Posted by Shyam Moondra
The Federal Reserve Board (FRB) is primarily responsible for the 2008 financial crisis that led to the demise of prominent firms such as Lehman Brothers, brought major financial institutions close to bankruptcy that prompted federal bailouts, crashed the stock market, led to a sharp decline in home prices that triggered the record number of home foreclosures, and caused severe hardship to the American people that suffered from chronic high-level of unemployment. It all started with the easy money policy of former Fed Chairman, Alan Greenspan, who failed to adequately regulate the sub-prime mortgage market that eventually led to the housing bubble. For a while, the current Fed Chairman, Ben Bernanke, misread what was going on in the housing market and he kept saying that sub-prime mortgage was not a problem. Then he said that the problem was manageable. Then, of course, we know that the housing bubble burst and the economy crashed. In the aftermath of the crisis, Bernanke pumped liquidity into the market to avoid a repeat of the depression of the 1930s. However, out of panic, he and the Congress proposed stringent regulations of the financial institutions that are now proving to be an obstacle in achieving full economic recovery. Recently, Bernanke admitted that the FRB lacks the tools to properly analyze how the new regulations would impact the financial sector and the overall economy. It's extraordinary that the government would make major changes in the regulations without understanding the implications. The recent recurrence of economic slowdown and record high budget deficit are the proof that the 2008 financial crisis and its aftermath have not been managed well.
Here are some observations on the flawed policies of the FRB, Congress, and the Obama administration that are preventing the economy from achieving its full potential:
· In the aftermath of the collapse of the housing market, Bernanke came up with a predictable strategy of reducing interest rates to revive the housing market. However, the housing market continues to deteriorate with the housing prices now down by over 33% since the peak of 2007. Low interest rates may in fact be encouraging potential home buyers to put off their decision to buy homes. They are taking low interest rates for granted and are just waiting for home prices to come down even more. If FRB were to start increasing interest rates, homebuyers' trade-off calculations (higher interest rate vs. lower home prices) will change and they may be induced to make a buy decision now rather that play a waiting game. The Fed's low interest rate policy may thus unwittingly be delaying the housing recovery and that may, in turn, be delaying sustainable growth in the overall economy.
· When some of the big financial institutions got in deep trouble, the FRB and Congress became nervous and proposed unprecedented regulations of the financial sector, thereby moving the pendulum from relaxed regulation to the other extreme of too much regulation. In fact, some of these regulations went too far and only now it is becoming apparent that hasty passage of the Dodd-Frank bill may have done more harm than good. For example, to reduce the risk taking ability of the banks, stringent capital requirements were proposed (some FRB members are even talking about doubling the capital requirements from the current levels) that are proving to be counter-productive. If the banks are required to park a big chunk of their capital on the sidelines unproductively, there is that much less cash available to be lent to businesses and consumers. This forced contraction in credit is in fact delaying economic recovery and job creation. The FRB and Congress need to have another look at their proposals that were put together in a hurry.
· President Obama got a massive stimulus package approved by the Congress but it seems to have had less than spectacular impact on economy. Because of the bureaucracy, corruption, and inherent inefficiencies involved with government spending, it doesn't always bring about the desired results in a timely manner. In general, reducing taxes is preferable than increasing government expenditures because taxpayers, that also happen to be the consumers, are in the best position to decide how to spend money. President Obama and Congress should look at targeted tax incentives that can be offered to businesses and individuals to stimulate economy without increasing the budget deficit. Another big spending package is, however, not advisable.
· The FED and Congress also need to reconsider bank regulations related to debit card fee and credit card transaction fee. The government price controls are inconsistent with the free-market concept. If there is lack of competition or there is price fixing, it should be handled through the anti-trust laws rather than through price controls. This micromanagement by the government has in fact backfired. To cover the revenue shortfall caused by debit/credit card regulations, the banks have been aggressively increasing fees on other services and in many cases imposing fees for services that were previously "free". The end result is that the fees and fines, that were previously paid mostly by a small number of irresponsible consumers, are now being paid by all consumers. The new banking regulations were not well thought-out and should be reconsidered.
· Many people in the government, including the state AGs are out to hurt banks if they don't agree to mortgage loan modifications. The government officials are trying to achieve their public policy goals by using private funds, absolving the borrowers of any responsibility of buying homes that they couldn't afford. Yes, banks made mistakes, but it's not all banks' fault. This undue burden has put tremendous pressure on bank stock prices and that is driving the overall market down. This is also negatively affecting consumer confidence, thereby delaying economic recovery. If issues surrounding faulty foreclosures make the banking sector weak or even drive them towards bankruptcy, we will have a financial crisis all over again. These aggressive actions by some of the most liberal state AGs are not helping the economy and unemployment rate may very well hit 12%. The banks must be made to reform their foreclosure processes to make them accurate and fair, but a huge monetary penalty that some AGs are after would be counter-productive. The FRB, Congress, WH, and state AGs are pursuing their uncoordinated policies that are creating a great deal of confusion. The uncertainty caused by all this is driving the stock market and economy down.
· The stock markets are manipulated by big frequent traders that use computerized trading algorithms to move the stock prices up or down in a yo-yo manner, especially around the option expiry dates. These big players make money at the expense of small investors that are not as technology savvy. This new trend has negatively affected the integrity of the markets and driven away small investors. We urgently need to implement reforms that could include limits on short selling/options trading, requiring investors to hold securities for a certain minimum period before they could sell (e.g., until those buy trades are settled), and making such trading practices as pumping-and-dumping, high-frequency trading, etc. as unlawful.
