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Wednesday, June 24, 2009

What the Fed Said and What it Means



That's a historical chart of the Prime Rate. Keep in mind that the Fed Funds Rate is 3 percentage points below prime. Starting in late 2002, the Fed lowered the prime rate to levels that were unprecedented, and, as I've said often, that lead directly to the crisis we have today, in my opinion at least.

Today, the Federal Reserve pronounced that the weakened economy means that they will maintain their current interest rate levels indefinitely.

The Federal Reserve on Wednesday held monetary policy steady and said the U.S. economic recession was easing, as it signaled its worries over a possible troubling downward spiral in prices were fading.

The Federal Reserve headquarters in Washington, DC.

Concluding a two-day meeting, the central bank said it had decided to hold overnight interest rates in a zero to 0.25 percent range—the level reached in December—and repeated that they would likely stay unusually low for some time.

With the benchmark interbank lending rate virtually at zero, the Fed has focused on driving down other borrowing costs by buying mortgage-related debt and U.S. government bonds.

Now, as you can see, the Federal Reserve only kept rates at levels that put the fed funds rate at about 1%, and even below, for about a year, and that created so much loose money that it lead directly to the housing bubble. We're already in the seventh month of having the fed funds rate at zero, or well below even those extraordinary low levels. It's clear we will be here for many more months.

I continue to worry that our current aggressive monetary policy is merely setting the stage for the next bubble. The Fed currently sees little risk of inflation. Of course, inflation can come in many forms. For instance, from 2003-2006, it was created almost entirely in real estate and it turned into a bubble.

In my opinion, the Fed has been overreacting to current problems since 1999 when Alan Greenspan supposedly raised rates in order to combat impending inflation. Each and every overreaction caused an even bigger problem. Greenspan's overreaction caused the internet bubble to burst and that lead directly to the recession in 2001. Then, his overreaction to the recession caused the housing bubble. Now, I fear this overreaction will lead us right into another bubble.

2 comments:

Shootist said...

I believe that it was the subsidization of sub-prime mortgages by fannie and freddie that led to today economic problems. In other words, Socialism.

mike volpe said...

That's the common conservative thought, and I disagree. Fannie/Freddie didn't specialize in sub prime but rather prime. I've written a very long white paper on all of this and I will let that speak for me rather than repeat myself.

Your view maybe right on theory but in reality there is simply no evidence that this happened.