Consequences of living in and on a bubble: Your money just isn't worth the same anymore!

Buy food for storage. Things are going to get mighty spendy here real soon.

There was once another Federal Reserve chairman who kept lowering rates to inject life into a sluggish economy with little regard for future ramifications, and he was actually the predecessor to Mr. Bernanke. His name is Alan Greenspan, and we are living on the bubble he created. The bubble that is popping before our very eyes.


Mr. Greenspan was appointed by Ronald Regan in August of 1987. His term from then through the end of January of 2006 would see amazing changes in the American economy. He would oversee the stock market crash later that year, the recession that dominated most of the first Bush Presidency, the euphoria that was the 1990's stock market, and the horrible hangover that has been the situation this decade. He has also seen two economic bubbles come and go – the dot-com bubble of the 90's and the housing market bubble of the 2000's. The former was thanks to technology mainly, the latter may go down in history has being partly (or mostly) to blame on him.

To stave off inflation bubble, the Federal Reserve raised interest rates from 6.75% (September 1987) to 9.75% (February 1989). This worked, but didn't prevent a recession from occurring, which is exactly what brought in the 1990's decade. The Fed responded as it should, gradually lowering rates and injecting more life into the economy. As rates lower and it is easier for banks to loan money, the effect makes its way into the public in the form of more attractive loans. This is actually a concrete way to stir economic growth – if the consumer can consume more, producers benefit, and the whole cycle feeds into itself. Rates were lowered all the way to 3% (September 1992) and were kept there until raised once more to 3.25% (February 1994). In the meantime, a new President took the White House, a President by the name of Clinton. One of the bills that he had managed to get through Congress before losing it to Republicans in 1995 was a minimum wage increase, bringing wages all the way up to $5.15 per hour. The combination of more credit available to Americans from the Fed and more money being made by Americans from Congress would combine to one of the most successful boom times in the history of capitalism. The mid to late 90's were absolutely golden from an economic standpoint – strong stock market, strong dollar, steady leadership in the government and the Federal Reserve, really couldn't ask for much better.

Rates were raised to 6% (February 1995) before a gradual period of lowering kicked in again – down to 4.75% (November 1998), which kept the economy humming along nicely. Add in at this time the explosive growth in new technology from the dawn of the Internet age, and suddenly there was too much good. More credit + more money is a good combination, but more credit + more money + a one off event creating a hell of a lot more of credit and money would cause the market to overheat. Seeing this coming, the Fed again embarked on raising rates gradually, up to 6.50% (May 2000). Still, a bubble like the tech bubble could not be controlled by simple monetary policy – this was akin to the railroad boom and other such booms in American history in that what went up so far so fast was almost guaranteed to fall flat on its face.

As the NASDAQ began to crash and a recession followed into the first couple years of this new decade, rates were lowered to 3.25% by August 21, 2001.

Then September 11 came.

Faced with financial people ready to panic, the Fed had to make a statement as to which way they would lead the economy. The choices on the table were to let the current recession drag on for years longer than it would have before, or to inject as much money into the economy as they could possibly do, and shock this barely beating heart of the market to make it strong again. The Fed took the latter position, starting with a half percent cut to 3% (September 17, 2001) and continuing all the way down to 1% (June 25, 2003).

Right there, we have the seed of all the problems that have plagued the housing market and have destroyed the value of the U.S. Dollar today.

Back to that idea about easy credit. That also includes the credit people use to purchase homes, which were for the longest time considered an investment (“The price of homes always rises!”), and so a group of people out there would take out huge loans to buy property, then sell the home a few years later at a profit, paying off the loan in the process. To put this into we-have-been-here-before terms, this is the same as the practice in the 1920's of buying stocks on margin (loans), selling when the prices doubled, paying off the loan and being on their marry way. We know how that one ended up, and it is yet to be seen if we are heading in that direction today.

That wasn't bad enough, though. After loaning institutions had hammered people with good credit for long enough to get loans and had pretty much used up the pool of willing people there, they turned to an under market of people who shouldn't have ever been loaned any money, the so-called “subprime” market. Here we have people who have spotty track records of things like paying bills or keeping employed. These people, already at the bottom of the American economy, would be used and exploited by banks to an epic degree. They were introduced to the wonders of the variable rate mortgage. Using the absurdly low Federal Funds rate as backing, people were teased into taking out huge loans at unheard of interest rates (some as low as 2%), with the knowledge that at some time in the future, the rates were going to be adjusted higher.

So what is a bubble? Many do not even know what this terminolgy refers to.

A bubble is when the value oif something is inflated becuase of percieved value as opposed to real economic value. An old car (say an old ferrari) is worth a lot. Not because the materials that make the car a real thing are expensive, but because people agree it is a rare find and should be expensive. The truth is, it drives like an old car and needs help like an old car. It is uncomfortable to drive and is unsafe, when compared to modern cars.

The value of this car is only what someone is willing to pay for it. If a millionaire wants to fork over millions for it then that is what it is worth. But what happens when one person forks over a million for a car and nobody else thinks it is worth that. Then you have a bubble. Someday the owner will sell that car for a huge loss and hence, the bubble burst. He paid a million for it, sold it for fifty thousand.

The dollar's value is what the world thinks it is worth when compared to other currencies. If countires want the dollar then it is worth more, if people dump the dollar then it is worth less. This is truly illogical, as not everything can, or should, exist this way.

What else have we had bubbles over - how about "tickle me elmo" during chrstmas, "cabbage patch kids" - remember those?

So a bubble exists when people decide to pay more for something than what it is truly worth.

Maybe the banks thought the economy would be better and people would have better and higher paying jobs by the time the rates adjusted upwards. Maybe there was some sort of idea that this was a good idea. Maybe they were out to pad earnings and just didn't care. We will probably never know which is accurate.

Fed Funds rates couldn't stay at 1% forever. That would lead to hyperinflation and the destruction of the U.S. Dollar. (Low rates lead to inflation which lead to more money which leads to a devaluation of the currency, supply and demand and all that.) As Greenspan's last series of acts, a program of rate increases was introduced in 2004, raising the rates from 1.25% (June 30, 2004) to 4.50% on Greenspan's last day on the job: January 31, 2006. His successor, Mr. Bernanke, continued this policy, raising the rates to 5.25% by June 29, 2006, and holding there.

As rates rose, the ability to do the low teaser rates on variable mortgages ended, which sapped up demand at the bottom end of the market, which led to less demand, which would become apparent in the summer of 2005 when the housing market – in terms of ever-rising values - abruptly stopped.

Now for the snowball effect.

As values stopped increasing, people who used to flip homes for profit were left without profit, and eventually when the banks stepped in and foreclosed, without a home. With less buyers around there was less demand to build homes, yet builders continued to build with promises of a return to the boom in short time. The return never came and there was a massive oversupply in homes. Oversupply of a good leads to lowered demand which leads to lowered prices and values which leads back to the start of this sequence to be repeated once more. This has gone on now since the end of 2005 and shows no signs of stopping. Home sales are falling at their steepest rate in nearly 20 years. Valuations are falling for the first time in which they have been closely monitored (since 1991).

Oh and those subprime people. Well, as Fed Funds rates rose, taking the rest of credit rates with them, suddenly people taking a 2.5% teaser rate are finding their mortgages adjusting up to 5%, maybe 5.5%, maybe even 6. They are seeing their mortgage in some cases double in price and they aren't seeing a better job or higher wages, and so soon they will be seeing that foreclosure notice if they haven't already.

The year 2007 is the year where all of this began to hit the fan. Over two dozen subprime lenders have gone under. The credit crunch spreads worldwide since in this wonderful global economy, everyone is left holding the bag instead of just one region.

Now the problem for the Fed. People are screaming for lowered rates to breathe some life back into this economy that was built on an unsustainable bubble in the first place. The logical response would to be to admit the bitter pill swallowed, and to ride this out as it should be. The end result of the bubble being so large and bursting so hard would be a recession, that is at this point unavoidable. Instead, the Federal Reserve decided to give more crack to the addict – lowering rates by .5% to 4.75% on September 18. The addicts on Wall Street ate it up, pushing major indicies like the Dow Jones back to near all time record highs. The realists who trade the American dollar here and abroad, they know the writing on the wall and they know what is coming.

What is happening in America in terms of housing, valuations, and everything that those two effect – the good times of the 2000's were fake, they couldn't be sustained, they were unnatural, and they are now coming undone in dramatic fashion. Millions of people are going to lose their homes. Those millions of people won't be making major purchases any time soon and that will act as a drag on the rest of the economy. The Fed still seems content with pleasing Wall Street instead of reacting to this situation how they should: by leaving it alone. Stupid people (in banks) made stupid decisions to loan to people who should have never been loaned to, those people defaulted, and soon they will have to as well. Instead of letting the market work itself out as it does, the Fed has decided to keep shocking this dying patient, hoping one of the hits will get a regular heart beat reestablished.

In the meantime, those dollars in your pocket just aren't worth what they used to be. The rest of the world is moving on and America is bleeding profusely from a massive self-inflicted wound.

Gains on Wall Street just aren't worth what they used to be. The Dow is quoted in dollars. For example: a “Dow 14,000!” in 2007 USD is actually “Dow 10,000!” in 2007 Euros. If there were a “Dow 14,000!” in the late 90's, when 1USD = 1.25 EUR, would have been “Dow 17,500!”. The point of the example is that as the dollar falls, rises in prices still wind up being falls when adjusted for what has happened to the currency. So in order to catch up to a “real” rise, a price on something would have to rise further, most likely faster than the rate of a wage increase, which leads to inflation, which leads to a sluggish economy, which feeds this monster some more.

If you bought a loaf of bread imported from Canada for $1USD when the exchange rate was $1USD = $1.75CAD, you see yourself paying $1 and are on your way. If the price of that loaf rises to $2CAD, and the value of your currency falls to $1USD=$.99CAD, that loaf of bread went up in price to $2.01 from $1. Now get rid of the bread example and do this for all the goods that aren't made in America, which is to say mostly all of them. Harder times are ahead, and we the people are in line to suffer. From the housing market to the grocery store, harder times are ahead.

And of course, don't forget, all this mess, all these words, it's only one part of the problem. You may begin to let your head spin now.

Hi Redheaded Stepchild, how are you?