[Marxism] fiasco

["Rakesh Bhandari" <bhandari@xxxxxxxxxxxx>]

So in a response to the piercing of the tech bubble and 9-11, Greenspan
lowers rates, and
then since military Keynesianism via the occupation of Iraq not only fails
to stimulate economy
but weakens it as the stimulus leaks abroad, the price of oil skyrockets
and the dollar falls with the explosion of deficits, Greenspan keeps rates
low and turns a blind eye to the collapse of lending standards, as a real
estate bubble is the only simulus the economy has going for it.
And a few years later American workers are now left not only with
recession but a one trillion dollar bill to buy back the toxic debt and
three trillion dollars in war costs.

How Keeping Short Rates Low Created a Fiasco
By Allan Sloan
Wednesday, September 17, 2008; D07

There's been so much financial turmoil this week that people have begun to
forget last week's big story -- the bailout of Fannie Mae and Freddie Mac.
But before we go off chasing the late Lehman Brothers or AIG or Washington
Mutual or the financial casualty du jour, let's briefly revisit Fannie and
Freddie, because there's one simple truth that doesn't seem to be part of
the national conversation. To wit: that the Fannie-Freddie fiasco is due,
at least in part, to the Federal Reserve Board's cutting short-term rates
to ridiculously low levels over the years.

Consider it yet another example of the law of unintended consequences --
dealing with one problem, such as troubled financial markets, can give
rise to others you didn't anticipate, such as borrowers bingeing on cheap
money.

The Fed generally gets tons of praise when it cuts rates, but the nasty
side effects of ultra-low short rates, like today's 2 percent federal
funds rate or the 1 percent rate in effect from June 2003 until June 2004,
are rarely noted. That's because few analysts link the low rates to the
problems, which generally erupt well after the rate cuts have been
instituted. And only a few of us media types complain about immediate
troubles caused by the rate cuts, which reduce the interest income of
prudent folk, such as retirees who've saved all their lives, while helping
the imprudent.

Fed Chairman Ben S. Bernanke, in office since 2006, has been bailing out
the imprudent for the past year, believing he has no other choice. His
predecessor, Alan Greenspan, episodically bailed them out during his 18
years as head Fed.

You can make a good case that low short rates were major contributors not
only to the Fannie-Freddie mess but to the overall problems of the U.S.
housing market, which in turn have caused many of the troubles in the
financial system.

How so? It's the old borrow-short, lend-long game, which every
sophisticated player knows is risky but oh-so-tempting. When the Fed cuts
short rates, which are the only ones that it controls, long-term rates
generally don't fall much, and sometimes even rise. That's because
inflation fears weigh heavily on long rates, and lower short rates are
seen, rightly or wrongly, as stoking inflation.

A big spread between short-term rates and long-term rates tempts players
to borrow gobs of short-term money, invest it in higher-yielding long-term
assets, and try to make a fat profit off the spread. This is also known as
the carry trade.

But carry-trade practitioners often get carried out when something bad
happens, such as a rise in short-term rates, a fall in the value of assets
they've bought or borrowed against, or lenders' refusing to renew their
short-term loans. And something bad almost always happens.

Fannie and Freddie borrowed so much -- call it 50 to 100 times their true
net worth -- that all it took was a 1 percent drop in the value of their
assets to land them in big trouble. Lenders got antsy, Fannie and Freddie
got fried, and Uncle Sam had to step in.

When the Fed, under Greenspan, cut short-term rates sharply in reaction to
the stock market bubble's pop in 2001 and to fears of nonexistent
deflation in 2003, the housing bubble inflated. People got ridiculously
low short-term teaser mortgage rates that let them buy vastly more house
than they could have afforded at long-term rates. Because housing looked
like a can't-miss deal, many people bought multiple houses on speculation,
hoping to flip them at a profit. The borrowers assumed that when the
short-term teasers came due, they'd be able to refinance with new teasers.
But the Fed started raising short-term rates gradually in June 2004,
lenders belatedly came to their senses, new teasers disappeared, housing
prices cratered, and the decline began feeding on itself.

That decline now threatens U.S. and world financial markets, which has
prompted Bernanke to take extraordinary measures to keep markets going.
Since the summer of 2007, the Fed has pumped hundreds of billions of
dollars -- soon possibly trillions -- into the world financial system to
bail out banks, investment banks, and soon, probably, Fannie and Freddie.

It looked really smart when it started. But don't be surprised if it all
comes back to bite us in some unanticipated way in the not-too-distant
future. It's the oldest economic story in the world: There's no such thing
as a free lunch.

Allan Sloan is Fortune magazine's senior editor at large. His e-mail
address isasloan@xxxxxxxxxxxxxxxx



© 2008 The Washington Post Company





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