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2007 Mar 20, 8:36am
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Is the Fed really responsible for the housing mess? They definitely contributed through their interest rate cuts, but buyers and realtors must also have some responsibility.
And is the Fed as wicked as the non-mainstream press believes? There are dozens of sites accusing the Fed of keeping the rest of us down through inflation and various shady deals, but I've never heard a really convincing explanation. As I understand it, a little inflation is good because it encourages people to invest or spend rather than simply sit on their money.
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One word: Unnecessary.
We have a habbit of trying to label things as good or bad. The Fed may make mistakes, or even be incompetent but like most things it was formed with good intentions. Its actions attempt to create the greatest good for the greatest number.
What people don't seem to realize is that interests in this country are different so there will always be a group not happy with a Fed decision. If people are savers, they will applaud interest rate hikes. If they are debtors they will frown at one.
Low interest rates may have created opportunity for a housing price runup but they didn't cause the housing bubble. The housing bubble was created by the subprime Johnny come latelys who saw people making money, and then borrowed irresponsibly, without regards to the fundamentals.
If people are savers, they will applaud interest rate hikes. If they are debtors they will frown at one.
So does the Fed have magic crystal ball to decide what the "correct" interest rate should be? Why not let the free market decide the rate?
Johnny come latelies added to the problem but with the loose credit and the artificially low rates, the bubble would not have happened.
Oops. Change "with" to "without" above. Thanks.
Worse than useless - harmful.
Here's my take.
The dot com bust was pretty hard on the economy, they saw a recession in the works. Well, to avoid a recession, you can make credit easier to get ahold of to boost consumer spending. So they lower rates, credit gets easy, and we start pulling ourselves out of that mild recession by 2003. All well and good. House prices have gone up a little quickly, maybe, but the economy is recovering.
Unfortunately, the recovery was broadly based on the housing market, with jobs created there, equity used to fuel consumer spending, and the 'sure fire investment' making people think other savings were undeeded.
So when they look around and realize the recovery is pretty much there, it's time to ease back on the easy credit. But since the recovery is BASED on credit, they try to ease it back, to make the 'correction' a slowdown instead of a recession. So the plan was to turn a recession today into a slowdown 5 years later.
However, they probably let the rates stay too low too long, and were too slow in adjusting them up, probably afraid of 'popping' instead of 'deflating' the credit bubble. Unfortunately, the lending environment they created with the housing credit bubble made it short term profitable to relax lending standards in the face of rising interest rates, which led to the 2004-2005 stupidity. Had the bubble peaked in early 2004, I don't think we sould have seen this much 'doom and gloom' and a few years of stagnant home prices and below average growth for a little while longer would have deflated the bubble without too much pain. But as we all know, prices took off even MORE in 2004 despite rising rates as lenders scrabbled for every last origination dollar and Wallstreet bought up the 'can't miss' mortgage papers.
It was a very clever scheme that got out of control, and they should have seen it coming. If, at the time they dropped rates, they had locked Freddy and Frannie's debt loads down to reasonable growth and put in real federal laws on lending practices, the scheme might have even worked as expected.
Instead, I think they wound up hoping it would start to deflate with every rate hike and watched with growing horror as it got larger and larger.
At that point, what's the Fed to do? Tell everybody what's coming and incite a panic? Or try and be as quiet as possible and try to deflate it slowly?
I think they chose the last path, but they haven't been successful at starting the deflation, and now things are at the point where it's going to correct no matter what.
The Fed was like a Brady Bunch kid who had a scheme go horribly awry, and then tried to hide it until it got WAY out of control.
The housing bubble was mostly related to greed and fear. The Fed interest rate hikes triggered both the boom (buy before interest rate goes higher) and the bust (oops, interest rate too high).
To really answer that question, we would need to look at how other governments have handled their mortgage markets.
I just asked a Canadian co-worker of mine yesterday whether getting an ARM, a NINJA, a 'liar loan', cash back at closing type of mortgage is even attainable in Canada. He looked at me like I had five heads and said "You mean, with less than 10% down, Americans can buy homes??"
Anectdotal I know, but I can't help think that the blurring of sub-prime and alt-a for example, was something the Fed should have hopped on like wet on water. How can investors rate banks if their lending products are so steeped in smoke and mirrors?
My take is that the Fed, as in so many areas of national concern (9/11) were outsmarted by those more ruthless and crafty. And I have to agree with Sriram's succinct answer. If they can't regulate it, get out of it. That goes for a bail-out too.
Is there such an animal as a 30 year loan with a 15 year interest only period? My coworker told me she just bought a house using one of these.
Is there such an animal as a 30 year loan with a 15 year interest only period?
More real than a unicorn.
15/30 IO loans.
Despite the Fed's actions, they have not yet lost all credibility with investors. Otherwise, the yield curve would not be negative and long term bonds would be building in a much bigger inflation assumption.
They could lose credibility, though, if they respond to the bubble bursting with yet another massive infusion of easy money. The alternative, which is to keep rates steady and let the bubble slowly unwind, is probably preferable.
Is there such an animal as a 30 year loan with a 30 year interest only period?
One way to end the "abusive lending" = make rent tax deductible. This would eliminate the disparity in tax treatment between home-ownership and renting. Thus, most consumers would prefer to rent, rather than get into one of those ridiculous 15/30 IO loans. (Same tax treatment, same (lack of) equity-building, but more flexibility.)
So does the Fed have magic crystal ball to decide what the â€œcorrectâ€ interest rate should be? Why not let the free market decide the rate?
The theory is that inflation rising indicates the rate is too low. If the economy is below target or looking recessionary the rate is too high.
The free market does decide the final rates charged, the fed is basically the wholesaler. There are many other factors including government bonds, savings rates, and foreign debt and interest payments that effect what the optimal balancing act should be. If rates go up so does our annual interest payment as a nation, this of course increases the deficit and raises the need for taxes. My belief is that it also causes stagflation since it raises the cost of most things since interest is an overhead burden. If interest rates are lowered, costs go down but easier credit promotes debt, and increases prices through higher demand for commodities.
Then the politics come in to play. The grey haired voting block is always worried about their life savings disappearing due to inflation eating it away. So the fed in essence is always trying to balance savings, with ease of credit to the overall economy.
One way to end the â€œabusive lendingâ€ = make rent tax deductible. This would eliminate the disparity in tax treatment between home-ownership and renting.
Why do you hate America and our Freedom?
Mortgage interest deduction is over-rated. If people want to pay less tax they should donate more to charities.
Rent tax deductible? I'd rent my house to my wife! Then she could deduct the rent from her taxes, and I'd use the rent to pay the mortgage interest and deduct it from my taxes!
Hmm, so there is a 15/30 interest only loan. I wonder when the credit tightening will really start - my coworker just signed the papers yesterday on a 100% financed loan. She does have a good credit rating though. She's going from $600 a month rent to $3800 PITI on an IO. The loan is 7x income. Oh well, whatever...
To those who say "useless" or "harmful" or worse, I have one question for you:
What, specifically, is your alternative? Short of a return to the inflation-inducing gold-standard imperial-mercantile era of musket-diplomacy trade and overt slavery, how do you recommend we operate an international financial system without independent central banks?
The Fed has a lot of flaws, and can stand a good round of improvements. But "unnecessary" or "harmful"? Hardly.
But we've been through this before.
Assertion: Let interest rates 'naturally' float with the free market
Response: We live in the real world, where many countries don't follow free market rules. In fact, none do purely. By surrendering control over nominal rates a country just lets other countries exploit them. But maybe we'll all hold hands, think positive thoughts, and this won't happen.
Assertion: A gold standard will keep governments from misbehaving.
Response: It didn't before, why would it now? Under gold standards of the past there was still inflation, deficit spending, and defaults. The gold standard just meant there was a more tangible focus for intermittent war making.
Assertion: Put the Fed back under direct Congressional control. Make interest rates work for the people and create jobs. (Soc1alists are often on this side of the argument, witness Royal in France).
Response: The minute this happens I'll move out of the country. Politicians will destroy the economy of the US, and probably the world, within 10 years of starting to set rates, which they'll operate so as to buy votes.
Assertion: Make the Fed a computer program.
Response: This might actually work, but again only if the program is continually refined (or a self-adaptive learning system), and it can learn/evolve/change to respond to foreign governments (or hedge funds) learning how to game it.
Assertion: [Insert myriad currency market arguments here]
Response: Ultimately, currency FX is subordinate to central bank action. FX has a lot of strength independent of central banks, more so with more free market global trade, but ultimately FX is an extension of the fiat which it trades.
Assertion: FDR and/or the Fed worsened/caused/prolonged the Great Depression.
Response: Dangerous historical revisionism resultant from either ignorance or cynicism. The Fed did worsen the early Depression, but without the Fed's directed action and coordinated fiscal spending policy, the Depression would have been a lot worse. Instead of ~25% unemployment we might well have approached the 60-75% unemployment suffered in other countries (most of which ended up with fasc1st or commun1st governments thereafter).
Assertion: It's all irrelevant because everything changes after hegemonic wars (or hot or cold).
Response: I believe this is true, but we still need independent central banks to fill the spaces in between.
The loan is 7x income.
It's best to think of the fed activity with respect to rates as pushing on a rope. They lower rates to create slack and hope that the banking sector will encourage more risk taking (investment) in order to prime the economy. Risk aversion (e.g. post-Nasdaq pop) dries up liquidity, slows the economy and puts people out of work. One can certainly debate the length of the super low rates under Greenspan but if the broader economy didn't seem to be overheating and the recession was minimized, then it may not have been a terribly problematic tactic.
Except... we now have this housing bubble. Unfortunately, the fed can't respond to each individual asset bubble by jiggling with interest rates. If the fed did this, investors would never invest in anything for fear that the fed will always ruin the party. Plus, it's "unfair" to tank the entire economy because the price of stocks or bonds (or lumber or beanie babies) moves too rapidly in price. So the fed creates a formula to detect inflation and adjust accordingly... You can debate the weaknesses of the formula. (Many do.)
IMO, the biggest government failure was lax oversight of lending. Any fool could see that a bunch of toxic paper was being pushed (especially in the last 2-3 years) and that LOTS of people took on too much risk. There were missed opportunities by regulators to deflate the bubble sooner but there were more elegant ways to deflate it gracefully without raising overnight lending rates.
"The loan is 7x income."
Yes, and she is the same person who complains when our payday is changed from Thursday to Friday because of a holiday. Paycheck to paycheck, and now at 7x income. I hope it works out for her, but...
If you want to know what's really going on, check out the history of the privately owned federal reserve bank corporation, and the history of central banks. See both parts 1 and 2.
Yes, and she is the same person who complains when our payday is changed from Thursday to Friday because of a holiday.
I do not even know when my paydays are. The money just automagically appear in the bank.
Honestly, a 3.5x income loan is already a bit stretching.
Lunar, if it's a nice house, maybe you can pick it up cheap in a year or so.
The house is in Fremont. Maybe if it was in Los Altos...
Maybe if it was in Los Altosâ€¦
I love Los Altos... but I will also consider the Peninsula.
I like your thinking Glen. An X/X IO loan could be construed as tax deductible rent.
As Peter P. noted, mortgage interest deduction is not the be-all end-all of loop holes. But at least you get a place to live in with that deduction. A rental tax deduction just spreads the advantage to everyone.
As for FDR and the depression, we're still living with it. His decision to start cutting social security checks dramatically changed the system from an annuity to a pay-as-you-go model. As the boomers begin retiring in droves, the rest of us will pay that price. In a sense, the depression which began around 1929 lives on (like Jason).
Would I have done it differently? Probably not. Millions starving in the street, big pot of cash in the back room... yeah, I would have busted out the funds too.
But these loans, come on! Who could not see how dangerous they were to our overall economy? I could see it. Everyone on this blog has seen it for years. Why oh why couldn't the Fed see it?
Maybe our grandkids will get to pay for the sub-prime bust? It's not nice to hear, but that's the way we do it. Financial calamity is spread out as far and wide as possible to keep our economy alive. I'm willing to accept that, as long as I get to benefit as much as lunarpark's "7x income" coworker does while we are (unwittingly?) building that next calamity.
The median home in fremont is $610,000 - so she makes $87k?
Is she single? Does she have kids? Husband?
What do I think of the Fed? One of my faaavorite subjects.
Here's what I think:
Soâ€¦ Mr. Bernanke, what would you say ya do here?
Making TPS (Treasury Printing Strategy) reports?
To those who say â€œuselessâ€ or â€œharmfulâ€ or worse, I have one question for you:
What, specifically, is your alternative?
The U.S. Treasury already handles many of the truly necessary functions of a central bank, such as creating and regulating our currency. I don't see why its scope cannot be expanded to other regulatory duties that have long been ignored and/or neglected by the current Fed. For example: setting and enforcing responsible lending standards (gee, what are those?), reserve requirements for banks/S&Ls (vs. today's "keep lending until you run out of cash" business model).
Short of a return to the inflation-inducing gold-standard imperial-mercantile era of musket-diplomacy trade and overt slavery, how do you recommend we operate an international financial system without independent central banks?
The Fed is technically a collection of for-profit private banks, so is not really operating "independently" nor necessarily in the best interests of average American citizens --rather it primarily operates in the interests of its member banks and major shareholders, and to a somewhat lesser extent, the politicians that appont and confirm Fed officers. If it did typically operate in the best interests of average American citizens, we wouldn't be having this conversation.
Are those really my only two options (gold-standard, imperial-mercantile musket-diplomacy & overt slavery vs. current Fed?), or are there better central bank models for us to follow? I don't have an answer to this one, just posing the question.
The Fed has a lot of flaws, and can stand a good round of improvements. But â€œunnecessaryâ€ or â€œharmfulâ€? Hardly.
How can you simultaneously: (a) believe in the credit/housing bubble, and (b) NOT consider the Fed to be harmful? "Unnecessary" is debatable, I'll give you that much.
As promised, seeds for spring planting. Click on my name for more info.
The Fed is the worst banking system, except for all other banking systems. Most of the current version's flaws lay with bad political decisions.
Assertion: Let interest rates â€˜naturallyâ€™ float with the free market
Response: We live in the real world, where many countries donâ€™t follow free market rules. In fact, none do purely. By surrendering control over nominal rates a country just lets other countries exploit them. But maybe weâ€™ll all hold hands, think positive thoughts, and this wonâ€™t happen.
The bond markets mostly set long rates right now. Why can't they set short rates too?
Assertion: A gold standard will keep governments from misbehaving.
Response: It didnâ€™t before, why would it now?
I can't argue with this one.
Assertion: Put the Fed back under direct Congressional control.
I would not advocate putting any "central bank" under direct Congressional control for the very same reasons you gave. But the current Fed is far from being truly "independent" or free from bankster corruption and poitical influence. It's rate-setting power is unnecessary at best, harmful at worst, and best left to the bond markets. The few (mostly unused) regulatory/enforcement powers it possesses could be transferred to the Treasury Department, who might occasionally make use of them.
Assertion: Make the Fed a computer program.
Let the bond markets set rates, give the Treasury power to set/enforce banking reserves and minimum lending standards, and no program is needed.
Assertion: FDR and/or the Fed worsened/caused/prolonged the Great Depression.
Response: Dangerous historical revisionism resultant from either ignorance or cynicism.
FDR took power well into the Depression (and mainly because of the Depression), so he can hardly be blamed for it. He did a number of positive things to repair the damage and institute badly needed regulatory reforms (like founding the SEC, limiting buying on margin, founding the FDIC, etc.). The early Fed OTH, may well have contributed to the severity of the 1920s stock market bubble as well as the aftermath.
"The median home in fremont is $610,000 - so she makes $87k?"
Her combined income with her BF is under $87k.
I don't disagree with most of your points, except the "efficient bond market" theory part of it.
We should agree that "harmful" is a subjective term, and determining if the Fed is harmful or not is kind of pointless. I think that all inefficiencies are "harmful", because they rob people of prosperity. This is why I eschew about 99 out of 100 taxes.
I also consider the bond market very close to an efficient market, by current standards. It is very good at setting long rates. Though, those rates are still heavily manipulated by foreign central banks (towards their own ends) and less often by big hedge funds.
Short rates are even more exposed to such manipulation, and are more critical for the day-to-day operation of the regular banking system and corporate financing of working capital and other short-dated needs.
Imagine the Fed turns into a big computer program that mechanically defers to floating bond market rates. What prevents coordinated attacks from a couple medium foreign central banks (or less likely a deliberate move by the BoJ or ECB) to purposeful invert/uninvert the yield curve, and arbitrage a whole host of possibilities?
China have lots of capital to sterilize? No problem, just change the shape of the US yield curve for a while while forcing your inflation into the US. Now want to spur GDP growth a bit, no problem, just reinvert the curve. After all, you're China and you don't really need to play by "free market rules" inside your own country, you can charge whatever nominal rates you want to, and make Americans eat the inflation and pay for the growth with their jobs and real incomes (even worse than they already do).
The problem really is that your idea is *exactly* what I'd want if the US represented a world government. It is exactly what I don't want in today's real world. In my mind it's like the neo-market-fundamentalism is to the geopolitical neo-cons. Great ideas. Theoretically sound. Probably mostly inevitable over time. But totally impractical right now.
Guns don't kill people, people do.
Knives don't kill people, people do.
Loans don't bankrupt people, people do.
Greenspan started the ball rolling.
Realtors, mortgage brokers, appraisers, etc.
They all do share the blame in one way or another, but the bottom line is that the FB's didn't do their research and made bad financial decisions. If it wasn't for them abusing the loans to overpay for a property, none of this could have ever happened.
Let the markets correct themselves; screw all those FB's!
It's no good unless society as a whole is willing to let stupidity suffer its own consequences and starve the idiots out of the gene pool.
And I don't see that happening. Humanity will probably die off due to its own stupidity soon enough.
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