Sunday, January 3, 2010

Great Cartoon

First Post of the New Year

After spending many hours trying to figure out what is the proper name for this year, I felt a renewed desire to post. The upcoming year will be very interesting economically, as the results of the massive bailouts start to trickle down to the economy as a whole. However, since the year is new and the market has not traded in the new year yet, I decided to post one last story over the last year.

As any reader of this blog knows, the issue of whether the Federal funds rate being artificially low between 2002-2006 or whether lack of regulation caused the downturn has been central. Today the New York Times has a story quoting the Fed chairman as stating that weak regulation of lending practices caused the housing bubble. According to Bernanke, a surgical approach to lending problems could have stemmed the crisis in its infancy. However, the two problems work in tandem to create an atmosphere of irresponsibility.

For example, a bank has money to lend at very low rates, so in order to make a profit it must clear out a lot of loans since the dividend income is reduced. Magically, the banks suddenly have this brilliant idea that they can make loans with one hand and then resell the debt on the loans to another. Making matters even worse is that this is done with common deposits, since the Gramm-Leach-Blilely Act allowed commerical banks to take over investment banks without oversight of their operations. Additional regulations such as the Community Reinvestment Act further forced lending to be more plentiful during the boom, so banks made loans that would not have been made had the financial oversight arms of the government done their job. In short, both low interest rates during a boom and lack of cohesive regulation doomed the economy to a massive correction.