patrick.net

Perhaps the entire credit crunch could be fixed with very high interest rates. Currently, banks and other institutions have to compete with the suicidally low interest rates of the Fed and the Treasury bailout programs.

Say you're a bank and you know that a new mortgage loan has a 10% risk of default. Then you have to charge at least 10% to compensate for this risk before you can even begin to make a profit. But you can't charge 10%, because you're competing with the Fed's 2% rates, and the Fed is lending without regard to default risk. So you would be committing bank suicide to make loans in a market poisoned by the Fed's rates, knowing such loans will generate a large loss on average.

OK, the bank can get something from the defaulted loans by foreclosing and selling off the houses, but still, the point holds: the Fed is ruining the market for credit. It's kind of like American manufacturers being ruined by cheap Chinese imports, only it's American banks and savers being ruined from within our own country, by the Fed.

The directors of the Bank of England once bragged that a 10% interest rate could "draw gold from the moon". If it's credit we lack, let rates rise, and watch credit problems disappear.

Patrick

#housing