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Jeff Madrick

Jeff Madrick

Posted January 21, 2009 | 09:33 AM (EST)

Obama Needs a Mortgage Default Plan Fast


The announced policies of the Obama team are not adequate. I don't mean simply that the stimulus plan is not big enough. There's time to build that up.

Rather, in the past few weeks, the credit crisis took a turn for the worse that is not fully understood. It showed up most dramatically in the losses Merrill Lynch reported -- and that forced Bank of America to go begging to the federal government for help. Then State Street of Boston stunned the community with gargantuan losses.

Was B of A foolish to buy Merrill? Yes. But what the Monday morning quarterbacks don't acknowledge is that the situation deteriorated rapidly after they made the deal. And this is now what the Obama team must handle.

What happened? Defaults are still running high, in a nutshell. Lost jobs and lower incomes are making them worse, and the value of those mortgage backed securities, which are now the heart and soul of banking -- and the deep mortal wound as well -- keep falling. Few if any have fully understood or anticipated the ongoing dangers.

President Obama moved with haste and intelligence when it became clear that a new stimulus package of substantial size was needed. He took care to add tax cuts, which is a pity. But this will be his style. Give a little politically to get something.

But more is now necessary. Many economists turned up their nose at Paulson's first instinct to stabilize the mortgage-backed obligation market by buying up bad assets. Just give them capital, the right and left argued with vehemence and a fair degree of arrogance. But if the value of the assets keeps falling, more capital just goes down a hole.

As of today, we hear the Obama team is talking about a plan to stabilize the market by buying or insuring bad assets. No plan can be perfect, but we need some plan quickly.

But, far more important , we haven't heard about a plan to stanch the mortgage defaults, which are daily making the stabilization of the credit markets ever harder. What's the Obama plan?

We also have not heard enough yet about re-regulating these entities. Granted, that can wait a bit. I'd be more comfortable if some "anti-deregulationists" were on board the Obama bus.

This economic team is technically capable but they are hardly visionaries. The leaders of the team -- notably Summers -- supported deregulation strongly in the 1990s. They were at one with Greenspan's free market philosophies. None of them warned about how serious the dangers were early on. None of them insisted Greenspan look more closely at shadow banking when they were out of government in the 2000s. None wanted to regulate derivatives. And Geithner was there, in a position to oversee banks, all along. Now, they have been slow to come up with a defaults solution. Why? It's risky, that's why. It's not a known quantity. But Obama now has to take risks. Here's hoping the Obama team has a few who are unafraid to stick their necks out.