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Monday, September 13, 2010

Fixing the Economy

Caroline Baum of Bloomberg has an interesting piece this morning on how to fix the ailing economy. What I like is that she explicitly cites Federal Reserve policy in 2003 as the prime cause of the housing market debacle and recession that has pushed unemployment close to 10%. Too few people understand or admit the role of the Fed, and the leaders at the Fed have successfully deflected the blame elsewhere. They point to rating agencies, banks investing in collateralized debt, and even the excessive saving rate of other countries as culprits and causes of the housing debacle. Little mention is given to their policy decision to lower short-term rates to 1%.

In fact, Chairman Bernanke gave a speech recently on the causes of the downturn, and you have to search through the speech for the role that policy played. His take on what triggered the debacle was "...the most prominent one was the prospect of significant losses on residential mortgage loans to subprime borrowers." He doesn't seem to understand the role that 1% short-term rates played in the build up of subprime loans. And he's an expert on the Great Depression?

What needs to be understood and put out front is that the only way to prevent future melt downs is to recognize explicitly the cause of the last one. Bringing Bernanke and his ilk in front of Congress to testify on the causes is asking the fox about the dead chickens in the farm yard. Bernanke played a key role as a spokesperson going around the country giving a "Chicken Little" speech on the dangers of deflation and calling for low rates and is, therefore, as culpable as Greenspan in laying the groundwork for a seriously flawed policy.

Only by getting at the cause of the last meltdown can the present bond bubble buildup resulting from a 0.25% federal funds target rate be understood.

The Fed is destablizing the economy. This is not why it was set up in 1913.


  1. Who's going to bail out the governments?

    I wonder if we're going to see a shift to sounder policy as a result of this, or if instead the MMT guys will get their way and government will spend without issuing bonds...

  2. Maybe the governments don't have to be bailed out. Maybe they renege on their promises - social security, medicare, G.I. Bill etc.

  3. I think the governments are going to have to renege on some of their promises, or else crank up the printing presses (not sure that is an option for the Eurozone countries).

    Personally, I thought the housing part of the crisis had at least three causes: 1) imprudently easy money by the Fed after 9/11, 2) the push for the "ownership society" by politicians, 3) and the political manipulation of Fannie and Freddie to lower loan standards until there were practically no standards.

    You should watch Overdose: The Next Financial Crisis (, particularly if you like Peter Schiff or some of the other folks in the hard money crowd.

  4. re: Grouch I hear what you're saying but I would love to rerun the period and keep the fed funds target rate above 3%. I think we would have had a mild recession and would have never had the onslaught of no doc, subprime and adjustable rate teaser loans.