The subprime crisis: the U.S. government has announced that it will aid Americans affected by the subprime mortgage debacle, but the "aid" will merely delay and worsen the consequences

New American, The, Jan 21, 2008 by Charles Scaliger

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Back before the dawn of the new millennium, years of rampant money creation on the part of the Federal Reserve combined with paranoia over the supposedly insolvable Y2K bug to create the perfect economic storm. As Y2K bore down on an increasingly nervous international investment community, the Federal Reserve opened the monetary sluice gates as wide as they dared, flooding banks with liquidity to stave off fears of a millennial software Armageddon. The new money, as is often the case, was created with repurchase agreements or repos, which the sellers (the banks) would be obliged to repurchase from the Fed upon expiration sometime after the turn of the new century, unless the Fed opted to roll them over.

Many banks decided, as they had so often before, to loan their newly created money to institutions that promptly invested it in high-potential, tech-heavy stock portfolios.

As events turned out, this little-noticed feat of financial wizardry was the final act of folly in the farcical drama known as the dot-corn bubble. Soon after the new year, as it became apparent that the greatly feared Y2K technological meltdown was not going to happen, the Fed decided not to roll over all those inflationary repos, and the banks, obliged to come up with the funds to repurchase them, abruptly tightened credit.

With the money spigots turned off, the demand for stocks contracted correspondingly, and in March 2000, the years-long, Fed-fed dot-corn frenzy came to an unlovely conclusion.

Here We Go Again

Now history is repeating itself. No sooner had the dot-com bubble burst than a new bubble appeared, much to the relief beleaguered investors. And once again, even though the dizzying rise of real estate prices has been recognized as a bubble almost from the outset, buyers and investors, unable to resist artificially low interest rates and unprecedented access to cheap financing, have rushed to acquire real estate which under normal economic conditions would be beyond their means.

In particular, subprime mortgage lending--that is, financing mortgages for borrowers of dubious financial resources and less than stellar credit history--has mushroomed since the early part of the decade into a multi-trillion dollar industry. Many subprime mortgages included adjustable rate structures allowing the buyer initially to make payments only on the interest, at comparatively low rates that would later be raised.

As with the dot-corn boom, the real estate bubble was and continues to be fueled by government mismanagement, most conspicuously the misallocation of credit by expansionary Federal Reserve policies. And once again, as catastrophe looms the Federal Reserve and the federal government are trying to fix the problems they helped to create by prescribing more bad medicine.

For many borrowers and lenders, the day of reckoning has already arrived, with mortgage foreclosures, declines in property values, and bankrupt lenders at epic levels. This year, however, many hundreds of thousands more subprime mortgages are due to be adjusted upwards to something closer to realistic market rates, and the cascade of foreclosures and bankruptcies in 2008 will probably dwarf that of last year. Understandably, Washington is in a panic, with some economists forecasting economic fallout so dire that an epidemic of bank runs, not seen since the Great Depression, may result.

How have things come to such a pass? Today's growing financial crisis has its roots in decades of federal manipulation of the economy via the Federal Reserve System and an ever-more-abusive regime of banking and financial regulations, none of which has any basis in constitutionally limited government, and all of which has severely distorted economic growth and investment, creating the house of cards that is our modern economy.

Where the Fed is concerned, years of artificially low interest rates encouraged a welter of speculative investments in real estate, which in turn drove prices to dizzying levels.

On the regulatory side, the Community Reinvestment Act (CRA), passed in 1977 by the usual assortment of congressional do-gooders, has taken its own toll on the banking sector. This act, urged upon us by anti-capitalist zealots concerned with the alleged problem of discriminatory lending, compels banks to loan money to borrowers who would otherwise not be creditworthy.

Bankers, it seems, are irrationally concerned about loans being repaid and, left to their own devices, will tend to avoid loaning money to high-risk borrowers. Because many high-risk borrowers are from poor or minority neighborhoods, the sponsors of the CRA routinely accuse the banking community of discrimination. Banks with an insufficient number of high-risk loans in their portfolio run the very real risk of running afoul of the CRA, with the inevitable fines and other heavy penalties ensuing. The subprime frenzy has been driven at least in part by the post-CRA mentality that bureaucratic overseers, in cahoots with exploitative political activists, have imposed on the banking industry.