March 19, 2008 - If you have been following the economy over the past week, you know that over the weekend the Federal Reserve (FED) essentially bailed out the Wall Street investment bank Bear Stearns. You also know that the FED lowered interest rates again yesterday by another ¾ of a point. But what you may not know is that these actions by the FED are likely to cause the price of milk to increase and equally likely to have no effect on foreclosure rates. In fact, the FED's actions over the past few days amount to what is essentially a huge tax increase on lower and middle class Americans in a flawed attempt to bail out the firms that actually caused the countries foreclosure crisis in the first place. And it should make you very, very angry!

To understand what the government is doing, you need to know how money markets work. Technical explanations of currency tend to be very dry and boring, so I'll try to keep it very simple.

The reason that gold is valuable is because there is only a limited supply of it. The same is true for money. The only reason that we place a value on it is because there is only so much of it to go around.

The FED controls the money supply by controlling interest rates. When rates go up, people borrow less money. This shrinks the money supply and makes the US dollar more valuable. When rates go down, the money supply goes up because people borrow more. This makes the value of money go down and increases the money supply.

Put another way, when the FED lowered interest rates this week, they essentially started printing more money. They also reduced the value of any dollars already in circulation. This includes the any money that you have in your bank account, in your wallet, or under your mattress.  

Now that your money is worth less, it takes more of it to buy anything. This includes what you pay for groceries, clothing and healthcare; all of the things you really need to live. This is called inflation.

But why would the FED take action that increases inflation? Well, because they don't really know what to do right now.

In a healthy market, the FED manipulates interest rates to keep the economy growing and at the same time, control inflation. But the current market is not healthy. And the thing that is hurting the market the most is the fact that a bunch of geniuses at companies like Bear Stearns thought that they could repackage subprime loans as AAA rated securities and then buy and sell them on the secondary market. In fact, Bear Stearns failed because they owned so many of these securities that they were about to go bankrupt.

So over the weekend, the government helped to negotiate the sale of Bear Stearns to JP Morgan for just 1% of what the company was worth on March 1, of 2008. Then the FED pumped billions of dollars into the economy by lowering interest rates. This appears to be largely an attempt to help prop up the very banking organizations that caused the problem in the first place.

At the same time, the Bush administration has actively opposed many efforts to help troubled homeowners facing foreclosure. The administrations policy is both short-sighted and stupid. Helping homeowners out would actually strengthen the holdings of troubled investment banks, and might mean that further interest rate cuts would be unnecessary. It might also help prevent more investment bank failures.

The truth of the matter is that there is no easy way out of the country's current financial woes. If the government would let markets correct themselves, then there would be a blood bath on Wall Street; this is probably the best alternative because it will be quick and the companies that get hurt will actually be the ones that invested in risky mortgage backed securities.

The alternative is what we are seeing now. The FED's actions may have prevented a blood bath so far, but they have only replaced it with a slow and painful bleeding process; with no assurance that the patient won't wind up dead in the end. More importantly, the FED's actions are causing prices to go up for everyone. This amounts to a tax increase on everyone to help keep firms which exercised poor judgment afloat.

by Jim Malmberg

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