Greenspan, Hamilton, Bordo…The New York Times reports on Alan Greenspan’s view on helping struggling homeowners.

Two ways to help homeowners directly would be to reduce taxes or to give cash grants similar to those given to disaster victims.

Either approach would strain the federal budget, but Mr. Greenspan said, “It’s far less damaging to the economy to create a short-term fiscal problem, which we would, than to try to fix the prices of homes or interest rates.”

It sounds as though he and I are no the same page. Better to give homeowners cash compensation to cover some of the costs of foreclosures than to artificially keep them in houses that they cannot afford.

James Hamilton writes,

Steve Cecchetti, former Research Director of the Federal Reserve Bank of New York and currently a professor at Brandeis University, is coming to the same conclusion:

This new mechanism [the temporary auction facility] is aimed at shifting assets from US Treasury securities (that are purchased for the permanent holding or taken in repurchase agreements) to some of the lower quality stuff that is accepted as collateral for discount loans. And the purpose of this is to try to reduce the risk premia charged in the one-month and three-month interbank lending markets.

So why is it the responsibility of the Fed to try to set not just the level of the fed funds rate but also the spread between the funds rate and the LIBOR rate? One possibility is that the Fed thinks that the market is currently overweighting the riskiness of short-term interbank loans.

Finally, Michael Bordo (written three months ago) offers historical perspective.

A well known tradition in monetary economics which goes back to the nineteenth century and in the twentieth century was fostered by Wesley Mitchell ( 1913), Irving Fisher (1933), Hyman Minsky (1957) Charles Kindleberger (1978) and others. It tells the tale of a business cycle upswing driven by what Fisher called a displacement (an exogenous event that provides new profitable opportunities for investment) leading to an investment boom financed by bank money (and accommodative monetary policy) and by new credit instruments –financial innovation. The boom leads to a state of euphoria where investors have difficulty distinguishing sound from unsound prospects and where fraud can be rampant. It also can lead to a bubble characterized by asset prices rising independently from their fundamentals. The boom inevitably leads to a state of overindebtedness, when agents have insufficient cash flow to service their liabilities. In such a situation a crisis can be triggered by errors in judgement by debtors and creditors in an environment changing from monetary ease to monetary tightening. The crisis can lead to fire sales of assets, declining net worths, bankruptcies, bank failures and an ensuing recession. A key dynamic in the crisis stressed by Mishkin ( 1997) is information asymmetry ,manifest in the spread between risky and safe securities, the consequences of which( adverse selection and moral hazard) are ignored in the boom and come into play with a vengeance in the bust.