FED: Finance & Economics Disability or FOMC: First to Originate Make-believe Crisis

The FOMC should have left interest rates alone as the housing bubble started to burst, and let home prices fall back to historic trend-lines. Granted there may have been defaults, but they were necessary. These people didn’t deserve to be in these homes in the first place, they bought overpriced assets with no equity up front, getting ARMs when interest rates where at historic lows. But the bleeding hearts thought these people should be protected and allowed to stay in their homes and have the American Dream. Yes, banks would have had to deal with defaults and the write-down of their asset base, but we could have resolved those banking issues in an orderly manner as the ARMs readjusted in phases if and when the defaults actually happened. Because of Fed actions, now we are forced to have to deal with the whole problem in one bang, making it an unmanageable problem, and banking has frozen up.

There are some issues that don’t seem to come up as some preach that we need to keep these people in their homes. They say this in a manner to imply that these poor people will go into default and be homeless. That is just a fallacious argument to begin with. Yes, these people may get foreclosed on, as they should be and have to leave that property. However, they obviously do have some sort of income, right? Or were we going to help them keep the house for free? They won’t be homeless, they will go find lower priced housing that they can afford. In fact, this lower priced housing may be renting from another homeowner in a lower housing price bracket who also is facing foreclosure, but if they can afford to rent this property and cover enough of the owners mortgage, then that owner can avoid foreclosure, rent the property and go seek lower cost housing in a rental themselves. This chain of events would trickle down through housing values. So some defaulters, in effect, could help avoid other defaults as they move back down the housing ranks to levels they can afford. That would have actually provided MORE liquidity to the housing market instead of freezing it up. But everyone acts like these people will be homeless if we don’t bail them out? Let me say that again…some defaulters would have directly saved other potential homeowners from default by seeking more affordable housing and the default risks in the market were overstated to begin with.

If the Fed had left rates alone, and let housing prices correct to norms, it would have also allowed bank lending for homes to return to historic, pre bubble terms. With average real estate prices still currently overpriced historically by roughly 20%, the banks not only need the traditional 20% deposit they once required, but also an extra 20% to cover for the still inflated asset price. Otherwise a 20% down payment, is like a 0% down payment on a loan on a correctly priced asset and that would just be plain stupid to expect a bank to do. If prices were allowed to drop to historic norms, then banks could return to lending by historic terms like the pre-bubble years. New real estate buyers would enter the market and get approved for financing also providing liquidity to the markets.

If the Fed had not continued to take actions to support a historically overpriced stock market, and had also left interest rates alone it would have shifted some asset allocation from stocks back into bank deposits where investors could have received a higher return at lower risk. This would have provided many of the banks the extra liquidity they would need to cover the mortgages that actually did default. If the Fed makes sure the stock market is a rigged game to the upside, and there is no perceived risk of loss, then why sell any stocks and put money back into bank deposits. Under the Feds rules, the stock market would still provide a better risk reward ratio than bank deposits and that shouldn’t be the norm either. Speculative markets should be SPECULATIVE, not guaranteed against loss. I saw a Scottrade commercial that sums it up: Asked why $7 stock trades were important, the man answers “after paying all these bills, $7 is all I have left.” Unfortunately, after the bubble markets, many average people seem to feel this way about their money and that every available penny they have should be invested in the stock market. When I saw this commercial, I really didn’t know whether to laugh at the ignorance of the statement or puke in disgust to the marketing spin.

The markets should have been allowed to correct in the free markets and the toxic assets would have been much easier to swallow in stages with less risk of toxic death. It is not the Federal Reserve’s mandate to protect asset bubbles in speculative markets. Somewhere in the past 10 years of bubble markets, they have forgotten that a booming economy is supposed to drive a booming stock or real estate market, not paper profits in booming speculative markets driving a booming economy. They have somehow convinced themselves the chain of events is backwards. The only reason there is no agreement about the price of the toxic assets on the financial books, is that the Fed won’t let the underlying asset go to its equilibrium pricing such that a value can be placed on the assets and the derivatives. Everybody is waiting for the real estate market to find a bottom, and the Fed keeps taking action to keep the real estate market from being able to find that bottom…how does that help clear the market and resolve price discovery? Their actions have been contrary to protecting jobs and fighting inflation, and in fact have been supporting inflation in housing prices.

Now that the Fed has done everything backwards and locked up the U.S. banking system, they have locked up the global banking system as well as a result. They have created a self fulfilling prophesy by over reacting. The Federal Reserve has acted like the poor elderly lady walking down the street, who over reacts to footsteps behind her and falls and breaks her hip thinking someone was coming to mug her…when the threat was never really there to begin with. Now, are you really going to try and tell me the real problem was that we didn’t have enough regulation in place about walking behind elderly ladies on the sidewalk?

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