Fannie Mae purchases so-called conforming mortgages (mortgages under a certain size) made by other lenders and packages them into securities, which it effectively insures. (Here's a historical table of the conforming loan limit, which was $417,000 for a single home last year.) Fannie Mae and its sister government-sponsored enterprise, Freddie Mac, are playing a central role in the federal response to the housing crisis. The stimulus package boosted the size of the loans Fannie and Freddie can buy, from $417,000 to "125 percent of the area median home price in high-cost areas, not to exceed $729,750." And then, earlier this month, OFHEO, the body that regulates Fannie and Freddie, said it would lift the cap on the amount of capital they could use to buy mortgage-backed securities and make loans, providing "up to $200 billion of immediate liquidity to the mortgage-backed-securities market."

4. The Federal Deposit Insurance Corp The FDIC, which was founded in 1933 and insures bank deposits, is playing more of a passive role. Many of the financial institutions that have failed or suffered near-death experiences in the current crisis—subprime lenders, jumbo lenders like Thornburg Mortgage and Bear Stearns—essentially fell victim to runs on the bank. Once customers and counterparties came to believe that it wasn't safe to do business with these firms, their days were numbered. But one sector has been largely immune to runs on the bank: banks themselves. Even as banking companies have racked up significant losses on soured loans, and as some tiny banks have failed, Americans haven't rushed to yank their cash out of their checking and savings accounts. The reason: in the event of a failure, depositors with $100,00 or less at FDIC-insured institutions are made whole.

© 2008