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Sunday, September 30, 2007

Bernanke Under Fire


This article asserts that the recent reduction in interest rates hurts individuals who have been cautious with their money and not overextended themselves financially. The Fed claims that its action was aimed at keeping the economy out of recession but the real reason behind the change is likely that the markets have been unstable since August.

An analysis beyond stock market changes indicates that those individuals who did not need to be financially bailed out by interest rate cuts are now worse off. This cut in the interest rate has adversely affected the currency markets as it caused the value of the dollar to drop. Furthermore, when the Fed cut short term interest rates it also affected the long term interest rates as they rose in reaction to the change. The benefits that might be brought on by the lower short term rates will surely be undermined to some extent by the higher long term rates. Another adverse affect of the mortgage bailout cut is that the interest rates of large fixed-rate mortgages, connected to long term rates, will now be higher than they would have been prior to the cut.

In this way the costs of the sub-prime mortgage dilemma is being passed on to those investors who wouldn’t have gone for a sub-prime mortgage. The individuals who were smart with their money are now paying for the problems caused by those who were not. In a sense the taxpayers are indirectly responsible for bailing out the poor investment decisions made by companies like Countrywide Financial who operate in the sub-prime mortgage market.

It seems as if the Fed has not acted in a way that is beneficial to the financially conservative but has catered to companies who have created their own problems with overreaching their investment ability. Taking these elements into consideration it can hardly be said that Bernanke’s actions were pareto optimal. I would say quite the contrary.


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