Credit Contagion

Such a new institution might well have to refinance as many as 2 million mortgages. Given low interest rates and the interest support from the lenders, this agency could borrow cheaply and find it easy to earn a profit, just as the old one did. But its purpose is not to make money; it is to prevent the housing market from collapsing if too many foreclosed homes are thrown on the market. The intent is to head off a crisis of financial confidence in the value of all securities, which might lead to even good credit being thrown out with the bad.

The Federal Reserve, the Treasury, and the rest of the government must prevent a wholesale breakdown of the financial system. The risks have risen sharply, given the unpredictable consequences of a multitrillion-dollar decline in the value of homes and the loss of hundreds of billions of dollars by the banking system in various categories of lending and investing. Never have such broad and severe credit problems preceded a recession. It is critical to preserve the viability of the banking sector and its capacity to lend. And, above all, to avoid a systemic financial crisis.

We are in uncharted waters with unprecedented risks that could result in a longer and deeper recession than any we have experienced since WWII. Bold leadership and new thinking are urgently needed.