The Real Financial WMD
In the blame game of what caused our financial meltdown following a massive credit bubble, we’ve all heard it was the bankers, the rating agencies, the mortgage brokers, the individuals whose eyes were bigger than their bank accounts, Fannie Mae and Freddie Mac and of course, deregulation. The point being missed in this discussion is that all these influences were just symptoms of the actual disease. The disease was artificially cheap money created by the Federal Reserve. One of the real tragedies of what our economy has experienced is the lack of understanding for what the true genesis of the credit bubble and bust was. Thus, the blame is not being pointed at the real culprit, the Federal Reserve, and scrutiny is unfortunately not taking place to nearly the extent it should. Without this, a true fix and repair of our economy cannot occur. A doctor that misdiagnoses the disease cannot then cure it. Many participants were reckless but the true enabler was easy money engineered by the Fed.
Typical monetary policy works very simply. To spur growth, lower the fed funds rate to encourage borrowing. Lowering rates even more and the more borrowing takes place as long as lenders are willing and capable to meet the demand. This brings us back to 2001 as the stock market bubble was in the process of popping, the US economy was entering recession and 9/11 froze business activity. The Greenspan led Fed with Bernanke in the background cut rates in 2001 alone from 6.5% to 1.75% which was then followed with a 1% rate from mid ’03 to mid ’04. Another catalyst for the 1% rate that stayed there was the fear and Fed’s bad forecast of deflation just as one of the greatest bull market in commodities was getting under way. With artificially cheap rates, the extraordinary demand for yield ensued as pension funds had to meet 7-9% rate of return hurdles, insurance companies wanted yield for the premiums they took in, savers were discouraged from saving and took more risk for more yield and international banks thought they were buying US Treasuries in disguise. More risk and more leverage were the only ways of achieving rates of return to meet obligations.
With a massive pool of credit supply searching for yield, enter home buyers and banks and mortgage brokers and paper subsequently created to further feed this that was blessed as risk free by the rating agencies. A housing boom ignites. The US consumer goes on a spending binge, fuels growth in all those countries that sell to them (mostly China), that money gets recycled into the US Treasury market and a self fulfilling credit party follows with Greenspan, Bernanke and the Fed playing the part of bartender.
The bust of course follows and the Fed deals with the consequences of the aftermath with the exact policy that caused the problem but this time, not just with cheap money but with even cheaper money. Why give a drunk more alcohol to cure the hangover and encourage more borrowing and spending?
So here we are now, the Fed talking about more money printing because of their fears of deflation and slack growth. They fear deflation just as the CRB raw industrials commodity index, which includes most major commodities except energy, is at an all time record high. Also, since the gold standard ended in 1971, the CPI price level has risen 447% and as of the last reading in Sept, is just .8% off its record high in July ’08. It’s like oil going from $20 to $110 and then dropping to $109.23. Is that deflation? They want inflation just as the American consumer can barely afford the current cost of living. When demand is slack, why does the Fed want to raise the cost of living and make things more expensive? Doesn’t the law of supply and demand call for lower prices when demand is low? Wal-Mart says many of their customers are literally living paycheck to paycheck and the Fed seems hell bent in making it worse for the average consumer in order to bail out borrowers who can pay back their debts with inflated money. In terms of actual economic stimulus, all cheap money has done has encouraged refinancing which just kicks the can down the road when our economy desperately needs to reduce debt. For many who have to and want to de-lever, who cares what the cost of money is. With respect to the economic cycle, recessions are good as they cleanse, they clear, they de-lever. If only they let the early 2000′s recession run its full course without monetary distortion I wouldn’t be writing this piece.
The monetary policy act of setting the short term cost of money (the fed funds rate) and embarking on quantitative easing is price fixing on a grand scale, Soviet Union central planning style. Leaving that decision to ten voting members sitting around a mahogany table in Washington, DC is the true error of our economic ways. The Federal Reserve’s policy of setting what they think is the right rate is the true weapon of mass financial destruction. It has led and continues to lead to a massive misallocation of capital, a terrible debasement of the US dollar where capital is literally fleeing the country and hiding in gold out of self defense and a hidden inflation that is not captured in their preferred view of the world, the CPI. The US dollar has lost more than 90% of its purchasing power since the Federal Reserve was created in 1913, case in point.
The Fed’s dual mandate of maximum employment and price stability must be altered to eliminate the former. Price fixing short term interest rates to manipulate human behavior to achieve some level of economic activity is a grand experiment that has failed miserably and the US economy will never be on firm footing without the market based setting of interest rates throughout the entire yield curve that can quickly adjust to changing behaviors and demand for credit. A free market supply, demand dynamic and pricing discovery mechanism for the cost of money would lead to sounder lending decisions and the more prudent allocation of credit and capital throughout our economy. A stable currency and sound money would hopefully then follow as the Fed’s printing press wouldn’t be given another reason to print more money than the economy demands.
The Fed’s monetary policy particularly over the past 10 years must be scrutinized and exposed for the mess that it has left. Unfortunately Bernanke and Greenspan have disabused themselves of any responsibility for what they have wrought upon us. They don’t see that cutting rates from 6.5% to 1% back to 5.25% and now to basically to zero, followed by quantitative easing is a problem with policy. Bernanke particularly thinks it was the lack of regulation that resulted in the credit bubble. In other words, he thinks it wasn’t easy money that created the excessive demand for credit that led to massive leverage that was the problem; it was the lack of oversight by bureaucrats in Washington, DC. I strongly disagree.
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October 7th, 2010 at 1:26 pm
You are absolutely 100% right. I have been saying for some time now that there isn’t enough blame or attention given to the Fed. And their mandates should be changed. Their ability to maximize employment is negligible at this point.
The other question is the extent to which the Fed’s balance sheet has been used as a dumping ground for the banks. I would love to see a proper mark-to-market of their balance sheet. Bernanke better run and hide if that ever comes out.
October 7th, 2010 at 2:07 pm
I have to agree as well. But what can we do to organize and rise up before the next WMD goes off and the damage is irreversible? It is nice to hear Fisher say that QE2 s not yet decided, but since he isn’t a voting member, I am not sure that really means much.
October 7th, 2010 at 2:09 pm
Fire requires three elements to be present – heat, fuel, and oxygen. All of these conditions are necessary but not sufficient for fire. At the risk of extending this analogy too far:
- Heat: greed in the economic actors, unhindered by ethics
- Fuel: Low interest rates supplied by the Federal Reserve
- Oxygen: Ineffective regulators.
This whole post seems to be like someone claiming that one of these factors is somehow more important then the other.
It seems to me that we perpetually have two of the three elements permanently in the system, and we are hoping that the third element, the federal reserve, doesn’t make a policy error. People make mistakes and I don’t want the stability of our financial system dependent on the decisions of a small group of individuals who are only but human.
October 7th, 2010 at 2:16 pm
“They don’t see that cutting rates from 6.5% to 1% back to 5.25% and now to basically to zero, followed by quantitative easing is a problem with policy.”
but I love that “seat of your pants” management style-
kind of like Custer- he was wrong of course- but man- he sure went in there like he knew what he was doing
October 7th, 2010 at 2:35 pm
Fraud got us into this, policy can get us out of it, but it won’t, because there’s still so much more middle class blood to suck.
With enough fiat dollars and the right allocation, this could go away in a puff of smoke, tomorrow. But that would destroy the power base.
October 7th, 2010 at 2:59 pm
If only we were in France, So many intelligent people see the problem but who is going to perform the first act of revolt besides defaulting?
October 7th, 2010 at 3:15 pm
LOL ahab.
October 7th, 2010 at 3:17 pm
I could not disagree more with Peter’s assessment. Let’s think about the current situation. Forget about its full employment mandate. It is not even meeting its inflation target (2%) mandate.
I look at this quote almost every day: http://www.bloomberg.com/apps/quote?ticker=USSWIT5:IND
It’s what the market believes the annual rate of inflation will average over the next 5 years. Needless to say it’s been below 2% for about 5 months now. The Fed is not doing its job. And that doesn’t mean the money is too loose. It’s too tight.
“Well, how can you say that? They’ve been doing SO MUCH.” I can hear that from everyone now. It doesn’t matter how much they have done. If they have not met their inflation target, they haven’t done enough.
I can also hear those that say the Fed is “pushing on a string” with all its moves. Wrong. You can always generate whatever inflation you want in a fiat currency system. The problem is the market doesn’t believe that first of all, the Fed’s monetary policy easy right now and second that even if it changes its mind (like its sort of doing now) it will have the commitment to follow it all the way through. What I mean by that is if the Fed says that its doubling the monetary base but will contract it as soon as inflation gets too high, absolutely nothing will happen. But if the Fed says that it is PERMANENTLY doubling the monetary base, then inflation will sky rocket.
For all of the Fed’s huffing and puffing, the market doesn’t believe that the Fed will have the conviction to follow a loose enough monetary policy for a long enough time to revert inflation back to 2%.
So, Peter here doesn’t really understand monetary policy. Read some Friedman & Schwartz to understand. Or how about Scott Sumner here at The Money Illusion blog. The best blog on monetary policy on the net.
http://www.themoneyillusion.com/
Read his FAQs to get a unique perspective on the Fed.
October 7th, 2010 at 3:24 pm
Gullibility – mass self-deception – is also required for a bubble. I suppose you could argue that the Fed made it possible, but millions of individuals are at fault, too.
Nobody likes to hear that, of course.
October 7th, 2010 at 3:26 pm
@Machiavelli999: Fair points, but what makes you think the Fed will know when to stop blowing another bubble if they go further, as you suggest? What gives you the confidence they’ll get it right this time?
October 7th, 2010 at 3:28 pm
And that doesn’t mean the money is too loose. It’s too tight.
There’s lots of money, but it is in the wrong places. When the Fed pushes, it’s like pushing on a stack of 2X4s… the top ones move, the bottoms ones stay put. The Fed has no tools to attack maldistribution of wealth. It isn’t directly in their mandate to do so, though you might argue that the ‘full employment’ part hints at it.
October 7th, 2010 at 3:28 pm
Exactly wally. Nobody wants to look in the mirror. We all have to play along without questioning it for these confidence shell games to work. And all too often we’ll do it because many of us are “getting rich” quickly (or think we will) by participating, while the “other guy” or sucker loses.
October 7th, 2010 at 3:30 pm
And they (and Congress) can do more to at least try to fulfill their so-called objective of “full employment” for my liking (MUCH more), but they choose to believe that if they hand it out to the banks and the rotten system that got us in this mess, that stated mandate will ultimately be fulfilled via a little trickle down to the rest of us. Hogwash.
October 7th, 2010 at 3:42 pm
Brilliant.
I love it.
October 7th, 2010 at 3:45 pm
The FED does not create inflation, the banking system does through fractional reserve lending. The FED can create money ad infinitum but if the banks don’t lend it out there will be no inflation. That is where we are now; the banks are awash in cash but they are hoarding it to protect their balance sheets and because the only borrowers they will lend to don’t need to borrow. ZIRP is nothing more than a subsidy to the banks. Consumers have seen their credit card rates go up while savers are punished. All thanks to an institution that has systematically destroyed the currency and wreaked havoc with the economy since its inception.
October 7th, 2010 at 3:55 pm
@ACS: But if the banks, instead of lending, then buy stocks, commodities and other assets, won’t there be asset inflation? Or does that not matter because the Fed says it doesn’t?
October 7th, 2010 at 3:58 pm
WMD at the FED — Do we have a rogue adviser to the man with the button ?
> Fed Needs to Pump Trillions More Into Economy: Analyst
> http://www.cnbc.com/id/39557679
>The Federal Reserve needs to pump at least $6 trillion to $7 trillion more into the U.S. economy to have any >meaningful impact on sluggish growth, former Bush economic adviser Marc Sumerlin told CNBC …
>”U.S. households have $70 trillion in assets,” Sumerlin explained during a live interview. “And the Fed essentially >needs to buy enough Treasurys and mortgages that you can get a bid on all those other assets …
What are these other assets he wants the FED to buy ?
October 7th, 2010 at 4:19 pm
The Real Financial WMD was deregulation and free trade. How can a nation that manufactures nothing and consumes everything ever hope to prosper, regardless of monetary policy?
It can’t.
A nation either manufactures and prospers, or it consumes and lives in slavery.
Boockvar has merely fallen victim to the temptation to blame yet another symptom rather than the cause.
October 7th, 2010 at 4:21 pm
Pocket veto vs rocket docket. It’s lawmaking like this that gives congress such a bad name.
http://news.yahoo.com/s/ap/20101007/ap_on_bi_ge/us_obama_foreclosures
October 7th, 2010 at 4:24 pm
Dr. Boockvar…now why don’t you tell us how you really feel…
As Tom Keene would put it…this is a missile…
Speaking of which…Tom is interviewing the Maestro tonight…I wonder if this missile will come up..
October 7th, 2010 at 4:25 pm
Now Obama has some leverage over the banks halfhearted mortgage restructurings
Be interesting to hear the justifications of those who voted for this bankster early Christmas present
October 7th, 2010 at 4:34 pm
Peter,
Been saying this since day one. (you been reading my blog?) You pointed out that the Fed’s easy money coincided w/ the greatest commodity bubble in history. You think the correlation might be indicative of some causation? Look at commodities now, already ready the balloon is filling. Wait until QE II really gets rocking.
To Machiavelli’s point that the Fed hasn’t been able to ignite inflation. Sort of true, if you accept the common definition of inflation. But why? The collapse in demand means prices should have declined–in fact, increases in efficiencies due to technological applications bearing fruit, and lower costs due to international trade with low-cost producers–mean that prices should have been coming down throughout the aughts. But the Fed fought it tooth and nail. This calamity is what believing a 1-2% inflation rate is “stable prices” wrought.
If prices don’t decline along with costs, then you’ve got inflation, whether that translates to an overall steady price level or a bit of actual price increases, or even price decreases that are not of the same magnitude as cost decreases. We’ve got inflation now, as prices have remained mostly stable through this collapse in demand. The ramifications of our inflationary posture will be mostly evident in the commodities markets, where costs and demand are far more stable than the ridiculously erratic prices, which instead reflect the manipulations of the currencies used to buy them.
October 7th, 2010 at 4:55 pm
Pocket veto vs rocket docket
you go Obama- let’s make the foreclosure process LAST FOREVER. That’s a smart move. The poor people will be homeless otherwise (what? they can’t rent)-
. . .and I wonder what would happen if they weren’t paying their rent ( eviction?)
let’s be grownups and understand that if your not paying your mortgage- then you need to be foreclosed (and push on to other living arrangements)-
some of the comments on this blog slay me
October 7th, 2010 at 5:15 pm
I quite agree with BR and the Curmudgeon concerning Easy Money as the root of the financial evils decried. George Soros has been saying such ever since his “Alchemy of Finance,” tracing the problem back to the Reagan years and the highly successful upward transfer of wealth “somehow” engineered since that time. Bernanke’s blindness to the problem of Easy Money runs as deep as it can go, being ideologically based: It has been clear for some time that “Helicopter Ben” is a doctrinaire (academic) Keynesian, whose solution to stagnation always involves Easy Money, whether from private or public sources (of course, the sources are always closely linked). The wonderful irony is that Ben’s myopia exactly coincides with that exhibited by “Easy Al” Greenspan–he of the “Greenspan Put”–an irony that should tell us that apparently contrary roads to asset inflation (Keynesianism vs. Ayn Randism) have their own common root in the class imperatives of a sinking capitalist ship seeking salvation by stampeding those in steerage . . . until they drop off into the cold sea when they run out of deck. The de facto inflation (not recognized in full since the Boskin Commission) for the asset-poor is part of the program, fully anticipated by the Keynesians in their doctrine of “sticky” wages vs. upward prices; and vociferously regaled by Greenspan in his denial of inflation, celebration of the occult wisdom of the asset markets, and marvelous declaration that fear on the part of the have-not’s is good for business. Bernanke and Greenspan, the regulators, are in fact regulated by common corporate capitalist imperatives, their contrary ideological prisms notwithstanding.
October 7th, 2010 at 5:19 pm
Do we seriously think that higher rates here would have kept a generation of workers in China and India on the farm? Maybe there’s a bigger picture here.
October 7th, 2010 at 5:36 pm
@ahab: But why can’t the banks follow the law? Are you saying that in SOME cases (the ones that benefit YOU personally), it’s OK for them to skirt the law? I’d like to hear your rationale for cherry picking on your outrage against the banking industry.
October 7th, 2010 at 5:50 pm
Many things outrage Ahab – it’s part of his shtick ;-)
October 7th, 2010 at 5:53 pm
hey manny-
where you been?
I guess my comment concerns timing- do we want this over with or not? And you know that I was 100% against the bank bailouts-
and I even suggested (and you may remember) that people who were (in non-recourse states), in a hopelessly upside down situation- should just stop paying (and find other living arrangements)- as the bank had no recourse outside of taking back their collateral (the home)-
but- that doesn’t mean I believe people who aren’t paying shouldn’t be foreclosed. That’s how the bank will eventually realize the loss and we can see where we are- as opposed to banks dragging their feet (because they don’t want to book the loss) and homeowner’s dragging their feet because they would rather pay nothing as long as possible.
So quicker in my mind- is better than slower- so we can get the foreclosure mess behind us.
October 7th, 2010 at 5:56 pm
Peter,
this, your Post, above, is a good thought piece. One, of course, more People should bother to ponder, at the minimum..
though, here “…The disease was artificially cheap money created by the Federal Reserve…”, might be a soft point.
this ‘re-write’, “The disease was loosed when Congress, in 1913, created the Federal Reserve.” , could be more helpful in lending a fuller understanding of the ‘affliction’..
this link http://search.yippy.com/search?input-form=clusty-simple&v%3Asources=webplus&v%3Aproject=clusty&query=The+Federal+Reserve+Fraud for starters, should be helpful in illuminating the egregious con that is ‘the FedRes’…
http://www.thefreedictionary.com/egregious
[from Latin ēgregius outstanding (literally: standing out from the herd), from ē- out + grex flock, herd]
Collins English Dictionary – Complete and Unabridged © HarperCollins Publishers 1991, 1994, 1998, 2000, 2003
October 7th, 2010 at 5:56 pm
I hear you, ahab. It just bugs me that they can’t ever seem to follow the letter of the law on virtually anything these days like the rest of us schmucks. I guess that’s what happens when our gov’t creates the kind of moral hazard writ large for the big banks corporations with its policies in recent years.
I’ve been around. Just busier with work stuff and quite frankly worn out from these issues. After a while, there’s no using ranting and raving about this stuff when none of it’s going to change anyway. Might as well seize the day.
October 7th, 2010 at 5:58 pm
The economy has needed cheap debt, to mask the effects of stagnant wages. 70% of the US economy is driven by US consumer spending. But most of those consumers have seen their wages stagnate for the about three decades. During the Bush Error, those wages actually lost ground against inflation.
To maintain their standard of living, the middle class has relied on ever increasing amounts of debt. Obviously, this state of affairs was unsustainable.
It’s not just the zombie banks that threaten future US economic growth. Where will the middle class find the money for consumer spending? More cheap debt? We’ve already seen where that road leads. High paying jobs? Not as long as Wall Street is calling the shots on the economy: wage stagnation is one of the keystones to decades of profit growth.
Chance are, Wall Street will continue to pursue its policy of squeezing wealth out of the bottom and into the top. Sort of like a tube of toothpaste.
The increasing numbers of people who are left behind, are very angry about this. But Wall Street has done an excellent job of using disinformation to create scapegoats for that anger.
http://www.ritholtz.com/blog/2010/10/estimates-of-wealth-distribution-are-widely-wrong/
October 7th, 2010 at 6:11 pm
a lot of this odd. the banks can’t seem to follow the law, cut lots of corners, and got them selves in a bad way. and if the banks can’t prove they own the property (which seems to be their problem. that and having a very loose connection to the truth, which you would think becomes a real problem in a court of law). if the banks don’t own the property, and we know that they residents don’t own it as they don”t have a clear title, that leaves the state to take the property until some one can get their act together and prove they own it. which considering how the banks sliced and diced the notes up, will be a long time in coming. but that will force the banks to right off the loans as they can’t prove they own it. but they will fight that for as long as they can.
the Fed may have been stupid (like people can be) in keeping interest rates to low. especially when the economy had supposedly recovered (if it did) or did they really know that the economy never recovered from that recession in 2001? \
if the Fed isn’t held to its jobs (full employment , what ever that means, and stable economic conditions, what ever that means) who does? we know that design by committee doesn’t work, and i can’t imagine that steering an economy by committee will work either.
Congress hasn’t cared about employment. not the current one, and certainly not the previous one. but both are really good at naming bills like they do that. even when they don’t.
October 7th, 2010 at 6:20 pm
The Fed bears culpability on 2 counts, viz., (1) for being a non-regulating “regulator” and (2) for the Greenspan/Bernanke put. The most important consideration was (2) by far, since, when their (exorbitant) livelihoods are known to have potential of jeopardy, even investment bankers can exhibit some common sense in risk assessment. Take away that potential jeopardy–as Greenspan had with LTCM, etc, etc –and you take away the financial engine’s only governor.
October 7th, 2010 at 7:12 pm
I had a nice detailed reply for you Mannwich but it was lost in cyberspace. Bottom line. Inflation is a rise in the general level of the prices of goods and services. I think we now have currency devaluation expressed as higher commodity (and services that have the monopoly power) prices but not classic inflation. At some point bank lending and therefore money supply velocity will increase and bring back real inflation with rising wages.
October 7th, 2010 at 8:31 pm
The author is totally wrong! The true culprit is greed-corruption. The WMD is derivatives.
Cheap money low interest rate is a bait. Or just one of the culprits. We won’t be so bad if the corrupted people were not that corrupted and greedy. Unlike other crazy people, I didn’t buy property when the priced were so ridiculously high and I didn’t buy into the stupid greedy trap that I could make lots money just flapping houses.
October 7th, 2010 at 8:41 pm
Economist Pete Boettke puts it this way: “Yes people got crazy Tyler [Cowen], but someone gave them the crazy juice. People don’t just wake up one day and say, lets go crazy.”
http://www.coordinationproblem.org/2010/03/v-u-w-l.html?cid=6a00d83451eb0069e20133ec544be3970b#comment-6a00d83451eb0069e20133ec544be3970b
October 7th, 2010 at 8:50 pm
Lie to me Pinocchio…Rep. Robert Aderholt, R-Ala., said in a statement that there is “absolutely no connection whatsoever” between his (interstate notarizations) bill and “the recent foreclosure documentation problems.” (just coincidence that it suddenly passed the Senate unopposed and without debate the night they sneaked out of DC)
Maybe O’Bama is starting to “get it” about these nefarious banks.
Read more: http://www.miamiherald.com/2010/10/07/1862731/obama-to-veto-bill-that-could.html#ixzz11iwBk2Fw
October 7th, 2010 at 9:03 pm
Yet people are still paying Greenspan 100K per speech, providinh him with an ongoing, highly luctrative arse covering opportunity. I can’t figure out why he can’t just be written down as the true cause of the problem and then we can all move on.
Atlas laughed.
October 7th, 2010 at 10:57 pm
for the umpteenth time, low interest rates does not mean easy money. Frequently it means money is tight, depressing it thru the Fisher and income effects.
As back in the 1930s, so many economists today confuse easy money and easy credit. Among other confusions…
Yes, easy credit might contribute to bubbles. But what is the Fed’s contribution to this? I thought it was well understood and accepted among monetary economists (as we read in all our monetary textbooks) that the Fed can only affect the real interest rates in the short run. Rates mostly are a reflection of the economic conditions. See here historic charts of the mortgage rate vs Federal funds rate:
http://investing.curiouscatblog.net/2008/01/28/federal-funds-rate-and-30-year-fixed-mortgage-rate/
Therefore, even if you argue that low rates fueled the bubble, you are not able to claim any easy (or tight) monetary policy by the Fed contributed to the bubble.
October 8th, 2010 at 12:10 am
Ahh, the good old 1945 days when the world was in ashes…
October 8th, 2010 at 12:11 am
@catalyst:
“Do we seriously think that higher rates here would have kept a generation of workers in China and India on the farm? Maybe there’s a bigger picture here.”
succint with plenty of depth. like it. i do think inflation exacerbates the gap though.
@xynz:
“Chance are, Wall Street will continue to pursue its policy of squeezing wealth out of the bottom and into the top. Sort of like a tube of toothpaste.”
nice writing.
October 8th, 2010 at 12:15 am
@Peter
“When demand is slack, why does the Fed want to raise the cost of living and make things more expensive? Doesn’t the law of supply and demand call for lower prices when demand is low? ”
Yes! Well written, sir.
October 8th, 2010 at 5:28 am
for franklin411
agree with you 100%. Boockvar and the rest are assuming that the economy is completely normal. It stopped being normal – my guess is in the mid’ 60s – and turned damn ugly in the last 20.
October 8th, 2010 at 6:48 am
Manitoumonk is right: it takes more than just low interest rates to create NINJA mortgages. Dishonesty, fraud and lack of regulation are needed as well.
One factor that contributes to unrealistically low interest rates is that we allow banks to engage in maturity transformation ( i.e. “borrow short and lend long”). For more on this see:
http://ralphanomics.blogspot.com/2010/09/flaw-in-maturity-transformation.html
Also, using interest rates to regulate economies is daft in that this policy is distortionary: it only affects those private sector entities that are significantly reliant on variable rate loans. You might as well boost an economy by boosting just the firms and households whose names begin with the letters A-F.
October 8th, 2010 at 8:38 am
“The disease was artificially cheap money created by the Federal Reserve. “
This is just plain silly. Is Bookvar saying there would have been no bubble if interest rates had been higher? The growth in real estate prices began in 1945, and continued for more than 60 years, during which time interest rates were high, low and in between.
Lending too much against too little collateral caused the problem. Low interest rates had nothing to do with it. The problem would have occurred even if rates had been much higher.
Rodger Malcolm Mitchell
October 8th, 2010 at 1:30 pm
Barry: I think your critique of the Fed is a good one, but even the most cogent historical analysis is of limited assistance in predicting the future. It seems to me you seem to stop short at a crucial point. When you challenge the idea of inflation as a good thing, noting the paycheck to paycheck economic life of Wal-Mart customers, the next logical step is to argue that deflation actually benefits the less affluent segments of the public. If there is an argument to be made for deflation, I’d like to hear it. I have good savings, and if my bag of money gets bigger and bigger by just sitting there in T-bills at “real” interest rates above.016, I’m happy. But what I have heard is “liquidity trap” a negative cycle in which real economy does not just de-lever, but liquidates. Barry, I’d love to hear your analysis or prognosis on this.
October 8th, 2010 at 10:46 pm
If we are talking about 10+ year time periods, anyone know of analysis that examines how the growth of 401K plans over the past 20 years affected equity prices? Lots of dumb money (still) entering the market…