Too Late and Likely Too Little

Here I go on my tangent again: Greenspan has waited too long to raise interest rates, and, in doing so, he has created a debt bubble America has never seen before.

In the same way that he waited too long to raise interest rates before the bubble in the stock market burst in early 2000, we now have him moving too slowly to raise rates to cool the housing market. Higher rates earlier on would have kept the housing market from creating its own bubble… and stopped consumers from taking larger mortgages and loans.

Now oil prices are out of control, housing prices are pushing the Consumer Price Index higher, and the Fed really has no choice but to raise rates. The big question, like I’ve said before, is not when, but by how much?

The Bank of England made good on my prediction that it would raise interest rates when it met last Thursday. The Bank of England raised its benchmark interest rate by one-quarter percentage point to 4.25%– its third increase in six months. Most economists are expecting to see rates rise by another fifty basis points by year-end in an effort to slow the rapid rise in house prices and restrain the UK consumer spending binge that could overheat the economy.

The same thing will happen here. The Fed will raise rates by announcing that, since employment growth is strong, the Fed does not want to have an overheated economy. But there are many other reasons the Fed will be forced to raise rates… and the one it won’t talk about is because of the housing and debt bubble it created when it lowered rates to a 46-year low.

You see, I don’t believe the Fed expected that such low rates would prompt consumers to spend their hearts out. The Fed forgot the golden rule of consumer spending-the great majority of consumers (90%) spend what they make, so they are not looking at the cost of a good… they are looking at what it takes in monthly payments to carry that good!

Now, with the majority of American mortgages at a variable rate, how are consumers going to afford higher monthly payments if their incomes are not rising? A variable rate mortgage at 4% could be 6% by next year. That means the average interest portion of a $200,000 mortgage goes from $667 to $1,000 a month-a 50% increase. It will take time to filter through the system, but when it does, the deflating debt and housing bubble will be a beauty.

In the same way the Fed created a bubble in the stock market up to the spring of 2000, for which we are still paying dearly for today, it created the same bubble in debt and housing. The public be damned again.