After the 9/11 catastrophe, then Federal Reserve Chairman Alan Greenspan immediately dropped interest rates fifty basis points in the Fed’s attempt to calm the financial markets. After 9/11, the Fed continued to lower interest rates until they fell to a 46-low in the summer of 2004.
What I’ll never understand is why the Fed permitted interest rates to fall so low. By lowering the Federal Funds rate to 1% in the summer of 2004, the Fed started a sequence of events that led to “froth” in the real estate market and the financing market.
Does the Federal Reserve understand human behavior? The lower rates go, the more consumers borrow–even if they don’t have the capacity to repay the debt they accumulate. The lower rates go, the more finance companies preach the benefits of refinance so consumers can borrow more money on their homes thus increasing their debt burden. The lower interest rates go, the more speculation enters the property market.
Simply, with rates having moved so low, the Fed created a borrowing frenzy. Now, with rates having moved back up, those consumers who over borrowed are feeling the ramifications of their lack of fiscal sense. In the years to come, we will pay for the excessiveness of the borrowing binge of this time period. We will pay the price.
Maybe it’s not Greenspan’s fault. Possibly, he felt he needed to bring rates so low so as to keep the U.S. economy from falling into recession. But you can only put something off for so long. At some point, the natural cycle of the market, and of the economy, will prevail.
But I do have to give Greenspan credit for this: Before he left office he clearly stated the housing market would cool because price appreciation in that sector had been too aggressive. And cooling it is. In fact, I don’t think the U.S. housing market could be softening any quicker than it is. Look at how long it now takes to sell a house in previously hot markets. Look at how the big home builder stocks are taking it on the chin. Look at how prices are softening. These factors are only small indicators of the problems that lie ahead in the U.S. housing market.
NEWSFLASH–In July, U.S. consumer prices rose at the slowest pace in five months. Deflation is definitely a looming problem for the U.S. Federal reserve. We now have both the consumer price index and the producer price index indicating price growth has come down to a snail’s pace.