When Central Banks Tamper with Interest Rates

I really believe that all bubbles must burst.  Bubbles are highly unstable!  This one had to pop eventually, and of course it did.  Most will blame it on greed, but that’s like blaming plane crashes on gravity.  There were several causes of the current depression, but the main one is that there is no ”market price’ on interest rates.  When I say ‘market price,’ I mean the marketplace setting interest rates, and not the Federal Reserve.  A credit worthy applicant might and should get a lower rate than a greater risk.  Bad risks should get no loans at all.  When a central bank attempts to stimulate an economy by setting low interest rates, and then floods the marketplace with low cost dollars, guess what is going to happen?  There should be no central bank which sets interest rates.  It destroys the marketplace, which levels all things.

When, on top of the central bank making interest rates absurdly low, and the Barney Franks and other do-gooders urging banks to loan to the unworthy and threaten to fine them if they didn’t, a lot of bad loans were made by bankers to those who were irresponsible.  They had to, because a Jimmy Carter “Community Reinvestment Act,” would cause the irresponsible bankers to get sued if they didn’t make bad loans. In addition to the pressure from the CRA, ACORN was blocking bank drive through lanes with pickets, and threatening banks if they didn’t make bad loans.  Loans requiring no money down were made by the thousands.  All you needed was to be a minority, or a bad credit risk, have a low income, and want a home.  Sort of like the Bol Weevil in the song.  “Jus lookin’ for a home.”

Homes were being bought so fast, and with such easy mortgages, that home builders decided to build to meet the demand.  With the good times rolling, developers borrowed, bought land, built streets, sewer lines, underground utilities, and waited for spec house builders to show up and buy the lots.  A few did, but by then, the crash had started.  There’s thousands of empty lots on hundreds of empty developments in America today.

Banks might not have been so irresponsible, but for the fact that if they made a bad loan, they immediately sold it off to Freddie and Fanny, thereby releasing them from any risk.  Fanny and Freddie, then bundled the loans in batches, and sold them to everyone who would buy them.  When the bundled packages of mortgages were rated at AAA by rating agencies such as Moody’s, how could they lose?

Cheap money is what it was, and everyone was partaking.  Cheap money draws people like flies to honey. More dollars were created between the years 2000 and 2007 than in the entire history of America, and that’s nothing compared to what’s going on now. From 1998 to 2006, home prices went up 150%.  Homes didn’t change; only their prices.  Mortgages were given to virtually anyone, who immediately sold them to Fanny and Freddie, who resold them in attractive “AAA” rated packages to investors around the world.  Everyone was off the hook! Victims are the buyers of the packaged mortgages which were falsely rated “AAA.”  Home prices got so high, and the flippers of houses did so well, that when the obvious peak was reached and the bubble would simply have to pop, guess who was holding the bag?  Governments, pension funds, central banks, individuals, and you name it.  Why shouldn’t someone buy a packaged group of “AAA” rated mortgages?  Besides, the mortgage packages were insured by AIG, the world’s largest insurer.  How many hundred billion to AIG so far?  Then, brilliant Wall Streeters decided to place huge bets on the phenomena, called ‘derivatives.’  Hundreds of trillions of dollars worth.

Fanny and Freddie are government backed institutions, “too big to fail,” have been bailed out, and operate at the instructions, funding, and power of the Congress.  When the Barney Franks told Fannie and Freddie to make sub-prime loans to help the poor and worthless, they did, and told banks to send them all they wanted.  They did, and made even more bad, sub-prime loans to virtually anyone who walked in the door.  Mortgages were so easy, that thousands of people became “Mortgage Brokers” overnight, and set up in shopping centers and any available office space.  Everyone was having a blast!  Commissions and points were flying around like trailers in a hurricane. When the peak was reached, a chain reaction was started, which hasn’t stopped, nor reached the bottom yet.

All the while, before the peak was reached, the majordomos of economics, such as Sir Alan Greenspan, were encouraging people to get ARMS, or Adjustable Rate Mortgages, which was a sure guarantee of a failure.  Greenspan said in 2003 that “The notion of a bubble bursting and a whole price level coming down, seems to me as far as a nationwide phenomenon, really quite unlikely.”  It may have seemed “unlikely” to Sir Alan, but it didn’t to me.  When it started down hill, naturally we needed more government to fix it, so the “Emergency Economic Stabilization Act of 2008” was passed, which authorized the Treasury to purchase $700 billion in assets “at any time.”  The taxpayer was on the hook.  Then there is the “Troubled Assets Relief Program Act,” which allows the Treasury to seize any financial institution’s assets at whatever price it dictates.  Then, short selling was prohibited under, “The Uptick Rule,” as it destroyed the banks reputation.  This is an outrage, of course, as are all the bailout programs.  Government officials are running around like the well-known chicken with its head cut off.  We now have the “Term Auction Facility Act,” the “Term Securities Lending Facility Act,” and the “Primary Dealer Credit Facility Act.”  Sound like more government to you?

On October 9, 2007, the Dow was 14,164.53.  See what the real estate crash did to even stocks? Let’s now get back to the primary cause, and that has to be interest rates.  The interest rate acts like a floodgate, or the market’s governing body, which keeps floods from ruining everything.  If the interest rate is controlled and manipulated, to ‘boost the economy,’ we get into a bubble phase, which feeds on itself, till it has to burst. My banker, I am sure, sets interest rates on those to whom he loans, based on their credit worthiness.  Interest rates, SHOULD NOT BE SET BY ANY GOVERNMENT OR PRIVATE BANK.  The setting of interest rates way below what the market would have set them, by the Federal Reserve, has caused the world-wide chain reaction we now see.  As you know, in my opinion, the Federal Reserve should be instantly put out of business, and the Congress should not subsidize or dictate to anyone.  The Fed raised interest rates and flooded the market with dollars 80 years ago, and caused the great depression.  It did the same thing between 1995 and 2000, by increasing the money supply 52%, which caused the ‘dot com’ bubble to burst.  The Fed’s lowering interest rates eleven times to help us out of the dot com bubble, started the housing bubble.  The Federal Reserve is an unmitigated fraud and disaster, and there is no logical reason for its existence.

To fix the mess we are now in by endless printing of dollars and creating more and more bureaucracy, is pouring gasoline on a fire. Hey DC Gang…STOP FIXING IT.

Don Stott

March 13, 2009

The Daily Reckoning