The weekend pump rumor is that central banks are going to take up the mass of mortgage-backed securities that are essentially either illiquid or worthless. From the Financial Times:

Central banks on both sides of the Atlantic are actively engaged in discussions about the feasibility of mass purchases of mortgage-backed securities as a possible solution to the credit crisis.

Now this rumor has been denied by the Fed, which makes it even more likely that it is true. So let’s say the Fed and/or other central banks start buying MBS on a grand scale. Either they simply print the money, in which case the Fed balance sheet skyrockets. Currently, the monetary base is about $860 billion. Direct purchase of any size by the Fed would be enormously inflationary, remember there’s some $11 trillion of mortgage debt out there. I doubt that they would do that.

So the alternative is to issue government debt, i.e. treasuries, to pay for the MBS. The current swap facilities are essentially doing this anyway, the only difference is that some third party would have to buy the Treasury for cash - and the taxpayer would take the credit risk. Basically you’re looking at a massive expansion of the Fannie/Freddie/Ginnie system, now formally guaranteed and the inevitable losses funded by the taxpayer. Basically the end of private finance of mortgages, they’d be originated by banks and brokers for a fee, presumably, and then bought by the taxpayer.

Would this make mortgages easier to get? Probably, depending on the terms offered by the taxpayer. Could it reflate the housing bubble? Possibly, if mortgages become easy to get again we’ll go right back into the bubble mode. Speculation will be rampant. I myself will be stepping up to be subsidised by the taxpayer if it is attractive to do so, because you’d be an idiot not to. Savings will be even less attractive, as there won’t be mortgage debt to invest in, only Treasury debt. If you wanted to ensure that the US economy will ultimately crater from underinvestment and malinvestment, this would be the thing to do. It sounds like just the kind of thing that Helicopter Ben would like.

The real issue here is government direction of the economy. The Soviets tried this with Gosplan, and ended up with no toilet paper. Or much of anything else, either. Mr Bernanke, and his predecessor Mr Greenspan, have been trying to do the same, in a broad sense, by manipulating monetary policy. As this fails, their response has been “do more”, more facilities, more manipulation, more Fed-speak and so forth. This will ultimately fail, because it is the paradigm that is broken. One more time, we need to establish an economic environment based on savings and investment for the future, rather than continuing to encourage short-term consumption of scarce resources without future benefit.

All of the bailout and liquidity enhancement proposals share a common flaw; they can’t possibly work. “Work” being defined as putting things back more or less the way they were - rapid price appreciation in housing juicing consumption so that economic growth appears to continue and defaults stop. There is just too much supply of housing.

The nasty fact is that the housing bust hasn’t really begun. It is well established that most of the defaults that we’ve seen to date are the result of fraud of one kind or another in the origination of the paper, not rate adjustment or economic stress (unemployment). The published inventories of new housing are way understated, because they don’t include cancellations or most condo developments, especially the high-rises. The inventories of resale houses are similarly misleading, even though they are already approaching last year’s fall highs in the bubble areas, because they don’t include large numbers of houses that are in the foreclosure process, stalled by processing backlogs at the lenders. Or the owners who have given up and are just waiting for the hammer to fall, or who will put their house on the market at the first sign of any hope of sale.

Even ECRI has finally acknowledged that the economy is in recession. Now we start to see the real bust, as layoffs start to bite at incomes and people who thought they were fine can no longer pay. Private mortgages are going up in price, not down - according to bankrate.com, the 30year jumbo fixed is at 7.17%. This has a the effect of driving the purchase price down to maintain a certain payment level, further eroding the collateral value for existing financing. And then commercial real estate starts to get hit.

Now we introduce the notion of further government subsidies to housing - not only the existing tax relief, but straightforward underwriting of loan losses by the taxpayer. The loan losses immediately convert to new federal debt, compounded by the interest paid on the debt as well as the subsidy. What it boils down to is allowing further borrowing by giving the lender the backing of taxation to guarantee repayment - ultimately that the lender can, in effect, collect at the point of a gun from the remaining people with income and/or assets. Needless to say, this is a sign of deep disease, attempting to defer the end by aggravating the problem. The end probably is the Zimbabwe routine if Ben goes down that path. A wrecked economy and a wrecked currency.

It is absolutely necessary to reduce consumption. It will happen, one way or another. A country cannot consume its way to wealth. But it will be painful, and politicians hate pain. So if it cannot be prevented, everything will be done to defer the pain, just so long as it happens to someone else.