Those that blame Bernake or Greenspan for all of the problems with real-estate or all that ‘ails’ in this economy, basically have it wrong. CONCHO got things very close.
Basically, the federal reserve has three mechanisms to effect the economy.
1) Federal Reserve rate (underpinning interest rate).
2) Effective outstanding Loan to Deposits rate on banks.
3) Federal Reserve ‘printing presses’.
Thats basically it. Each of these has limitations and consequences in their actions. The Federal Reserve Chairman can not control how much congress wants to or will spend… but he has a partial responsibility with finding the money that they will spend (can’t deny them the purse strings).
Each of the above mechanisms can stimulate or hold back the economy. In addition, deficit spending by Congress can limit the Federal Reserve Chairman’s options (as hinted by CONCHO).
Method #1 (Federal Reserve Rate), this is considered an ‘underpinning’ interest rate because the US Gov. is consider to have 0% chance of default on its debt, therefore it is considered the risk free rate of return on capital. Any returns that have a higher risk of default or failure, will have a risk premium associated with it, increasing the effective interest rate. The risk premium is to offset the chance that you will not get any return or will loose part or all the capital (ie. short shale/foreclosure).
This Federal Reserve Rate is also around the rate that US. Treasuries return since a Treasury Bill is effective a loan to the US Government with the noted rate of return. When Congress is running a deficit, this rate can not be lowered below the indicated rate or return at which people will buy a Treasury Bill at (because the Treasuries will not sell and Congress would not get its deficit spending funded). One of the flies in the mix, is that foreign countries have historically been picking up US Treasuries as investments. While there is 0% risk of default, the chance that the US dollar will decline vs. foreign exchange currency will add an implied risk to the foreign investor and therefore they will demand a risk premium. An example would be: A treasury yielding 5%, but the dollar to foreign currency exchange rate changes by -7%, approximate net would be -2% return. Now take a look at the following links: http://www.x-rates.com/ http://www.x-rates.com/d/CNY/USD/graph120.html http://www.x-rates.com/d/EUR/USD/graph120.html
Method #2(Effective outstanding Loan to Deposits) Otherwise known as M2 (Money supply) adjusted by fractional reserve rate. If banks were originally having to hold 40% of deposits, and allowed to loan out 60% of deposited dollars, a change to holding 30% of deposits and loans on 70% of dollars would free up money for loans. This is in part why the banks were securitizing loans (bundling them as securities and selling the loan packages). The securitized loans no longer count against them on the fractional reserve rate. In addition caveat to some clauses it removes the bank from the risk of those loans failing. see: http://en.wikipedia.org/wiki/Money_supply http://en.wikipedia.org/wiki/Fractional_reserve_banking http://en.wikipedia.org/wiki/Mortgage-backed_security http://en.wikipedia.org/wiki/Image:Money-supply.png
NOTE: The banks really abused securitization of loans during the R.E. bubble by creating wholly owned subsidiaries to do this dirty work and are presently closing these subsidiaries (having them declare bankruptcy) to protect themselves from liability. Because it is a separate company, there is a corporate ‘veil’ between the bank and the wholly owned subsidiary, which also applies to liability. This veil would need to be pierced to go after those that are responsible for the bad loans. If the subsidiaries were created primarily to shield the owning company from liability, and most of the money was being transferred back up to the parent, there may be a good chance to pierce the corporate veil. The wholly owned subsidiary would not have been acting as a separate company in that instance. The suit to pierce that corporate veil may have to be instigated by the holders of the mortgage backed securities. The abuse of the securitization was also a large part of the cause of the drop in lending standards and the crazy prices. The lenders felt safe to lend money to those who they felt couldn’t handle it, because the lenders didn’t feel that they would be caught holding the bag (in a manner of speaking).
One side effect of adjusting fractional reserve rate downward (lower on-hand deposits), is an increased risk of bank failure should those loans go south. Adjusting this rate downward does not help Congress fund its deficit spending either.
Method #3This is firing up the printing presses, otherwise known as M0 (another money supply variable), and relates to the amount of physical currency and central bank accounts that can be exchanged for physical currency. A zero inflationary stance here would be that the growth in physical currency would match the growth of the population. Because of the leverage that fractional reserve rate gives on this figure, increases here can be highly inflationary.
Finally, deficit spending itself is also stimulative to the economy and can be quite inflationary.
Therefore, in reality, it is very unlikely that the Federal Reserve will lower rates. The part that is worrisome, is that with the amount of destruction of capital that the Real Estate deflation will cause, the economy will need to be stimulated again to keep it on its feet. With deficit spending presently occurring, this can not be done by lowering the Federal Reserve Rate. Because the banking industry has put themselves at risk due to their lending behavior, the stimulation can not be done through the fractional reserve rate (Method #2), therefore method #3 is left. To keep inflation at bay when increasing M0, reserve rates may need to be further increased… which has the possibility of worsening the R.E. situation.
As for csr_sd’s situation: I am in much of the same boat, except that I do have a significant investment ‘stash’. I look at the situation a different way. A home is also a ‘performing’ asset. It gives shelter etc at a cost. So does renting. I could use some of my investments to buy a house, but my expected return should be better than the return that I get from the investments. To those that claim that I would get a tax write-off by buying, you forget that at the $100K+ /year level and with investment returns, you are already banging against AMT.. which would limit your deduction for mortgage interest. (LTCG rate is 15%, floor on AMT is 26%, mortgage deductibility is only for interest).
