Commentary

Wall Street Relies Too Heavily on Interest Rate Cuts

A decaying housing market, deteriorating credit conditions, a sickly dollar, sky-high oil prices, two expensive and useless wars, and the looming mass-retirement of baby boomers are the main ingredients that will create the fuel for a tumble in US economic growth over the next year or two (or three or four, etc.)

Yet the party on Wall Street continues unabated. Even as major investment banks write off monstrous piles of bad subprime mortgages and trading bets that went sour, the forecast is for sunny skies as far as the inebriated eye can see.

It seems that all the market needs are massive injections of opiates – in the form of liquidity and interest rate cuts – to keep the grotesque orgy of debt-fueled investment and consumption from dying a sudden and painful death.

The Fed is set to cut rates on overnight rates again when it meets today. If it does as Wall Street wishes, short-term lending rates will decline for the second time in two months.

The problem with bailing out over-leveraged gamblers by reducing borrowing costs is that it introduces moral hazard and does nothing to cure the problems plaguing the markets. Without the prospect of punishment for bad decisions, foolish speculators will only be encouraged to do more of the same.

In addition, reducing short-term interest rates does little to lower mortgage lending costs. Private and institutional lenders are increasingly determining these rates. They see nothing but increasing risks to the stability of the US real estate market – so why would they want to reduce the cost of borrowing at such a time as this?

And, the final argument against lowering rates is the wobbly U.S. dollar. It is sinking hard and fast against almost every other world currency. Lowering US interest rates reduces returns for overseas investors, and will cause them to shift their funds – loans actually – elsewhere.

So, party on Garth, party on Lawrence Kudlow. As for anyone that is even casually acquainted with reality – watch out below!

While you’re here, sign up for my feed so you can get some of the best in original political cartoons and commentary.

© 2007 Splendid Marbles.