The announcement over the weekend by the Treasury secretary and the director of the Federal Housing Finance Agency that two of the largest Government Sponsored Enterprises (representing roughly half of the total mortgage lendings in the U.S.) would effectively be placed into conservatorship was yet another attempt at stemming systemic risk. The market fanfare this time around lasted less than 24 hours as it was rapidly hijacked by news of a battered Lehman losing the little credibility it has left with investors.
The GSE bailout was, in our opinion, a necessary operation to try to stem the debt deflation that, like a black hole, is threatening to pull everything in its vicinity. Indeed, in an attempt to delever, firms are fire selling their assets but when everyone is doing the same, you get a perverse effect of rising debt to assets ratios as the value of existing assets shrink faster than the debt.
So what is the solution? I'm afraid there isn't much that can be done apart from attempting to reduce the severity of the downturn. The housing price deflation (resulting from a bubble) has to run its course and still has some distance to go before reaching bottom (see the Case-Shiller U.S. home price graph above) with some pundits suggesting that we are only half way there! All this is to say that the drag on the economy will continue at least until sometime later next year.
So what is the solution? I'm afraid there isn't much that can be done apart from attempting to reduce the severity of the downturn. The housing price deflation (resulting from a bubble) has to run its course and still has some distance to go before reaching bottom (see the Case-Shiller U.S. home price graph above) with some pundits suggesting that we are only half way there! All this is to say that the drag on the economy will continue at least until sometime later next year.
