Artificially Low Interest Rates, Pre- and Post-9/11

LATE BREAKING:Fannie Mae, Freddie Losses Make Them `Insolvent,' Poole Says

LATE BREAKING: Fannie, Freddie Downgraded by Derivatives Traders Over Capital

In a column I wrote for The Ecologist magazine in London a few years ago I posited that the financial "environment" was as precariously pitched on the edge of an economic abyss as any of the ecological disasters such as climate change, fishing stock depletion and deforestation.

The globe's financial markets were emitting toxic waste in the form of too many dollars leaking from too many leaky investment banking ships; BearStearns, Lehman, Goldman, etc. Just like the Exxon Valdez hit a rock and spilled crude into Alaska's Puget Sound so too various financial companies were destined to hit the "rock" of higher interest rates and spill hyper-inflationary, unaccounted for and financially toxic trillions of U.S. dollars into the pockets of millions causing inflation and hardship at the gas pump and grocery store.

It appears as though my prediction has come true. The rogue ship I mentioned four years ago, Fannie Mae, has finally capsized and the results are seeping into inflationary expectations for the dollar (bad) and gold (good). I also mentioned in the same article that the U.S. economy would probably collapse at around the same time as the casino industry in Las Vegas. Las Vegas is built on two faulty premises; unlimited credit for free spending, equity extracting gamblers and an unlimited access to natural resources like water. Both have dried up.

"If Fannie or Freddie ever became critically undercapitalized, their regulator would have no choice but to put in place a taxpayer rescue," said Karen Shaw Petrou, managing partner of Federal Financial Analytics, a consulting company.

To ward off that possibility, in recent weeks Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry M. Paulson Jr. have both urged Freddie Mac and Fannie Mae to raise additional capital from investors.

But as share prices at the companies have declined, raising new funds has become increasingly difficult. Freddie Mac, for instance, announced on May 14 that it intended to sell $2.75 billion in new common stock to investors. Since then, the company's stock price has declined by 56 percent.

As a result, Freddie Mac will have to issue more than twice as many shares to raise the new funds. When those new shares hit the market, they are likely to further push the company's stock price down, and make it even harder for Freddie Mac to recover when the market eventually rebounds.

Similar problems are likely to plague investment banks and other financial firms also hoping to raise new money. So, as the housing market declines, there are new concerns that the financial spigot that keeps Wall Street and the economy afloat may be closing.

Terror Prophets
The Ecologist, Sept. 2004

Anger seems to be one commodity with no upside limit these days. The price of being upset is making new highs every day. The big question is: are high-profile outrage-causing events like the Enron and Worldcom accountancy scandals and 9/11 connected in some way? Connected in the same ways that all business these days is connected?

Just for a moment, consider this possibility: that the destabilizing of US stock and real-estate markets resulting from the Federal Reserve's overly relaxed approach to setting interest rates may be at the root of both the Enron-style scandals and the attacks on the World Trade Center. By not raising interest rates sooner, and more aggressively, Fed chairman Alan Greenspan (who many argue serves the interests of the crony class ahead of the interests of the grubby masses) kept the cost of finance artificially low. This encouraged a culture of widespread financial chicanery on Wall Street, which was simply too tempting for the world's extremists -- be they balance-sheet bad guys wanting to join in, or box-cutter-wielding terrorists looking for a target.

In other words, easy money has wider ramifications than just the obvious problems of inflation; there are real dangers attendant on not clamping down on speculation with higher interest rates, and those dangers are manifesting themselves in scary ways never dreamt of by the architects of the central banking system.

At the risk of sounding macabre, is it possible to make an educated guess as to where this easy-money risk might manifest itself again. In other words, if there are going to be more Enrons and Twin Towers, as US authorities and regulators suggest, can we predict, just by assessing money flows, where these might be?

The answers can be found by digging deeper into Greenspan's easy-money policies, keeping in mind the fact that it's cheap money that makes stocks and real-estate properties weak and vulnerable: the intrinsic value of such assets has been strip-mined by bankers and CEOs using derivatives and what US investment guru, Warren Buffett, describes as "weapons of mass financial destruction."

My guess is that the two stocks that look the likeliest to implode at the hands of derivative-wielding Wall Street financial types (and other fundamentalists) preying on a US economy made weak by cheap money are Fannie Mae and Freddie Mac. These two quasi-government backed mortgage dealers are not required to disclose fully all the details of their multi-trillion dollar lending practices. And, as with the Savings and Loan, Long Term Capital Management and Enron crises, earning for the two companies appear to be generated by trading worthless slips of paper back and forth between subsidiaries and booking these transactions as "profits."

According to Washington-based financial accounting advocacy group, FM Policy Focus, a default by Fannie and Freddie - who together underwrite 20 percent of US mortgages -- would cost each American taxpayer more than $16,000 to bail them out. Ouch!

In the US real-estate sector, the properties that look kind of vulnerable are in Las Vegas - at the heart of the country's over-consumption "culture." Deregulation, mergers and acquisitions and other "value-added" Wall Street "restructurings" have hollowed out any intrinsic value, and prepared the ground for another GDP-boosting catastrophe.

Am I being too cynical? It just seems to me that the US banks have become more like casinos, and US casinos have become more like banks. Both camps are engaged in loan sharking and money laundering in one form or another. And both are on the radar screens of fundamentalist arbitrageurs from Wall Street to Tora Bora. If only denial traded on the New York Stock Exchange: we'd all be rich.

Comments

[NABNYC]

It's my money, right? The federal government's only money is what they collect from me, us, the citizens, the taxpayers. Then they loan that money to others, and earn interest on the loans. Right?

So why should the government loan my money to wall street insiders at 2% interest/year, when those same wall street insiders turn around and loan the money to average citizens at 30% interest/year (credit cards), make billions of dollars living off the float -- make billions of dollars from doing nothing except writing checks and crediting payments -- and pay their insiders millions in bonuses to make sure their businesses (i.e. Citicorp) are completely broke at the end of the year -- all the money is paid out. Then if the economy goes down they turn to their friends in the government and say: Well, we have no money, you'd better bail us out. Give us more taxpayer money, for free, which we will not pay back. Right?

This is just theft of the citizen's assets. The Wall Street boys pay enormous bribes to our politicians, and our politicians let the Wall Street boys steal my money. Low interest rates? That's I guess another way of putting it.

[Henry]

Speaking of artificially low interest rates, the country of Japan registers as the decade-in decade-out low rate king of the world. How, Max, can Japan get away with this domestic money policy which, as we know, leads to a lot of speculative borrowing in the so-called carry trade.

http://seekingalpha.com/article/82006-central-bank-rates-around-the-world

[boogieandjive]

The Japanese savings rates have dropped precipitously since the near zero rates.

http://search.japantimes.co.jp/cgi-bin/nb20070113a3.html

Mrs. Watanabe has been one of the biggest speculators on the planet and that is how they have got away with the domestic interest rate policy - - that is, Mrs. Watanabe has been making so much money during the wild risk free carry trade days that, perhaps, domestically, she just didn't care that interest rates were so low. Now that interest rates are rising and volatility is back, let's see how things change in Tokyo . . .

[xtown]

A prescient article indeed. And to your point, I think denial has traded on Wall Street for
a long while.

[Henry]

http://www.federalreserve.gov/releases/h15/data.htm

From July 2003 through June 2004 the Fed Funds rate was 1.0%, Prime Rate was 4.0%. Inflation was running at some positive rate, say 2.0% (likely an understatement)
The historic real rate of interest (Prime minus inflation) should be 6.0% or thereabouts. During that period when the nominal rate of Prime was 4.0%, the real rate was 2.0%!. Real rates on Savings were -1.0% or so. There was no incentive to save and indeed, the banks showed negative savings rates by Americans. Greenspan was able to "pull" this off because the trade deficits were monetizing our debt in respective Asian central bank reserve accounts! (and he called himself a banker!)
Fed Funds are now 2.0%, Prime Rate is 5.0%. Inflation is around 3.0% (likely an understatement) making the current real rate of interest 2.0% (borrowing rate) and -1.0% savings. There is still no incentive to save in America.
For whatever reason, both Greenspan and Bernanke would "fail" Money & Banking at any reputable university. Yet here they are...our leaders!