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S. Balakrishnan

As the Federal Open Market Committee (FOMC) goes into its bi-monthly session, excitement is noticeable only for its absence.

No one expects the FOMC, which is charged with setting interest rates, to act one way or another. The unanimous forecast is for no change.

Since the last meeting, there have been no cataclysmic events to provoke the Fed.

Headline inflation is well above the comfort level of 2 per cent, but shorn of food and energy (the ‘core’ rate), it is just a smidgeon over.

But, Fannie Mae and Freddie Mac, the two government-sponsored mortgage institutions, had to be rescued on the familiar excuse of ‘too big to fail’. With the Fed stepping to save Bear Stearns, there was hardly any reason not to do so in a case where much greater public – even national, given that foreign investors, led by China, are among the biggest owners of agency debt (as that of the mortgage giants is called) – is involved.

The latest are measures to help homeowners in financial trouble, which passed Congress last week.

Ideology was thrown to the winds as conservative Republicans coalesced with liberal Democrats to legislate government intervention.

Much against his natural instincts, President Bush is being forced to sign the bill into law.

He is not facing re-election but his party is, as are many Republican Congressmen and Senators. Like hunger, politics focuses minds.

In sum, government and the Fed are throwing a lot at the problem. But is it enough?

More radical solutions are on the drawing board – no less than a new government institution to take over distressed mortgages.

The problem is that every private sector financial institution is up to its neck in terms of risk-bearing and absorption and capital-raising capability. True, they have found saviours in China’s, Singapore’s and the Arab’s sovereign wealth funds, but that just about restores normalcy to their balance sheets.

The appetite and capacity to lend has shrunk considerably. It will be restored only when confidence on collateral values returns.

By guaranteeing repayment of restructured mortgages, a government initiative might just achieve that. In fact, the Resolution and Trust Corporation of the nineties, set up to take over the assets of insolvent Savings and Loans associations, wound up selling them at a profit when the market revived. The Government of India has made windfall profits on the shares held by the UTI, which it took over, when that institution collapsed

You need deep pockets to survive business and financial cycles. Governments have the deepest pockets. They can stay solvent longer than the market can stay irrational, to paraphrase an insightful comment of an investment expert.

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