The Wall Street Journal “Home Prices Declined at Record Pace in October” reports that the Standard & Poor’s/Case-Shiller home price index fell 2.2% month over month and 18% year over year for October. Some of the metropolitan areas fell more than 30% year over year. Prices peaked in mid 2006, but are still 58% above early 2000.

The value of homes to a large extent depends on where consumers are anchored. Those that bought during the bubble endear the Federal Reserve’s view that we are in a deflationary spiral. Those that were priced out or too cautious during the bubble still see inflated prices. Funny, how the Fed only sees the danger of asset price deflation, and never recognizes the inflation in asset prices. Anchoring plays a large role in a person’s view of economic value.

It’s old news that the Fed and Treasury are trying to prop up housing prices by every free market means possible. Most of their methods are truly bizarre. After socializing Fannie Mae (FNM) and Freddie Mac (FRE), the Fed wants to purchase up to $500B of their MBS in the free market. At the same time the Treasury won’t explicitly guarantee the GSE debt. Wouldn’t it be cheaper and more effective for the Fed to buy directly from the GSEs? All this to create a shortage of guaranteed high quality agency MBS theoretically pushing conforming mortgage rates to the mid 4% range. The Fed apparently believes that low mortgage rates are the answer to everything. History warns us that the Fed never believes that consumers consider the long-term value in asset purchasing decisions.

All of the Treasury’s previous attempts at free market mortgage modification have failed. I believe this is because mortgage investors are viewing the long-term economic value of housing based on more than temporary measures by the Fed. “Lite” modifications have failed because mortgage investors, banks and servicers have not matched payments with borrowers’ ability to pay. And investors only want to take true write downs if they can completely exit the transactions through foreclosures or short sales.

The purposeful failure of free market mortgage modifications will lead to the feared “cram-downs” by bankruptcy judges if enabling legislation is passed during the next Administration.