Bernanke's Federal Reserve Freakout

The other day Ben Bernanke came as close as a chairman of the Federal Reserve will come to a public freakout. Call it a subdued, bankerly freakout.

In a speech at Columbia University's Business School he used the word "crisis" as in "the foreclosure crisis." Fed chairmen do not generally use words like "crisis"; they use words such as vanilla, cream sauce, custard and tapioca.

What's got Bernanke scared is that "about one quarter of subprime adjustable-rate mortgages are currently 90 days or more delinquent or in foreclosure. Delinquency rates also have increased in the prime and near-prime segments of the mortgage market.... foreclosure proceedings were initiated on some 1.5 million U.S. homes during 2007, up 53 percent from 2006, and the rate of foreclosure starts looks likely to be yet higher in 2008."

Spooking Bernanke is the Fed's discovery that many thousands of delinquencies are not caused by unemployment or even, perhaps, inability to keep up with payments but rather by the quick, steep drop in the price of real estate. "Sharp declines in house prices, and thus in homeowners' equity, reduce both the ability and incentive of homeowners, particularly those under financial stress for other reasons, to retain their homes," he said.

"Non-owner occupiers -- investors or purchasers of vacation homes," he went on to say, make up an important slice of those defaulting on their mortgages, as well as those who bought with the assistance of "junior liens (or piggyback loans), often an indicator of little borrower equity at the time of purchase." All of this is the long way around of saying that many thousands of those whose property is being foreclosed on are not tough-luck families being tossed out of their homes. They are people walking away from an investment because it now is worth less than the mortgage on it.

The denouement Bernanke and not a few others fear is that "high rates of delinquency and foreclosure can have substantial spillover effects on the housing market, the financial markets, and the broader economy. Therefore, doing what we can to avoid preventable foreclosures is not just in the interest of lenders and borrowers. It's in everybody's interest. "

The Fed's remedy is apparently, first, to stop the drop in prices, and next to push them back up to the point that real estate is at least worth the mortgage debt it carries. A bill presently in Congress aims to do that, although nobody can be certain about its succeeding, since such a thing has not been done before.

The cost would be immense in dollars and in civic morale, since any broad save-the-real-estate scheme would include saving speculators, wealthy people's vacation homes, those who lied to fraudulently obtain mortgages, and spendthrifts who put their homes under water so that they could buy large sailboats and/or Cadillac Escalades. The mere thought of such a bailout has the millions who saved for down payments, bought sensibly and have sacrificed to keep up with their mortgage installments somewhere between a slow boil and a tooth-grinding rage.

Yet the much respected Floyd Norris, a premier business writer of the New York Times, says, "The government may eventually decide that it is necessary to bail out the undeserving as well as the deserving, no matter how repugnant that seems at the moment, and no matter how bad the inflationary impact may be."

Let' s hope he is exaggerating, because runaway inflation destroys the society it eats up. We saw it pave Adolf Hitler's way to power in Weimar Germany many years ago. We see it contributing to the destabilization of Zimbabwe today, and we see what inflation at a relatively moderate level is doing to ordinary salaried people in our country now.

Though Ben Bernanke is willing to risk some inflation (as though one can finely calibrate inflation), some of his fellow Federal Reserve Board members are not. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, is calling for yanking up interest rates, because "there is a significant risk that higher inflation will become embedded in the economy."