If you just have time to read one more thing tonight, may we nominate today’s speech from KC Fed President and Fed Board dissenter Thomas Hoenig, who delivered a powerful speech today in Santa Fe blasting the Fed’s ongoing zero interest rate policy, lovingly known as ZIRP.
Hoenix acknowledges reasons why the Fed is in no rush to tighten: The job market isn’t so hot, the construction business is still horrible, and real estate has yet to come back to life.
But what Hoenig gets is that the current regime is a free lunch to Wall Street, and the Board of Governor’s decision to keep the “Extended Period” language intact is a clear signal that there’s nothing to worry about for at least the next six months.
Basically, Bernanke & Co. are living in the same never-neverland as Greenspan found himself in coming out of the 2002 recession, in thinking that it’s better to be late than sorry, which is reasonable if your only fear is a little bit of inflation, but if the real damage is in creating bubbles, then it’s not so reasonable.
Indeed, perhaps having seen the fallen Maestro, Greenspan, Hoenig understands how mere humans can acknowledge their failure to see bubbles, and yet still prevent them.
Here’s his conclusion:
Low rates, over time, systematically contribute to the buildup of financial imbalances by
leading banks and investors to search for yield. The Wall Street Journal article tells a story about the
market coming back that also makes my point. The search for yield involves investing in less-liquid
assets and using short-term sources of funds to invest in long-term assets, which are necessarily
riskier. Together, these forces lead banks and investors to take on additional risk, increase leverage,
and in time bring in growing imbalances, perhaps a bubble and a financial collapse.
I make no pretense that I, or anyone, can reliably identify and “prick” an economic bubble in a
timely fashion. However, I am confident that holding rates down at artificially low levels over
extended periods encourages bubbles, because it encourages debt over equity and consumption over
savings. While we may not know where the bubble will emerge, these conditions left unchanged will
invite a credit boom and, inevitably, a bust.
Read the whole speech. It’s quick. And if you like it, for more Hoenig, also check out his recent interview with The Huffington Post, in which he calls for the breakup of megabanks and the end of too big to fail. Good stuff.
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