The irony of it all. The unrestrained creation of excess dollars (liquidity) via the Fed and the credit markets over the last 10 years is the underlying problem in today's financial upheavals. When the tech stock market bubble popped back in March of 2000, followed by 9/11 in 2001, the Fed dropped interest rates to 1% and pumped boat loads of dollars into the financial system for the next several years. They overreacted. The result was a mild economic downturn followed by the new favorite investment vehicle of all those low interest dollars sloshing around... the housing market, soon to be bubble. Well as the prices of homes rocketed up from 2002 through 2007 everyone seemed to love it because buying became so simple with all the easy credit. But in order to cash in even more on the party, lending institutions lowered their standards to the point where anyone with a pulse, the ability to fill out an application, and a wink and a nudge could get a loan. Not just any loan, but loans that required nothing down, no interest for a set periods of time, and all other sorts of "innovative" financing that was the equivalent of throwing caution to the wind for the buyer and the lender.
Well that hissing sound over the last number of months has been the sound of the air going out of that housing bubble as prices began turning down, and in many markets dropping drastically. All too quickly homeowners with adjustable rate mortgages found themselves with rising payments as interest rates began going up. People began waking up with negative equity (value of the house less than the purchase price) in their homes. As banks have now understandably tightened credit standards, there are many less buyers for many more houses on the market. It's a recipe for foreclosures (which are mushrooming) and soured loans for mortgage companies. And gobs of loans have been going bad, real bad.
The credit squeeze has now been affecting the various financial markets, hedge funds, and financial/trading institutions that invest in and trade those loans securities here and in Europe. Instead of allowing the painful consequences of the careless decisions of the market players and it's own irresponsible money creation, the Fed along with the central banks of the world are grabbing for the bottle once more and pouring drinks on the house for all the patrons who are reeling... the only thing the Fed seems to know to do... create more money out of thin air, pump it into the system to keep the party from ending. Always needing more and more dollars to keep the high intact or the hangover from beginning. More dollars worth less and with an increased moral hazard mentality (don't worry if investments are risky and may fail... the profits are too good, the Fed will bail us out if things get bad) injected into the profit seeking calculations of the market players, only worsening the systemic problem.
From The Wall Street Journal (after hours):
"Central banks continued to pump money into distressed markets for the second day and investors concluded that a rate cut soon by the Federal Reserve is increasingly likely and expected rate increases in Europe and Japan may be deferred.
Explaining that it was "providing liquidity to facilitate the orderly functioning of financial markets," the Fed injected $38 billion Friday on top of Thursday's $24 billion. The European Central Bank, saying that its "liquidity-providing fine-tuning operation" were aimed assuring orderly market conditions, added $83.56 billion (€61.5 billion) on top of the $130 million it injected to euro-zone markets Thursday. The Bank of Japan put in 1 trillion yen ($8.4 billion). Central banks from Australia, Singapore, Canada Norway and Switzerland also pumped money into their markets; others said they were prepared to do so if necessary."
And on A WSJ Economists React Forum: "Today we do not have only a liquidity crisis like in 1998; we also have a insolvency/debt crisis among a variety of borrowers that overborrowed excessively during the boom phase of the latest Minsky credit bubble. First, you have hundreds of thousands of U.S. households who are insolvent on their mortgages. And this is not just a subprime problem: the same reckless lending practices used in subprime – no downpayment, no verification of income and assets, interest rate only loans, negative amortization, teaser rates – were used for near prime, Alt-A loans, hybrid prime ARMs, home equity loans, piggyback loans. More than 50% of all mortgage originations in 2005 and 2006 had this toxic waste characteristics. That is why you will have hundreds of thousands – perhaps over a million - of subprime, near prime and prime borrowers who will end up in delinquency, default and foreclosure. Lots of insolvent borrowers." – Nouriel Roubini, Roubini Global Economics
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