World-News

Cato Institute
by Gerald P. O'Driscoll Jr.

05/05/08

The U.S. economy is in the midst of an old-style credit crunch brought on by a combination of bad policies and incredibly lax underwriting standards at financial institutions. The biggest policy failure was the decision by Alan Greenspan’s Federal Reserve to hold interest rates too low for too long. That led to a tsunami of credit that inundated the economy with cheap money. Mortgage lenders in particular were flush with funds and searched for deals wherever they could be found. Heretofore unqualified borrowers suddenly ‘qualified’ as underwriting standards relaxed and then disappeared. Egged on by statements from Chairman Greenspan, market participants came to believe the era of low interest rates would last indefinitely. But the era did come to an end as the Fed was forced to begin raising interest rates. Faced with the prospect of paying higher rates on their mortgages in the future, borrowers began defaulting. First home prices stopped rising, and then home prices began dropping — precipitously in some overheated housing markets. Now we are approximately six months into a new cycle of lower interest rates, but with no end in sight to the crunch...

http://www.cato.org/pub_display.php?pub_id=9379


Informant: Thomas L. Knapp



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