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Continuing the prior post:

No one can blame the Fed for cutting rates after the events of 9/11.  But here’s why it lead to an overheated real estate market.

The Fed had already been cutting rates gradually through the preceeding years.  I was in the mortgage industry during the 90’s and watched the rates fall.  At one time, it wasn’t unusual to have a mortgage of 9 percent with good credit.   I could put you asleep explaining the Savings & Loan bailout years before that and the impact on interest rates. ( how about 14% on a 30 year mortgage? Yes indeedy) Instead, I’ll just bottom-line it for ya.

There’s no way the Fed could have prepared for 9/11.  The discounted rates of the 90’s had already helped the stock market gain inflated values, leading eventually to a dot-com bust.  While that was a bump on the road, the events of 9/11 caused a real financial panic and the Fed had only one card to play.  Thus, the prime rate was taken down again and again and again in the hopes of breathing life into a threatened economy.

When it started to work, the Fed kept it up because the housing frenzy was the only major source of new employment.  ( Manufacturing jobs, by this time, were going to China.)  And so the government embraced the fact there were 2.5 million licensed real estate agents and umpteen people working in construction and score of clerical jobs in the mortgage industry.  It was the only bright spot in an economy that saw real wages shrinking and other forms of employment disappearing as a whole.  The tonic given in remedy, was continually lower rates, which faciliated cash-out refinancing that gave Americans buying power for cars and splurges that basic wages would never cover alone.

So why did the party stop? This is where it gets controversial, and I’ve yet to see any “real” financial writers broach the subject.  But here it is.

Simply, the costs of the continued Iraq conflict forced the Fed to raise interest rates.  With a government in trillions of dollars in debt and the dollar weakening against the Euro, the interest rates had to go up before deflation caused it’s own havoc.  (think of the Mexican Peso, where it takes about 100 of them to buy a Coke.)   Iraq was supposed to be a SHORT conflict.   Easy in, easy out.  Just as the Fed couldn’t predict 9/11, it was not prepared for the Iraq Conflict to last more than…oh, 18 months.

As things stand, the Iraq conflict has no end in sight, the price of oil remains high, China has most of the manufacturing jobs, tech jobs have gone to India, and somewhere in there we had the Katrina thing too - but somehow we don’t see insurance companies bleeding to death like we do mortgage companies.  Interesting how that works, eh?

This is why I never majored in finance.  Frankly the subject pisses me off.  Anyway….

The Fed has had it’s head in the sand for the past six months, waiting for the real estate crisis to fix itself.  Sorry boys, but that won’t work.  It was delayed reaction by the Fed in correcting interest rates that lead to the current problem.  Would it kill the economy to loosen the purse strings just a little, and lower the rates just enough to give would-be home buyers and refinancers some hope? 

And about all these adjustable-rate mortgages…how about re-writing the damn loans and converting them to fixed rate?  Oh wait, that’s right…the interest rates now are TOO HIGH! DUH!!  Guess we still have to lower the prime rate a little bit, don’t we.

We also need a mortgage equivilent of the FDIC.   The FHA loan program has an outdated structure and it’s inapplicability to modern real estate is evidenced by how many consumers were driven into “subprime” mortgages.  This is the exact customer base FHA should be serving. 

It amazes me, that the Federal government jumped in on the Savings & Loan bailout in the 80’s, and entered labor negotiations during air-traffic controller strikes, and climbed all over insider stock trading and “accounting irregularities” and a hundred other things that can adversely impact the economy….but it can’t seem to take action as homes roll into foreclosure at alarming speed and a major sector of our economy is falling apart.

Earth to Fed:  This is your mess.  Clean it up. It won’t be cheaper or easier later.