Notes from the Risk-Averse Underground

In response to this, Paul Krugman asks,

"Why not just turn GSE debt into Treasury obligations, rather than stuff the obligations onto the balance sheet of the Federal Reserve?"

In the comments, someone mentions that declaring GSE debt fully backed by the faith of the US government would add to the national debt - assuming, of course, that the GSEs wouldn't be able to meet their obligations out of pre-existing funds - and the Bush Administration doesn't want to add to the national debt. (Now they're worried about the national debt?...)

The real question is: how bleak a picture is it for the mortgage companies at this point? A while back, Calculated Risk predicted that the subprime mortgage failures would be followed by Alt-A and commercial real estate mortgage failures, which would really take the juice out of Fannie and Freddie.

At any rate, the Federal Reserve, in its ongoing efforts to creatively fulfill its original mandate, will operate a new Treasury lending facility that will loan money to investors who plan to buy securities backed by credit card, auto and student loans.

This is all well and good, but if I were an investor in those loans, I would already be skittish about possible foreclosures considering the recent rises in unemployment (a trend that is expected to continue). There's a good chance that many people won't be able to meet their obligations. The fact that the government will lend me money to buy such seemingly-risky assets wouldn't encourage me at all: should foreclosures occur, I will be left holding not only a trash asset but I'll also have to pay back my debt to the government.

Arguments against that earlier argument: those who are buying these assets are doing so in bulk, and a government loan might offset the perceived risk of a greater percentage of failures due to market instability.

Response to that earlier argument: since when does a loan offset perceived risk??

Response to that earlier argument: since the government started writing blank checks to financial institutions to ease the costs of their bad investment decisions, bad decisions that include but are not limited to buying on margin.

The other frightening possibility, of course, is adverse selection, as pointed out by the Wall Street Journal: "It's unclear whether there will be restrictions on the types of investors who are able to borrow money, how the Fed will judge their credit worthiness and how the government will ensure they are using the loans to buy the intended assets."

Wasn't the grand lesson of the mortgage-backed-security crisis: Never lend money to absolute strangers?