Low interest rates building the momentum for another bubble

Pour futur carnet

Financial Fiasco

According to Norberg, after the dot-com bubble and 9/11, Federal Reserve Chairman Alan Greenspan acted to avoid a recession by stimulating the economy with record-low interest rates in a sort of “pre-emptive Keynesianism.” But the Fed misjudged the state of the economy and kept the interest rates down far too long. Effective interest rates actually turned negative, building the momentum for another bubble.

The low rates encouraged even greater risk-taking, not to mention a mountain of debt passed on to the future. Instead of going into a recession, the global economy saw an artificial, temporary rise in prosperity. China’s policy of keeping its currency undervalued to stimulate its exports while pumping its surplus of capital into U.S. bonds supported the process and hid the imbalances created by the Fed.

Low interest rate

Predictably, artificially low interest rates inflated the real estate market. No sector of the economy is more sensitive to interest rates than real estate, and American politicians put massive pressure on two government-sponsored enterprises, Fannie Mae and Freddie Mac, to lower their standards to enable vast numbers of unsound mortgages. The resulting foreclosures will leave a terrible mark in the minds and on the credit reports of millions.

Norberg is no less critical of the actions of the Wall Street capitalists. Weak oversight of money placed in investment and pension funds, coupled with huge bonus systems, encouraged shortsighted gambling with other people’s money. Lurking behind all that was the assumption that there was little risk because the mortgage-backed securities were implicitly guaranteed by the federal government.

An interview with Johan Norberg on his book Financial Fiasco

Laissez faire

In the public debate following the credit crunch, many argued as if the financial markets were ruled by laissez faire, but the credit-rating agencies had an oligopoly due to regulations. Such regulations break down the barriers between the government and the market. The problem was not too little regulation.

Rather, it was faulty regulation upheld by a multitude of national and international agencies. Tough international bank regulations punished traditional banking, while pushing bad loans into a shadow banking system to avoid transparency.

Ruled by Illusions (1).

Financial Fiasco ends on a pessimistic note, predicting that we will see extensive, long-term government involvement in the financial sector for years to come.

“Create a crisis, and people will give you more power to fight it,”

Norberg writes. He points to the risk that politically well-connected corporations and interest groups will not only further distort competition (as in the case of TARP), but also cause new losses and crashes.