The Fed and the Mortgage Crisis, in 10 Easy Steps

David, my conservative, ah, whatever, has been ranting for a few years now about the evils of the Fed. At first I thought this was just another one of his weird Republican fixations. Now I know it's more properly libertarian than Republican, and that his revulsion for the Fed is shared by a bazillion financial bloggers as well as by Ron Paul, the congressman from Texas running for President.

Normally, it would be easy for me to ignore the Fed. (Actually, this is quite an understatement.) But since today's papers are full of mortgage meltdown stories, with only more to come, I thought I'd give you David's view about why the Fed is ultimately responsible, put in easy-to-understand terms that I pulled out of him, one by one and in sequential order, with pliers. (If you still don't care, and only want to read about sex, skip to the previous post.)

1. The Fed is a government-chartered monopoly - basically a trade association for banks -that sets the price of money. This is a function that the general economy, through competitive processes, could do better. But ...
   


2. If the government gave up the Fed, it would give up the one thing it really, really likes - the ability to purchase lots of goods and services for voters without raising taxes. The Fed also gives the government the wherewithal to encourage consumer spending. If people stopped spending, the economy would tank.
   


3. All this free-spending leads to people living beyond their means.
   


4. Nevertheless, the government still wants people to spend. The Fed helps them spend by increasing the money supply (and creating credit, through lots of technical mechanisms). This creates inflation, which the Fed always says it's against, but isn't really.
   


5. Bankers like inflation, because inflation means ever-increasing demand for credit. When banks give credit, they get banking fees and interest.
   


6. In the early part of this decade (around 2002 or so), the Fed became worried that the stock market bubble that had burst in 2000 was going to ripple through the rest of the economy. So ...
   


7. It dropped interest rates so fast and so sharply that suddenly average people could borrow at the lowest rates in a generation. What did people do with this windfall in credit? Among other things, they bought houses. Lots of houses.
   


8. But about 2005, banks began to see that their pool of well-qualified borrowers was nonetheless drying up. To keep the good times rolling, they ...
   


9. Began lowering their underwriting standards in order to lend to people who normally wouldn't have been able to get loans. There were lots of ways to do this: accepting lower credit scores and no proof of salary, for instance, and requiring no cash down payment on the house. Shortly before this, for reasons that still confuse financial types, Alan Greenspan encouraged consumers to take out adjustment-rate mortgages as a way to save money - despite the fact that interest rates were already so low that they would only go up in the future, when ARMs would readjust. Finally, to cap everything off, the Bush administration was busy touting the "ownership society" as a social ideal. Everybody should own a home.
   


10. And, in 10 easy steps, there we have it: lots of people who are losing their homes, because - who could guess? - they couldn't really afford them in the first place.

Greed, irresponsiblity, and ignorance play major parts in this tale, and everybody - borrowers who wanted more than they could afford, and the financial institutions who threw money at them - all share some of the blame. But the real villain? The Fed.

This, in a nutshell, is David's view. Actually, there's a lot more than this, and it gets much more arcane. You can imagine. Well, on the other hand, perhaps you can't. And that's probably just as well.