It’s about time for the United States to have a recession, no matter what Ben Bernanke and the Fed have to say about it. The housing market bubble has burst and needs to be fully deflated, and any attempt by the Fed to mitigate the damage this late in the game will only lengthen the recovery period. The Fed’s plan is simple: It cuts rates, driving new borrowing and spending while simultaneously keeping housing prices up by encouraging new buyers to invest, and heroically rescues our economy from a recession. Sounds nice, however If history is any indicator, drastically cutting interest rates to counter a deflating bubble (dot-com ringing a bell?) encourages the type of irresponsible investment that leads to a new bubble altogether. Lower interest rates also mean less demand for dollar-denominated treasury bills and consequently a further depreciation of our currency. If the dollar gets weaker, and it’s already pretty weak, there are inflationary risks as everything we import from other countries (oil in particular) gets more expensive. I am with those who propose letting the whole thing crash, as it’s bound to do anyway, and letting the economy sort itself out during the recession that follows. The market will get rid of the inefficient and lagging companies, and American consumers will finally have to cut their spending. This may even reduce the enormous trade deficit we’ve been running. Most importantly, leaving interest rates alone or possibly even raising them will ensure that all the excesses currently in the economy are swept away, and that no new bubble grows out of the remains of our current one.
Speaking of letting things die, I am disturbed by the news of our government’s plan to bail out defaulting homeowners. The Treasury’s plan to freeze subprime interest rates before they can readjust is, as many experts have already noted, just a band-aid on the open wound that is the housing market. It is true that allowing banks and other lending organizations to foreclose on people’s homes is socially undesirable, but government involvement will only shift the burden from responsible parties to the rest of us. The housing bubble was caused by overzealous borrowing and careless lending by people and institutions that thought the market would only go up. Borrowers went after the “easy” money and neglected to read the fine print regarding subprime resets on their mortgage contracts, while lending organizations were all too willing to overlooks bad credit histories in their rush to make money. It is a sad reality but these are the groups responsible, and by bailing them out we encourage continued bad behavior in the market. Someone has to lose money on these bad loans, and a government bailout is likely to go much further than just hurt credit institutions, especially since the plan calls for only assisting the group of homeowners who can afford to repay the introductory mortgage rates but not the reset ones. This is a disaster waiting to happen, as many people can’t even pay off the introductory rates and will find ways of rearranging their finances to be included in this privileged group. In that case it is likely that a portion of the bailout will be coming from taxpayers. Is it right that we should pay for the folly of our irresponsible neighbors?
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Indeed, there has been so much speculation by government analysts, investors, the media and within academic circles for months now as to whether there would even be a recession. Now it seems that the argument is no longer "Will there be a recession" but rather "How bad will the recession be" or "Will the U.S. economy experience a recession or slower growth in 2008?" Even the Bush administration has finally acknowledged that we have to do something about the state of the economy.
Granted a Fed interest cut probably won't do much in terms of increasing investment in terms of fiscal policy, but monetary policy experts argue that an interest rate cut makes a significant difference in expanding the housing market (see Paul Krugman's blog). Of course as he and you note, the problem here is a bursting housing bubble and hence it might not even be possible for the Fed to cut rates enough to renew expansion enough to boost the economy.
It's also interesting to note the Bush administration and Republican responses to the economy. When the economy is doing well, it's because of the Bush tax cuts. When the economy is in peril, uh oh, we need more cuts to bail us out.
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