http://seattletimes.nwsource.com/html/opinion/2013203972_guest20fullencamp.html

The Fed needs to soup up new stimulus package

The Federal Reserve will soon unveil its new approach to economic stimulus. If the Fed is serious about revving up job creation, guest columnist Connel Fullenkamp suggests the agency find ways to stabilize the still-fragile housing market

By Connel Fullenkamp

Special to The Times

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FOR the past few weeks, the Federal Reserve system has been acting like a car company about to unveil its latest model. Public remarks from several Fed officials have built up the expectation that a new stimulus called QE2 — short for Quantitative Easing, Mark 2 — will be introduced soon.

But in the best tradition of Detroit, the details about QE2 are being kept secret. What does the QE2 look like? Will it have the power to pull our economy out of this miserable slump and get it up to job-creation speed? We won't know the answers until early November, when the Open Market Committee is expected to launch QE2.

Unfortunately, what we do know suggests QE2 will be the same kind of underpowered, undependable stimulus model that Washington has been producing for several years now. If the Fed sticks to its current design, QE2 will be a lemon.

For one thing, it will have too small of an engine. The plan for QE2 appears to be to use newly printed money to buy $100 billion of bonds at a time on the bond market. But these purchases are likely to be too small to budge the economy. Remember that QE1 had to purchase more than $1.2 trillion of securities to prevent the economy from going into free-fall.

The bigger problem with QE2, however, is its lousy transmission. The Fed expects that quantitative easing will drive economic growth in the usual way: banks will end up with more cash on hand, which they will then lend out to consumers who will buy cars and houses, and to firms who will buy machines and hire more workers.

But these days, nobody wants to borrow! Households are still up to their ears in debt, and firms can't justify expanding their operations in this uncertain environment. And banks don't want to lend anyway, since their wounds from the subprime crisis are not healing quickly at all.

So if the Fed dumps hundreds of billions of dollars into the bond market, where will it all go? Most likely, it will pile up back inside the Fed in the form of bank reserve deposits, which is what's happened with much of the money from QE1. Or it could end up in the hands of the few players who would like to borrow money these days, such as hedge-fund operators who could use it to help push gold prices higher and the dollar lower. No thanks.

If the Fed really wants to wow us with daring design and unexpected power, it should produce a hybrid — a plan that uses monetary policy to do the one thing the Treasury could have done, but has been afraid to do — and this is to bail out homeowners. Mounting evidence suggests the economy won't get moving again until the housing market stabilizes.

More than one quarter of homeowners owe more on their loans than their homes are worth, and millions more face monthly payments so high that they are unsustainable. The federal government has repeatedly promised help and then botched these relief efforts, never actually doing the one thing that underwater homeowners need them to do — reduce the amount they owe.

And now we are finding out that the foreclosure process could drag on for years before these homes are repossessed and resold.

What the Fed should do is use the housing market to drive the stimulus. Within a few months, the Fed could stabilize the housing market simply by paying down millions of underwater mortgages so families owe less than the value of their homes again. This could be paired with a program to enable these homeowners to refinance at far better terms than they currently face.

If millions of struggling families suddenly had manageable mortgages, they could look forward to the future again and resume spending. And keeping additional foreclosed homes from the housing market would allow home prices to stabilize. Only then can a true recovery get under way.

Yes, this would be a bailout for homeowners. But at this point, who are we kidding about the need to set a good example? If the Fed really wants to roll out QE2, then it should give us something that will get us from point A, 9.6 percent unemployment and no hope, to point B, a growing, job-creating economy. Then we can talk about next year's model.

Connel Fullenkamp is an economics professor at Duke University.