We need a new HOLC - more than a new RTC or RFC- to provide massive debt relief to the household sector. We need to create the HOME (Home Owners’ Mortgage Enterprise)

In the last two weeks financial markets reached near panic conditions with almost every day another major financial institution on the verge of collapse (first Fannie and Freddie, then Lehman, then Merrill, then AIG and now Morgan Stanley, Goldman Sachs, WaMu, Wachovia and other banks under pressure), money markets seizing up and interbank spreads spiking like never before, Treasury bills yields plummeting as investors were seeking the safety of near cash instruments, credit spreads surging and stock markets tumbling on Monday and Wednesday. Even the Washington policy makers finally realized that this is the worst financial crisis since the Great Depression and that their ad hoc step-by-step and unsystematic approach to resolving this crisis was not working and the effect of ad hoc and band-aid policies in boosting market confidence was fizzling out. Indeed , after the March bailout of Bear Stearns markets rallied for two months; after the July announcement that Fannie and Freddie may be rescued markets rallied for three weeks; after the announcement of the actual bailout of Fannie and Freddie last week markets rallied for only one day on Monday and went into a tailspin starting on Tuesday with the worries about Lehman and other broker dealers; and after the bailout of AIG stock markets did not even rally: actually they tumbled almost 5% on Wednesday while money markets and credit markets went into a total seizure.

So by Wednesday this week as markets were in total panic (stock prices collapsing, interbank spread surging to levels never seen before, credit spreads reaching new highs and Treasury bill rates practically down to zero as investors rushed to safety) the policy authorities decided that something more radical – that many of us had advocated for a long time – needed to be done. The most important policy action is not the decision of extending the swap lines between central banks (so as to provide dollar liquidity to non-US banks abroad); it is not the re-imposition of limits to short sales (a policy action that is itself a naked attempt to manipulate upward stock prices); it is rather the realization that a generalized debt and solvency problem required a solution that leads to significant debt reduction.

Let me explain in detail how we now need bold policy action to resolve this most severe financial and economic crisis…