America’s Self-Made Financial Woes and What’s Next

In the days after the September 11, 2001, terrorist attacks, then-Fed chairman Greenspan attempted to reassure the investing public of the Fed’s commitment to an orderly market by lowering rates half of one percentage point. That wasn’t the end for interest rate cuts. Over the next couple of years, Greenspan continued to bring rates lower until they hit a 46-year low.

With interest rates being low, Americans started buying homes in record numbers. And with the demand for housing came higher home prices. As interest rates started to rise in late 2004 and early 2005, the mortgage companies came out with even more innovate loan products so Americans could buy homes.

No income? That’s okay. Mortgages were developed that didn’t require homeowners to show verification of income. Subpar credit? Not a problem. That’s when the subprime market boomed and billions in loans were made to people who didn’t qualify. Can’t make that monthly payment but really want the house? That’s fine, too. ARMs were developed so payments would be artificially low the first two to three years before resetting to normal rates.

While the boom in the housing market and the mortgage market were going on, something else happened. The value of the U.S. dollar started a free fall against other world currencies as foreign investors became concerned about the amount of debt American consumers and the American government (to fight the War on Terror) was accumulating.

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Interest rates started to move up. Rates rose to cool the housing market, too. Inflation reared its ugly head and rates were pushed up again. All of a sudden, the boom in the housing market was halted. At first, the Fed told us it would be a soft landing for housing prices. But the opposite happened. It has been a hard landing for property prices. So while the remainder of the world’s central banks raises interest rates to fight off inflation, the U.S. has its hands tied.

If rates move up in the U.S., the poor housing market could cause a recession. If, on the other hand, interest rates in the U.S. do not rise, the greenback could come under immense selling pressure, making it very difficult for us to sell our bonds to foreigners in order for the U.S. to finance its debt.

Where do we go from here? The U.S. housing market bust is far from over. Expect lower home prices ahead. As for interest rates, don’t be surprised to see the Fed raise interest rates at some point to support the ailing greenback.