Is a Return to Boom and Bust in Our Future?

After three decades of boom and bust in the economy, wouldn’t you think that the Fed would quit trying to manipulate things and just let the free market bring some balance back?

Nope, they’re not doing it. They still believe that manipulating our behavior is the best course of action.

It turns out that our real estate bubble was planned – it was a reaction to the stock market bubble bursting when business investors realized they had been pouring money into bad investments.

In 2002 economist Paul Krugman advised creation of a housing bubble to replace the Nasdaq bubble. He believed that the increase in household spending would offset dying business investment and bring order and balance to the economy. The Fed apparently believed the same thing, in spite of history telling them they were wrong.

In a report entitled “When Credit Bites Back,” Oscar Jorda, Moritz Schularick and Alan Taylor explain the results of an extensive study of the business cycles of 14 rich countries. The study, which dated back to 1870, found that excessive private credit growth predicts deep downturns and slow recoveries.

And excessive private credit is what we got. The Fed’s plan encouraged wanton borrowing and irresponsible lending – and we all know the result.

So now what do they plan to do?

They plan to continue today’s extremely low interest rates, perhaps for the next 5 or 10 years.

And banks, in their zeal to make more money, will once again take on more and more unwise credit risk. After all, the taxpayers (unwillingly) provide a safety net to protect them from their mistakes.

The Fed says we don’t need to worry – It now has supervisory and regulatory tools to prevent granting unsustainable loans. However, one governor on the Federal Reserve Board doesn’t believe it. Jeremy Stein’s take is that the Fed cannot possibly oversee and regulate all lending. He believes that the worst practices of the recent bubble years will return – and that if interest rates remain at these low levels we’ll go back through this cycle of destruction all over again.

We’re already seeing low down and no down loan programs offered in an effort to entice more people to borrow money. How long before those programs are once again offered to buyers who truly can’t afford to make their payments? And how long until home prices soar again? We’re already seeing housing shortages in many markets. It stands to reason that the fewer the homes available for purchase, the more the law of supply and demand will force prices upward.

They say that doing the same thing over and over again and expecting a different result is a symptom of insanity. Are the majority of members on our Federal Reserve Board insane?

References:
http://www.frbsf.org/publications/economics/papers/2011/wp11-27bk.pdf
http://www.bloomberg.com/news/2013-04-19/is-the-federal-reserve-insane-.html

Mike Clover
Mortgage Banker
www.mikeclover.com