"Central Problem: The Central Bank" By Bob Klein

In the article Central Problem: the Central Bank, Bob Klein, and George Reisman discuss how the financial crisis was at root, not a housing crisis or a Wall Street banking crisis, but rather a monetary crisis.

In 2009, President Barack Obama put the blame of the financial crisis on the shoulders of “fat cat bankers.” Upon further examination, the crisis was not caused by the bankers themselves but rather in the creation and lending of money. Lending money that has been created from thin air, leads to economic booms and busts.

The 2009 financial crisis, can be tracked to the Asian Contagion of 1997 and the meltdown of the Long-Term Capital Management hedge fund in 1998. To respond to these crises, the Federal Reserve decided to cut the interest rate and expand the money supply. With an excess of money, stock prices were pushed to higher levels.  However, due to the excess amount of money created by the Federal Reserve, the rest of the economy faced the negative consequences.

The excess money caused prices to rise on consumer goods.  To combat this, the Federal Reserve enforced a stricter monetary policy, which caused a huge plunge in stocks. To help investors and vitalize a better economy the central bank lowered rates once again. After experiencing low returns on bank deposits and money-market funds, investors turned to real estate in the hopes of gaining higher returns. The new money created by the Federal Reserve and the corresponding lower mortgage interest rates helped boost home prices significantly.

In the 2008 crisis, we can see the same trend. The Federal Reserve created an excess of money, causing a rise in consumer prices. Again the Federal Reserve raised interest rates, which then raised mortgage rates. Subprime borrowers were the first to feel the effects of the higher rates. To keep up with their interest payments, they would refinance their loans by taking out new ones. However, loans became harder to refinance and many borrowers began to default.

If we look at the real estate boom that ended in 2008, debt rose to 375% of the gross domestic product. In a desperate measure to fight the bust that it caused, and to get out from under the heavy debt load, the Federal Reserve added over $2 trillion into the system in the attempt to hold overnight interest rates close to zero, and to stimulate the economy.  As a result, stock, real estate, and commodity prices soared, and credit spreads tightened. Thus, we have a new boom largely fueled by easy money from the Fed.

After seeing history repeat itself one too many times, it makes one question how many more crises must we undergo until we realize the Federal Reserve is doing more harm than good. Instead of injecting the economy with newly created money, the Federal Reserve should move to a monetary system that is free from booms and busts caused by the government.