One idea for boosting the economy that I’ve been touting for a while is to use the federal government’s control over Fannie Mae and Freddie Mac to facilitate large-scale refinancing of mortgages for borrowers who lack sufficient equity in their houses to refinance under current conditions. Those of us who are eligible under current conditions and have looked into it know that the potential savings are quite large, and could be even larger with more vigorous Federal Reserve action. One recent high-profile proponent of mass refinancing has been Willian Dudley, President of the New York Federal Reserve. One major objection to this I’ve heard is that any stimulative impact of refinancing via higher household disposable income will be dollar-for-dollar offset by lost income by bondholders. A couple of Dudley’s colleagues at the New York Fed have an insightful post arguing that this isn’t correct.
Their most important point is simply that there’s a mathematical oversight in that critique. Fully 22 percent of Agency Mortgage Backed Securities are currently owned by the Treasury or the Federal Reserve system, with another 11 percent owned by Fannie and Freddie, and another 15 percent owned by foreign investors. There’s no reason to think that losses accrued by those agents will somehow lead to dollar-for-dollar offsets of final demand. They further note that beyond that “the tendency for borrowers to spend out of increases in their disposable income likely exceeds the tendency for investor households to cut back spending in response to decreases in their interest income.”
The best criticism I think there is of this policy is that it’s not obvious to me why it’s necessary. Mass refinancing to increase aggregate demand is only going to work if the Federal Reserve is willing to allow aggregate demand to spike upwards. Since this is an idea being pushed in this instance by a permanent member of the Fed’s Open Market Committee, I take it for granted that Dudley intends it in that spirit. But if the Fed wants to see aggregate demand pushed upwards, it could—and should—say so clearly and directly and take the steps that are under its direct control that could help achieve that objective. Why call on other sets of policymakers to enact AD-boosting policies that are then accommodated by the Fed rather than simply have the Fed step up on its own? Federal Reserve officials seem unduly hung up on questions of perception. The modern undergraduate textbooks all say that thanks to its more streamlined decision-making structure and subject matter expertise, it’s better to leave recession-fighting up to the Fed and not involve the entire clunky apparatus of the American political system. In principle, that makes a lot of sense. But it turns out that when faced with a really big problem, they too get mighty gun shy.