Fed Created Conditions That Led to Pressures It Now Addresses

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By KATY DELAY

The Los Angeles real estate market is finally starting to feel the pinch. The Busy Blondes, popular realtors of Marina del Rey, are beginning to advertise substantial price reductions. The lack of jumbo loans is breaking deals, and foreclosures are up across Los Angeles County.


To parry this situation, the Federal Reserve Board of Governors decreased interest rates by half a percentage point on Sept. 18 “to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.”


Will these actions cure the problem, or will they make it worse in the long run? Calming irrational panic is certainly useful; in fact, it’s one of the Fed’s jobs. But beyond this, even though Fed officials do influence certain rates, they know they don’t control all of them, judging from former Fed Chairman Alan Greenspan’s now famous quip a couple years ago about the “conundrum” in which long-term interest rates flattened and even dropped despite the Fed’s campaign of raising rates. Even current Chairman Ben S. Bernanke’s most recent speech concerns the cause of market interest rates’ inexplicable resistance to the Fed after 2004.


His hypothesis is this: Asian, Middle Easterners, Russians and Latin Americans have been saving to an unusual degree due to increased production, and have been investing this “global saving glut” in America, particularly since 1996. This in turn has contributed to the current U.S. account deficit, the current account surpluses in their own emerging-market economies, and “a worldwide decline in long-term real interest rates,” especially in the United States, the United Kingdom, Canada, Germany, Sweden and Switzerland.



Other events

Bernanke’s reasoning may be sound as far as it goes, and the research is probably still at too immature a stage to be judged; but his methodology and assumptions cause us to question the wisdom of having given the Fed board the market intervention control now at its disposal. Bernanke’s focus is narrow, and he makes no reference to the potential existence of any other tangentially causal events.


Let’s get specific: There is one real event that beats its chest for attention, of which Bernanke makes no mention. During the late 1980s and up until 2004, the Fed, especially when chaired by Greenspan, began an episode of very loose monetary policy. Its target interest rate went below real zero when you take the CPI into account. No one will deny that this action had the effect of unleashing liquidity into the pockets of borrowers of all kinds banks, companies, investors, speculators, asset buyers and consumers and of driving down interest rates, if only because this was the intent. And the United States was not alone in increasing liquidity.


What did consumers consume, and quite rightfully and naturally so?


Imports from China and elsewhere, sending trillions of dollars overseas to Bernanke’s foreign “saving glut,” from whence they came right back here through the securitization markets and into other vehicles, only to renew the pressure on U.S. interest rates and start the rate-depressing cycle all over again, with perhaps a year or two of delayed-reaction time. A double whammy.


For some reason, in his analysis Bernanke neglects to mention the original Fed rate action altogether, as though it didn’t exist. Why does he look overseas for a culprit? Why can’t he also accuse this gorilla standing right here in the room?


As of now, it looks like the Fed is going to attempt to jump-start the process all over again. This may restore access to funds at a reasonable rate to homeowners in Los Angeles and elsewhere, but it won’t give the market correction enough time to weed out the problems.


The Fed must get a handle on any immediate panic attacks, if any there are; but in the end, our monetary managers should ask themselves if they were not the ones who started feeding this gorilla in the first place.



Katy Delay is a freelance writer who lives in Marina del Rey.

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