The Federal Reserve is expected to reduce interest rates, again, to the lowest level on record: somewhere between zero and one-quarter of one percentage point.
In the past 14 months, there have been nine rate cuts — augmented by $1.4 trillion in emergency lending — intended to shore up the financial system and put the brakes on the current economic downturn. These measures have been ineffective. There is little reason to believe that further rate cuts will be sufficient to turn around the economy, and ample reason to suspect that these rate cuts may have deleterious long-term consequences.
At the same time, Treasury is considering a separate plan to lower another, narrower set of interest rates — those on home mortgages. With the support of the incoming Obama administration’s economic team, Treasury plans to use Fannie Mae and Freddie Mac — the government-backed odd couple at the center of the housing meltdown — to buy mortgage-backed securities in an effort to drive down mortgage rates from their current average, about 5.5 percent, to 4.5 percent, nearly a 20-percent reduction in borrowing costs. That’s on top of the Fed’s purchases of mortgage-linked securities, some $600 billion worth.
There is a case to be made that the pre-existing superabundance of cheap money in the housing and financial system is at the root of our present difficulties. Like medieval physicians hoping to counteract poison with a smaller dose of the same poison, the various arms of the federal government propose to ameliorate the effects of defective public policy with more of the same. This is not to make the argument of the “market fundamentalists” — those who protest that the downturn is exclusively the result of free markets’ being victimized by politics — but merely to take into account the historical facts as they are known: As the millennial stock-market bubble deflated and 9/11 threatened to throw the nation into a sustained downturn, interest rates were cut and cut again. Some of that easy money went into real estate, driving up home prices and helping to create the recently burst bubble in the housing market. It seemed like a good idea at the time. It usually does.
Combined with a wide array of political measures intended to increase homeownership, those low interest rates contributed to the inflation of home prices and the consequent distortion of the market for mortgage-backed securities and related derivatives. But just as water finds its own level, prices eventually will reflect the underlying supply and demand; politics can only sustain market distortions for so long. The unwinding is painful and introduces corrosive uncertainty into the markets.
That uncertainty is likely to be made worse — significantly worse — by political action. Government intervention into the banking system may — may — have been helpful in preventing a paralytic seizure of the credit markets, but the unpredictability of federal actions — this bank is saved, that bank dies, these shareholders are thrown a lifeline, those are thrown the anchor — increases uncertainty, meaning that the markets have a difficult time knowing how to price risk. And lenders who do not know how to price risk will hesitate to lend — whether for mortgages or for moribund automobile makers to restructure their operations. The government seeks to use cheap money to overcome the current atmosphere of caution. One man’s panic is another man’s prudence.
The case for supporting house prices is psychological, not economic. The government does not know what the price of a single house should be, much less the general price level of all the houses in America. But voters feel rich when their houses are appreciating and poor when they’re depreciating, and political incumbents don’t want voters to feel poor. There is no secular reason to believe that house prices should be higher — recent prices have been far, far out of line with historic home-price trends — and it is worth noting that rising house prices hurt at least as many people as they help. Higher prices are good for homeowners and people who have very large mortgage debts. Lower prices are good for people who want to buy houses and for people who save money instead of borrowing it. There is not much reason to privilege the former over the latter other than the fact that homeowners tend to have higher incomes than non-homeowners and to vote more regularly, and for these two reasons enjoy disproportionate political influence.
If our financial system has suffered from anything, it has suffered from too much risk, which has been poorly priced and poorly understood. Lowering interest rates — making it less expensive to borrow money — encourages greater risk. There are better ways to encourage investment, such as reducing taxes on dividends and capital gains, or by reducing the taxes on income derived from bond investments. Investors already can earn tax-free income from certain kinds of bonds — those that finance municipal-government projects — so it would not be unreasonable to extend similar benefits to those who invest in private-sector operations. A new Toyota plant would surely do as much good for a community as a soccer field or public swimming pool.
Excessively high interest rates are probably not the cause of our present economic troubles. Excessively low rates probably will not solve any economic problems and will present new problems of their own — not the least of which is eroding the value of the dollar, which impoverishes us all. The Fed and Treasury seem intent on trying to reinflate the housing bubble, at least a little bit, as though a new bubble were the solution to the problems caused by the collapse of the old bubble. During Japan’s “Lost Decade,” that country discovered that interest-rate cuts alone are insufficient to rebuild a damaged economy. We should let Japan’s loss be our gain rather than taking ten years to relearn the Japanese lesson the hard way. The Fed should stick to its core mission, which is fighting inflation, and the Treasury to its mission, which isn’t inflating housing prices. And we will know when house prices have fallen far enough the same way we will know when GM shares have fallen far enough: when people start buying.
— Kevin Williamson is a National Review deputy managing editor.