The Daily Walk of Shame: The Fed

This Motley Fool series examines things that just aren't right in the world of finance and investing. Here's what's got us riled today. If something's bugging you, too -- and we suspect it is -- go ahead and unload in the comments section below.

Today's subject: Last year's "Autumn of the Massive Collective Pants-Soiling" heralded what I like to call the ensuing "Year of What The --" … well, suffice to say, the Fool frowns on publishing certain words.

Much of the blame for our economic crisis can be pinned on the Federal Reserve's monetary policies. Even worse, the "cure" for an ailing economy always seems strikingly similar to what caused the problems to begin with, at least according to the Fed. That means our problems aren't over by a long shot.

Why you should be indignant: Way before Ben Bernanke came along, former Federal Reserve Chairman Alan Greenspan's low interest rates, left in place too long, fed the frenzy of borrowing that fueled the housing bubble. Recall that we had back-to-back asset bubbles; before housing blew up, the dot-com bubble popped, leaving only a few survivors like Amazon.com (Nasdaq: AMZN  ) , Yahoo! (Nasdaq: YHOO  ) , and eBay (Nasdaq: EBAY  ) amid the wreckage.

The death of dot-com drove us into a recession that turned out to be artificially mild, however painfully it hit us at the time. Just as Internet and telecom stocks started tanking, the housing bubble began to take off. The housing market mayhem was just as crazy and speculative as the dot-coms had been, yet it gave the comforting illusion of economic growth. Who doesn't want that?

Pumped up by low interest rates, our overinflated economy lifted homebuilders such as Toll Brothers (NYSE: TOL  ) and high-profile mortgage lending monstrosities like Countrywide. People were thrilled with the inflated "values" of their homes -- never mind whether their meteoric rise made any real sense. They bought into the red-hot real estate market with interest-only loans and other exotic vehicles, then used their homes as ATMs to finance bling, trips, fancy cars, and more. The ripple effects expanded throughout the economy as greed, myopia, and rampant consumerism took hold. Too many people realized it was fun to spend way above their means; everything went "up," and the piper seemed to go unpaid.

This manic mentality was even worse in the housing market, yielding flawed financial models that never bothered to account for a fall in housing prices or other negative possibilities. I guess it wasn't convenient or pleasant for many to think too hard about economic realities. As last fall amply proved, it was even less pleasant to live through them.

In the wake of the collapse, some financial companies have gone bust or been swallowed up by rivals. Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , Wells Fargo (NYSE: WFC  ) and many others took a shot of taxpayer money to stay on their feet. We're all on the hook for pulling them back from the brink of collapse.

Is the "fix" better than the disease? Bernanke's Fed has lowered interest rates to record lows to rejuvenate the same terrible behavior that got us into trouble in the first place. To juice the economy, the Fed's encouraging banks to make new loans, even when there are still plenty of bad loans out there. Overly indebted consumers and businesses have not yet deleveraged, plain and simple.

Meanwhile, the massive bank bailouts have partly made their way into bankers' pockets, thanks to a continued abundance of lucrative pay and bonus packages. We were all told that bailing out the banks was a necessary evil to ensure economic survival. Apparently, some of us are "surviving" better than others.

With economic friends like The Fed, who needs enemies? (Unless, of course, you're a bank executive.)

What now? The Fed's policies keep some of us awake at night. True, high inflation has not set in despite the steady printing of more money, lending us a false sense of security. But there are real dangers if the Fed screws up its "exit strategy."

Texas Congressman Ron Paul has been pushing for an audit -- and calling for an eventual abolishment -- of the Federal Reserve. Given the Fed's control on our nation's line of credit (a real bummer of a way to run a household or boost an economy in the first place), this idea may frighten people who are fond of the status quo. However, if we're relying on borrowing, not income or savings, to fuel ourselves, do we really have a "real" economy?

Government stimulus may be getting our economy back on its feet, but it isn't real or organic, either -- and most of it's also funded by money we had to borrow from someone else. In that light, the GDP "growth" we supposedly recently experienced looks suspiciously artificial.

We need to look beyond prevailing "conventional wisdom" for solid solutions that emphasize real growth, not irresponsible borrowing and speculation. We won't achieve real economic prosperity if we stick to our current course. At best, printing new money to keep the economy afloat will only put us at greater risk of inflation. The Fed's prescriptions for "health" seem to only encourage the disease.

Do you agree, or do you like what the Fed's been doing? Share your thoughts in the comments section below.

Amazon.com and eBay are Motley Fool Stock Advisor picks. Try any of our Foolish newsletter services free for 30 days.

Alyce Lomax does not own shares of any of the companies mentioned. The Fool's disclosure policy knows better than to be interviewed by Bruno.


Read/Post Comments (28) | Recommend This Article (43)

Comments from our Foolish Readers

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  • Report this Comment On November 03, 2009, at 12:48 PM, rd80 wrote:

    "To juice the economy, the Fed's encouraging banks to make new loans,"

    That's what they say they want. In reality, the combined actions of the Fed (cheap money), Treasury (flood market with gov't debt; encourage more reserves) and FDIC (encourage more reserves and less risky assets) have set up a system that discourages banks from making commercial loans.

    The push for stronger balance sheets and more reserves (good things) discourages making risky commercial loans while the cheap Fed money and flood of Treasury paper gives banks a viable alternative means of making money.

    Banks simply borrow from the Fed, go out a little bit on the yield curve and buy Treasuries. They profit on the spreads and make the regulators happy by putting high quality assets on the balance sheet. Why bother with commercial and consumer loans?

    Treasury and the Fed may want the banks to make commercial loans, but that's not how they've set the rules of the game. All we're getting now is money going from the gov't to banks to gov't to banks to gov't....

  • Report this Comment On November 03, 2009, at 5:27 PM, JChief wrote:

    Who's Ron Paul?

    lol j/k..

  • Report this Comment On November 03, 2009, at 5:46 PM, DDHv wrote:

    Ron Paul is a doctor in congress, who seems to have the sense to look past the theories to the evidence, He is basically saying that we had a good constitution in the US, but do not understand it and are not following it.

    Example: most people don't know that the Federal Reserve is not government, but a set of private banks. This is why he is pushing for an audit!

    The modifications to the constitution that allowed private control of our money supply make as much sense as the repeal of Glass-Steagal. Bankers make theirs from debt, not economic improvements.

    We need to divide carefully between the real economy and our debt-driven money "economy,"

  • Report this Comment On November 03, 2009, at 6:29 PM, AnarcoCapitalist wrote:

    Nice article! The reality is the Federal Reserve was created by the elite for the elite in order to keep wealth flowing to the power mongers at the taxpayer's expense. Read about how the Federal Reserve came into existence at Jekyll Island. You will be infuriated. It was a bloodless coup d'état that marked the end of the United States as created by the founding fathers.

    End the fed!

  • Report this Comment On November 03, 2009, at 6:32 PM, jm7700229 wrote:

    The problem was too much debt owed by the wrong people. Responsible people (and businesses) continued to manage their debt conservatively throughout the bubble. There is no reason not to lend to people who have the means and the desire to repay.

    Bankers aren't bright people. When I worked in the insurance industry, a senior executive told me that we needed banks so that insurers could have someone to look down on.

  • Report this Comment On November 03, 2009, at 6:48 PM, bc0203 wrote:

    Banks are just doing whatever they need to do to stay in compliance with regulations (i.e. stay in business.) If the government creates a regulatory environment in which buying treasuries is the safest way to do that, then that's what they'll do.

    So when do people wake up and realize that most of the the "value" of the banks is made up of our (increasingly insolvent) government's T-Bills?

    This looks to me like just another creative way to monetize debt - this time via regulation.

  • Report this Comment On November 03, 2009, at 7:24 PM, xetn wrote:

    And, according to the U.S. Constitution (the basic law of the land) only gold and silver coins are "money". Fiat currency (the US dollar) is counterfeit and since the Fed's creation, it has lost over 95% of its value. This is due to the massive inflation of the money supply by the Fed and its fractional-reserve banks (which the Fed controls.)

    Historical note: no fiat currency has ever lasted in all of history. If there were no legal tender law in the US forcing everyone to use the US fiat, it would disappear in a heart beat.

    We need to end the Fed and fractional-reserve banking or at least end the legal tender law and allow totally free banking and money.

    Finally, we have this little tidbit:

    No Collateral… No Problem

    This next story is pretty unbelievable.

    A group of federal agencies including the FDIC, Federal Reserve, and Office of Thrift Supervision just released new guidelines for how banks deal with troubled commercial real estate loans. And get this:

    Under the guidelines, loans to creditworthy borrowers that have been restructured and are current won't be classified as high risk by regulators solely because the collateral backing them has declined to an amount less than the loan balance.

    Yes, you read that correctly. Banks won’t have to show losses “solely” because the collateral has fallen in value below the loan. Perhaps most incredible is that this move is being applauded by the business community. The next step will be a federal move to facilitate refinancing that same collateral.

  • Report this Comment On November 03, 2009, at 7:48 PM, starbucks4ever wrote:

    +1

  • Report this Comment On November 03, 2009, at 8:36 PM, FoolishJayhawk wrote:

    Great article, but what was the solution as we approached the precipice of the vortex that would have taken us back to the stone age?

    You summarize:

    "We need to look beyond prevailing "conventional wisdom" for solid solutions that emphasize real growth, not irresponsible borrowing and speculation. We won't achieve real economic prosperity if we stick to our current course. At best, printing new money to keep the economy afloat will only put us at greater risk of inflation. The Fed's prescriptions for "health" seem to only encourage the disease."

    Agreed, 100%. But, I think we all already knew this.

    What we need are solutions and not just finger pointing and eloquently stating and restating the problems. So, I ask you, what should we do now? Or, what should we have done instead of flooding the system with greenbacks?

    Either way, we're screwed - our **culture** of spend-until-you-drop-dead will take years to unwind. And that's the crux of it. The Fed may aid and abet, but does it really have a choice? If it doesn't, we choke now. If it does, we'll choke later. My time is more valuable today - I choose to choke later.

  • Report this Comment On November 03, 2009, at 9:23 PM, Bossweenie wrote:

    Glad to see someone else has read Ron Paul's book. It's an easy read and makes very good points. His basic premise is to go back to a gold standard or any commodity standard. He also suggests having a free market for money so that the most sound and the most useful is what gets used.

    I really liked the book as it was NOT political but simply laid out his arguments in a way that could be understood by the average reader.

    I am glad that Alyce brought this argument more into the mainstream. I've always considered myself somewhat financially aware but this massive problem had never even crossed my radar.

  • Report this Comment On November 03, 2009, at 9:50 PM, bc0203 wrote:

    I haven't read his book. I just understand basic economics ;-)

  • Report this Comment On November 03, 2009, at 10:09 PM, burrowsx wrote:

    What is happening now is that Barack Obama is providing cover for a financial coup de'tat. When the bailouts collapse as designed, troglodytes will romp all over the airwaves blaming "socialism."

    What is really happening is "lemon socialism" -- where the public buys out the shareholders of a failed company (viz. Amtrak), refuses to upgrade the assets of the company with the investment needed to make the business viable, and then blames "social policy" for the failure of the enterprise. The winners, of course, are the execs and shareholders of the failed company, who were holding a pig in a poke, and get handed a gold mine.

  • Report this Comment On November 03, 2009, at 11:33 PM, Ibeatmykids wrote:

    "if we're relying on borrowing, not income or savings, to fuel ourselves, do we really have a "real" economy?"

    This pretty much sums it up. Try taking out a loan and then claiming it as income. It doesn't work. Washington knows that the game will eventually end. I also find it funny that we borrow money from China just to buy their products. They are making a killing off of us X2.

  • Report this Comment On November 04, 2009, at 12:03 AM, bbwyo wrote:

    Can any one tell me what is the relationship between the Fed and the IMF? If the dollar is devalued or a new currency created who makes these decisions?

  • Report this Comment On November 04, 2009, at 12:45 AM, ET69 wrote:

    You folks should stick to talking about capitalism because everytime you open your mouth about 'Socialism" it is obvious that you haven't got a clue what the word means! To associate Obama or the Feds with socialism is ABSURD. Lenin we associate with socialism. Marx we associate with socialism. Trotsky we associate with socialism...not Benanke or Obama for christs sake.

    By the way

  • Report this Comment On November 04, 2009, at 12:50 AM, ET69 wrote:

    By the way...whats everybody's obsession with gold ? In a real crisis you can't eat it, drink it, or sleep in it. What did a gold standard get us before? Hell lets have a useful commodity---like liquor or or ice cream!

  • Report this Comment On November 04, 2009, at 1:51 AM, ikkyu2 wrote:

    The year of "What The Fool" doesn't like to publish!

  • Report this Comment On November 04, 2009, at 2:25 AM, jimialvin wrote:

    I was wondering whether this was true or not . I remember watching a short video about a depression in 1920 ( not the one in 1929 ) . The government let the banks fail and congress cut the budget . By the end of the next year , the economy was humming along again .

  • Report this Comment On November 04, 2009, at 4:14 AM, globalsailor wrote:

    ET69: Gold and silver are durable, fungible, and scarce. They are also appreciated by women. They are also very difficult to counterfeit. In fact, the only reason why we aren't using gold and silver as money is because they are so difficult to reproduce that the government can't control them. That's why they issue paper money.

    If we were on a gold standard the government would actually have to keep a balanced budget.

  • Report this Comment On November 04, 2009, at 5:04 AM, RRGGBB wrote:

    I am so glad that this conversation is happening - I have been frustrated for years with the Fed and people thinking it was part of the government. People do not realize how undemocratic the US is - the corruption is turning a leading nation into a third world mess.

  • Report this Comment On November 04, 2009, at 7:55 AM, GettingtobeaGuru wrote:

    Ok, this all makes sense (but then again most of what I read here does). What I don't understand is why the dollar hasn't inflated to ridiculous proportions yet. Can anybody help me out with that?

  • Report this Comment On November 04, 2009, at 8:00 AM, coerte wrote:

    Because the rest of the world in in debt even deeper. (as compared to GDP) see Italy, France, Germany and above all Japan.

  • Report this Comment On November 04, 2009, at 9:11 AM, rbashmore wrote:

    According to G. Edward Griffin in his book "The Creature from Jekyll Island (where the FED was founded), the FED was created to help establish the New World Order with banking families such as the Rockefellers, Morgans, Warburgs, etc... sitting at the top power wise. He seems to be correct about the FED being neither federal nor a reserve, but another way private bankers have taken control our government and create havoc for the people.

  • Report this Comment On November 04, 2009, at 1:46 PM, punterman wrote:

    If we have a top-level structure which operates on Ponzi and counterfeiting principles, there is encouragement and reward built into the system for those downstream to imitate/emulate/admire what is practiced at the top. It seems logical and rational to explain behavior such as bankers wanting bailouts and CEO's fleecing share owners and their workforce in the context of the congress and the FED, which are THE context for our laws and money because they are in fact the source of our laws and money.

    The paradoxical question remains: "If our source institutions openly practice ponzi (social security system design, fractional reserve tools, etc.) and counterfeiting (currency creation by fiat with no collateral) and self-granted immunity from legal recourse (cannot sue the government without its own consent, public officials are immune from prosecution), then in truth is it really illegal for people to practice ponzi, counterfeiting, or operating outside of legal process?"

    If the laws are written down somewhere, yet the people that wrote them violate them everyday in an open documented manner, are those laws legitimate and in force? Does our third branch (Justice) remain legitimate if it routinely enforces the laws for some people but not for other people?

    I see this modeling of illegal behavior as one of the primary damages that the FED causes for our culture and country, and it is playing itself out right now by people that simply emulated it in our banks, brokerages, mortgage companies, etc.

  • Report this Comment On November 04, 2009, at 3:10 PM, withoutlimits wrote:

    End The FED!

    Get the country on a sane system where everyone who produces gets rewarded. No more: "Money for nothing" which hurts everyone.

  • Report this Comment On November 10, 2009, at 11:44 AM, BABentley wrote:

    I would like to reply to Punterman: I have asked similar questions of the CPAs, JDs and other such Economic professors when they would touch some of the same points that you did (regarding "Why should we follow the laws that the government itself doesn't? Shouldn't we model our behavior on what we see the masters do?") in my courcework in college. Basicly, they said "Play nice. The system may not look fair, but that's only because it isn't. Still, if we really fight the system, we're going to get steamrolled. It may not be fair, but do you see a better practical alternative?" Justice may not be what we have in this country, but My port hasn't done quite so well as to be able to afford the legal representation to fight a war that I don't have the resources to win. "Justice for who can afford it!" (Motto of the US Department of Justice)

  • Report this Comment On November 12, 2009, at 8:22 PM, JustWhoIAm wrote:

    Just think of the fun you can have telling your grandkids about 2009 "when we borrowed a stable economy." That is if the borrowing from the future generations is giving us anything like stability.

    Keith

  • Report this Comment On November 12, 2009, at 8:23 PM, JustWhoIAm wrote:

    Just think of the fun you can have telling your grandkids about 2009 "when we borrowed a stable economy." That is if the borrowing from the future generations is giving us anything like stability.

    Keith

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