Recession 2.0

As proof that our government and its “expert” economists haven’t learned anything from the 2008 financial crisis, Federal Reserve Chairman Ben Bernanke signaled earlier this month that the Fed plans to keep interest rates near zero “at least through mid-2013.”

If you thought the 2008 collapse was bad, just wait. It’s about to get much worse.
To understand why, we must first take a trip down memory lane to revisit the policies that served as the catalysts for our current economic plight.

After the dot-com bubble burst in March of 2000 and the Twin Towers fell in September of 2001, the US economy was in trouble.

The Federal Reserve responded by lowering interest rates gradually from 6% to around 1%. The Fed hoped that by doing so banks would lend more, resulting in greater investment and more consumer spending.

At the same time, the government pushed through policies to encourage home ownership. It utilized two government-sponsored enterprises, Fannie Mae and Freddie Mac, to essentially tag federal guarantees to mortgages issued by banks to low and middle income families.

If these borrowers failed to meet their mortgage obligations, the government, or Freddie and Fannie, would be most liable, not the bank that issued the loan.

The government also pushed through policies to subsidize down payments for those low-income families for whom down payment was a barrier to home ownership.

The combination of low interest rates and government policies encouraging home ownership created what we call today the housing bubble.

Here’s why:

Interest rates are used to tell investors where the market is heading. High interest rates indicate a time for savings; low interest rates a time for spending.

When the government artificially lowers interest rates below where the market would naturally set them, investors invest more than they should, resulting in “malinvestment.”

This is what happened in the housing market. The artificially low interest rates made it really easy to qualify for a mortgage, so people bought homes that they probably shouldn’t have been able to afford in the first place.

As a result of the increasing demand for houses, housing prices were rising by 10% a year and investment in new housing projects were sprouting up across the country.

Banks didn’t bother worrying that some of the families they were issuing mortgages to probably couldn’t meet their payment obligations because the government guaranteed the loans.

Some banks repackaged their mortgages and sold them as securities all across the world. Investors ate these securities up because they were given AAA ratings by the credit rating agencies and appeared, at least on the surface, to be good investments.

As it turned out, they were not.

In late 2008 the housing bubble burst. All the mortgages that the banks issued during the bubble went bad and with them the securities.

Why? Because during the bubble, the government was encouraging banks to make loans to people who, under normal market arrangements, shouldn’t have
qualified.

Fed Chairman Alan Greenspan knew full well this could happen. In his memoir, “The Age of Turbulence”8, he said that the artificially low interest rates might “foster” a bubble. Well Chairman, they did.

And how did his successor respond in 2008 when the world’s economy was on the brink of collapse? With the same policies.

This time, instead of interest rates at 1%, he lowered them almost to zero. And instead of liquidating the bad assets created by the bubble, he suggested the
government buy them up.

Seriously, what could be wrong with that solution?

Now, instead of one housing bubble that could have been corrected through a liquidation process we have countless stimulus-funded bubbles.

Except when this bubble bursts, as they all do, we’ll see governments collapse not individual industries. We saw it happen in Iceland and Greece.

By keeping interest rates low through mid-2013, Bernanke is just keeping the bubble inflated and the malinvestments coming, thus making the coming “burst” all the more damaging.

If he were smart he would let all the bad assets be liquidated. Sure, we would suffer through a tough liquidation process, but afterwards the system would be corrected and prosperity would return.

But instead Bernanke is condemning us to years of continued economic stagnation. Aren’t we so glad the “experts” are in charge?