By Matt Bisanz
The American housing market is in trouble. Millions of Americans have mortgages that they can never hope to afford, and already the foreclosure rates are rising.
At the same time, people who owned the rights to the payments of those mortgages are seeing the return on their investment decreased as people default on their loans. That brings us to the question of who should we help and how?
If you listen to Jim Cramer of MadMoney and Ben Bernanke of the Federal Reserve, the solution is to cut the Federal Reserve’s Discount Rate. That would be the rate at which the Fed lends money to banks, who in turn make loans or pay depositors. The theory is that as long as banks can make loans, they can continue to operate. In turn, people who bought pools of mortgages, can now resell them to the banks. In short, Bernanke was trying to prevent the massive devaluation of mortgage backed bonds to keep Wall Street afloat.
That’s what I don’t understand. In the whole scheme of the mortgage industry, the people who bought the mortgage backed bonds and the pools of mortgages on Wall Street are both the best equipped to recognize they were getting into a risky investment and the prepared to withstand the losses from the investment.
Why then should the Fed help protect their risky investments? Some will argue that the Fed was keeping afloat the larger stock market and that that’s in the interests of everyone. I disagree.
Joe Public invests in Wall Street via his 401K for his retirement. Over the long run (10-20 years), the stock market’s averages rate of return doesn’t change due to recessions. So the whole idea of the Fed smoothing out the market does nothing for Joe Public.
Another person the Fed has been ascribed to be protecting is Everyman Home Owner. Well, no again, the Fed is not helping him out. In the process of helping the banks continue to make loans to people who can’t afford them, the Fed injected something along the lines of $100 billion into the economy. Without giving an economics lesson, if there is more money in economy, inflation increases, increasing interests rates.
What problem does Everyman Home Owner face? He faces the problem that the interest rate on his mortgage is tied to the economy’s interest rate and the economy’s interest rate is rising. So really, by helping out the banks, the Fed is making life harder for mortgage holders.
So who is getting helped by the Fed? Well I would imagine that the millionaires who own hedge funds are very happy. They invested in subprime mortgages because they pay such a high rate of return. They pay that high rate because they are so risky.
However, if the Fed will step in and bail out the banks and bolster the markets, every time it looks like their going to lose money, well, that investment is very safe.
What Bernanke should have been doing is nothing. Markets are very efficient operations. If a hedge fund goes bankrupt because it made some bad investments, that’s part of life. If a bank goes under because it loaned too much money to the wrong people, well that’s an issue between the bank’s shareholders and management, not the Fed. If Bernanke had done nothing the homeowners who are in default today would still be in default today. Nothing would have changed, other than the fact that inflation might be just a little lower and bank profits might not be as spectacular as they’ve been for the past several years.
It’s not the duty of the Fed to make sure Wall Street gets a million dollar bonus every year. The Fed’s job is to manage the money supply for the benefit of the entire nation. Keeping inflation low is its goal. By giving the Richie Riches of the world a free insurance guarantee on their risky investments, it’s just using its tool to help the select few.
Matt Bisanz is a graduate student. You may e-mail him at [email protected].
(Ryan Broderick)
Matthew Bisanz