The Fed’s Role in the Housing Crash of ’07


Richard Moore

Original source URL:

The Fed¹s Role in the Housing Crash of Œ07
by Mike Whitney
January 9, 2007

       ³This is the biggest housing slump in the last 4 or 5
        decades: every housing indicator is in free fall, including
        now housing prices.²
        -- Economist Roubini Nouriel, Dow Jones, August 23, 2006

       ³The Fed, in effect, has become a serial bubble blower.²
        -- Stephen Roach, chief economist, Morgan Stanley

The American people appear to be oblivious to the economic hurricane that is 
expected to touchdown in late 2007. That¹s when $1 trillion in ARMs (Adjustable 
Rate Mortgages) will ³reset² triggering a massive increase in foreclosures and 
plunging the country into a deep recession. If energy costs continue to rise at 
the same time or if the dollar loses more ground, we may be rooting around in 
the backyard garden plot looking for passed-over spuds and radishes.

The crisis is entirely the work of former Fed Chairman Alan Greenspan, whose 
³cheap money² policy caused a speculative frenzy in the real estate market that 
sent home prices through the stratosphere. In fact, the bubble originated in 
2001 when Greenspan lowered interest rates to a meager 1% and ignited a 
refinancing boom as well as a sudden up-tick in home sales. Now, after 17 
straight interest rate increases, the bubble is quickly losing steam and the 
effects are being felt from sea to shining sea. Rest assured, the sudden 
downturn in the housing market is just the first gust from an impending tornado.
By the end of 2007, America¹s matchstick economy will look like the rubble 
strewn landscape of New Orleans 9th Ward.

Greenspan has been the biggest player in this pre-Depression operetta. He kept 
the printing presses whirring along at full-tilt while the banks and mortgage 
lenders devised every scam imaginable to put greenbacks into the hands of 
unqualified borrowers. ARMs, ³interest-only² or ³no down payment² loans etc. 
were all part of the creative financing boondoggle which the kept the economy 
sputtering along after the ³dot.com² crackup in 2000.

It worked like a charm too. Aided by the Fed¹s cheap money policy, the housing 
market sizzled. In just six years the total value of real estate jumped from $11
trillion to $21 trillion! (³From 2001 through 2005, outstanding mortgage debt 
rose 68% from $5293 billion to $8888 billion²) It¹s the biggest expansion of 
debt in history and it was all engineered by seductively low interest rates.

Greenspan executed the swindle with the adroitness of a carnival huckster, 
luring millions of buyers to the real estate gold rush. Now, many of those same 
buyers are stuck with enormous loans that are about to reset at drastically 
higher rates while their homes have already depreciated 10% to 20% in value. 
This phenomenon of being shackled to a ³negative equity mortgage² is what 
economist Michael Hudson calls the ³New Road to Serfdom²: paying off a mortgage 
that is significantly larger than the current value of the house. The sheer 
magnitude of the problem is staggering.

For example, an article in the New York Times last week noted that, ³1 in 5 
sub-prime loans will end in foreclosure. . . . About 2.2 million borrowers who 
took out sub-prime loans from 1998 to 2006 are likely to lose their homes.² In 
real terms, that translates into roughly 10 million people!

Greenspan, of course, nodded approvingly while the new regime of shaky lending 
practices was being put into place. What really mattered to the Fed chief was 
making sure the economy could be kept on life support while the massive 
³unfunded² tax cuts were provided for his well-healed buddies in corporate 
America and while the country charged off to war in Iraq.

Greenspan knew that his ³low interest rate bonanza² was driving the wooden stake
into America¹s heart. In fact, every banker understands the effects of interest 
rates; it¹s fundamental to their trade. Lower the interest rates and the people 
will swarm to the banks like piranhas to a hambone. It never fails.

The housing bubble has nothing to do with ³market forces² or (Gawd help us) 
supply-and-demand. That¹s all gibberish. Low interest rates provide a channel 
for pumping cheap money into the economy, which inevitably creates equity 
bubbles. When Greenspan lowered rates to 1%, he knew that he was simply trading 
a technology bubble for a real estate bubble. Now, of course, he has retired 
before the wheels fall off the cart so he can avoid being blamed for the coming 

The fallout from the housing explosion will be much more destructive than what 
most people imagine. In fact, Peter Schiff, president of Euro Pacific Capital 
Inc., believes that the NY Times¹ estimates are too optimistic. Schiff 
anticipates that failures in the sub-prime loan market will put greater downward
pressure on housing by increasing inventory and lowering prices.

Schiff says:

³The secondary effects of the ³1 out of 5² sub-prime default rate will be a 
chain reaction of rising interest rates and falling home prices engendering 
still more defaults, with the added foreclosures causing the cycle to repeat. In
my opinion, when the cycle is fully played out we are more likely to see an 80% 
default rate rather than 20%.²


40 million Americans headed towards foreclosure? Better pick out a comfy spot in
the local park to set up the lean-to.

Schiff¹s calculations may be overly pessimistic, but his reasoning is sound. 
Once mortgage holders realize that their homes are worth tens of thousands less 
than the amount of their loan they are likely to ³mail in their house keys 
rather than make the additional mortgage payments.²

As Schiff says, ³Why would anyone stretch to spend 40% of his monthly income to 
service a $700,000 mortgage on a condo valued at $500,000, especially when there
are plenty of comparable rentals that are far more affordable?²

Why indeed? There¹s simply no incentive to hang on to a home or condo that¹s 
losing value every day.

³Lobster Potted²?

Economist Nigel Maund describes what over-leveraged homeowners can expect as 
real estate values continue to plummet:

³For the majority of homeowners, they are now Œlobster potted¹ for the rest of 
their lives in the 21st Century¹s version of the Victorian treadmill. Welcome to
modern debt-controlled serfdom, where if you lose your job, either through 
retrenchment or illness, you lose your home. It has become a veritable Sword of 
Damocles, or a stick with which to beat recalcitrant labor into a bloody pulp, 
should they ever prove restless or disobedient. The ruthless and faceless 
plutocrats who benefit vastly from this dreadful scheme must be laughing on 
their return to a status of demagogic power which is the modern equivalent of 
Roman or Medieval Aristocracy at its exploitative worst. . . . The mortgage 
weapon forms an integral part of the armory of the so-called New World Order 
(NWO) as it seeks to accumulate wealth and power to control people by stealth.²

Maund nails it. The ³mortgage weapon² has been used effectively to thrust 
millions into debt servitude and shift the nations¹ wealth to the upper 1%. 
Meanwhile the Decider-in-Chief has been busy rewriting the nation¹s laws so they
meet the requirements of an economically polarized society. (The erosion of 
civil liberties is the unavoidable consequence of the greater divisions in 

The first wave in the tsunami is timed to hit in late 2007 when $1 trillion in 
ARMs reset, wreaking havoc across the country. That means that millions of 
borrowers will see dramatic increases in loans on homes that are of steadily 
diminishing value. (Many monthly payments will nearly double!) The number of 
foreclosures will skyrocket, unemployment will soar, and America ¹s consumer 
economy will swoon.

How bad will it be?

According to statistical analyst, Jim Willie, ³One third of job creation has 
come from the housing industry in the last 5 years.²

How will we make up those losses in employment?

Equally worrisome, is the amount of money that will stop flowing into the 
economy because of the declining home values. In 2005, Americans pulled $732 
billion out of their home equity to spend on consumer items. By the 2nd quarter 
of 2006 that number was down to $327 (annualized) a loss of more than half. In 
an economy where 90% of growth has depended on the housing boom, these are 
ominous signs of impending disaster. (Current Fed Chairman Ben Bernanke said 
that the slowdown in housing has been a ³major drag² on the economy, which has 
already caused a 1% decrease in GDP in 2006. What effects will it have in 2007 
when the real storm hits?!)

If homeowners can¹t tap into their equity to augment their stagnant wages, GDP 
will shrink and investment will flee to foreign markets. That¹s when we¹re 
likely to see the lines at the neighborhood shelter winding around the block and
whole families camping out in the backs of their Suburbans.

The Sub-prime ³Time Bomb²

It looks like the meltdown in sub-prime loan business will trigger a steady 
downturn in the entire housing industry. The Center for Responsible Lending 
(CRL) issued a report which says that they anticipate a ³humanitarian disaster 
worse than Katrina.² The report states:

³The sub-prime market was designed with a built-in time bomb. In testimony to 
the Senate Banking Committee in September, Michael Calhoun, the President of the
CRL, showed an example of the most typical sub-prime loan, known as a 2/28, with
an Œexploding ARM¹ (adjustable rate mortgage). Buyers can qualify for this type 
of loan if the original (Œteaser¹) monthly payment is not higher than 61% of 
their after-tax income. At the end of two years, even without a rise in interest
rates, the payment will typically rise to 96% of the purchaser¹s monthly income.
No wonder then, that the study conservatively forecasts that one-third of 
families who received a sub-prime loan in 2005 and 2006 will ultimately lose 
their homes!²

³96% of the purchaser¹s monthly income²?!! That leaves a measly 4% of one¹s 
earnings to pay for clothes, food and other essentials!

The disaster in sub-prime loans is leading the housing market into a waterfall 
type decline. It¹s the first indication that a real catastrophe is just around 
the corner. The inability of over-leveraged borrowers (many with a poor credit 
history) to meet their obligations is spreading to other areas of the market. 
This is called ³contagion². The defaults are symptomatic of a larger problem 
that could quickly affect the entire system.

Realtor Don Stacey describes the phenomenon this way:

³The fact of the matter is that sub-prime lenders are closing shop and dropping 
like flies . . . What does this signal? To me it suggests that the sub-prime 
lending cycle is history . And, if it is history, then a very large chunk of the
nonconforming borrowing seen in 2004, 2005 and most of 2006, will not be 
repeated in 2007.²

Why should this matter to the average homeowner?

Because in 2003, 35% of all mortgages were ³nonconforming² loans. In 2004, it 
went up to 59%. And in 2005, nonconforming loans were a mammoth 65% of all 
mortgages! As the lenders return to more conventional practices the pool of 
potential customers will dry up accordingly and housing prizes will fall 

Once again, we need to remind ourselves that the housing boom was not created by
market forces, ³real demand² or increases in wages. It is entirely the outcome 
of Greenspan¹s ³cheap money² policy (low interest rates) as well as the 
widespread shabby lending practices. (³Creative financing², ARMs etc.) These 
factors have caused the largest expansion of personal debt in history and are 
creating a real risk of a complete financial collapse.

So, why would the banks commit to such a risky scam when the standard criterion 
for loaning money has been understood for hundreds of years?

For the banks to ignore the rules for prudent lending (20% down payment, fixed 
interest rate, sufficient collateral and income) is like a scientist saying that
the rules of gravity no longer apply or that the chemical composition of water 
has changed.

It simply makes no sense, does it?

It¹s different for the Federal Reserve. The Fed knows that the US consumer is 
already overextended and mired in debt. They¹ve decided to increase our 
(collective) obligations while their corporate colleagues load the boats for 
more promising markets in Asia and Europe. They cling to the notion that they 
can preserve the greenback as the ³reserve currency² even after it has been 
deflated to the value of the Peso. (The actual face value of the dollar makes no
difference to the Fed as long as they continue to produce the ³international 
currency.² That preserves their power base and control of the global system.)

³Cheapening² the dollar by doubling the money supply paves the way for 
hyperinflation and (the Fed believes) a more competitive American workforce 
going nose-to-nose with competitors in China and India. It¹s a plan that 
globalization¹s foremost champion, Tom Friedman, would probably greatly admire.

By pulverizing the dollar, the Fed can crush the middle class and lay the 
foundation for a ³class-based,² police state -- Bush¹s nascent Valhalla.

The first step to ³reordering² society is destroying the currency.

Famed economist John Maynard Keynes showed a keen grasp of this when he said:

³Lenin was right. There¹s no subtler, no surer means of overturning the existing
basis of society than to debauch the currency. The process engages all the 
hidden forces of economic law on the side of destruction, and does it in a 
manner which not one man in a million is able to diagnose.²

This suggests that the greatest threat to ³democratic institutions² is not 
repressive legislation (as most believe) but monetary policy. The manipulation 
of currency can precipitate economic divisions in society that make democracy 
impossible. That¹s why Thomas Jefferson said:

³I believe that banking institutions are more dangerous to our liberties than 
standing armies. If the American people ever allow private banks to control the 
issue of our currency, first by inflation, then by deflation, the banks and the 
corporations that will grow up around (the banks) will deprive the people of all
property until their children wake up homeless on the continent their fathers 
conquered. The issuing power should be taken from the banks and restored to the 
people, to whom it properly belongs.²

Jefferson understood that monetary policy is central to the maintenance of 
personal freedom and should not be ceded to a few ³unelected² and unaccountable 
men whose interests diverge from the public good. The Fed¹s ability to ³inflate 
and deflate² the currency allows privately-owned banks to decide the country¹s 
future and remake society according to their own inclinations.

America¹s political transformation is being engineered by the Federal Reserve.

But what about the banks?

What would compel the banks to break with traditional lending practices and put 
themselves at risk of millions of foreclosures?

The banks eke out their survival in an extremely competitive environment where 
short-term profit determines their behavior. Not only have they loaned out 
zillions of dollars to people with poor credit, they¹ve also played a major role
in repackaging substandard loans and selling them off to Wall Street as 
³mortgage backed securities² (MBS) These MBS are high-yield debt instruments 
that evolved through ³deregulation². They¹re sold to hedge funds as securities 
and are rarely (if ever) checked for the reliability of the borrower. This has 
created a great opportunity for the banks to loan as much money as possible 
using funky ARMs and nontraditional loans knowing that they¹ll be rubber-stamped
on their way to Wall Street. (The practice of shipping B-grade loans to fund 
managers is like gift wrapping dog poop and selling it as Belgium chocolates. 
Nevertheless, it has fattened the bottom line for nearly all the major lending 

Unfortunately, the terms of the MBS allow non-performing loans to be sold back 
to the lender that originated the loan. Now that the number of ³non-performing² 
loans is on the rise, (through defaults) the banks are scrambling to avoid 
liability. (In fact, according to National Mortgage News, Fifth Third Bank is 
³selling $11.4 billion in securities (almost all MBS) before year-end 2006 and 
is taking a loss of approximately $500 million.) This reflects the new mood in 
steering away from shaky loans.

As the great housing Hindenburg continues its downward trajectory, the banks 
will undoubtedly do their best to prevent the deluge of foreclosures (and 
failing MBSs) from dragging them under. Perhaps, they will offer more flexible 
terms to over-leveraged homeowners as a way of recouping their losses; it¹s 
impossible to know. It¹s also hard to gage how many struggling homeowners will 
be able to hang on even with a more flexible payment schedule. Unfortunately, 
the present trend lines offer little reason to be hopeful.

These are grim times for the mortgage industry and we shouldn¹t be too surprised
if one or two major banks hobble into receivership before the storm is over.

Housing Hullabaloo: ³The worst is yet to come²

Reports in the mainstream media tend to obscure the severity of the housing 
bubble. Typically, the articles are full of ³Sunny Jim² claptrap about a 
³rebounding market² that is suddenly ³correcting² after an explosive decade of 
growth. For example, over 250 articles appeared in US newspapers this week 
celebrating; ³New Home Sales Rise in November.² Readers should not be taken in 
by this type of hype. A careful reading of the facts indicates that, ³rather 
than foreshadowing a quick rebound, the news highlighted how fragile the 
residential construction remained and suggested that the downturn rattling the 
housing market has not run its course.² (NY Times)

Translation: The worst is yet to come.

The number of homes sold in November was the LOWEST IN ALMOST 4 YEARS causing 
inventories to swell to a ³7.7 month supply, the highest since December 1995.²

These are very bad numbers.

So, why is the media cheering?

The news reports draw attention to a slight 3.4% increase in sales in November 
from a thoroughly dreadful October! If, however, we compare the figures from 
November 2005 to November 2006, we find that housing sales are actually down 
12.4% from a year earlier. (And this, of course, is how one normally evaluates a
downturn in the market)

The media is no more dependable in their coverage of the housing bubble than 
they are about Iraq. The reader must do his own research and draw his own 
conclusions. But one thing is certain, house prices are way beyond any 
historical relationship to rents or salaries. They are bound to come down . . . 
and fast.

We can also assume that the number of foreclosures will skyrocket in 2007 from 
defaults on sub-prime loans and the ³resetting² of Adjustable Rate Mortgages. 
(The monthly payments on these loans will go up significantly whether the Fed 
raises interest rates or not)

Business Week summarized our current predicament saying:

³Today¹s housing prices are predicated on an impossible combination: the strong 
growth in income and asset values of a strong economy, plus the ultra-low rates 
of a weak economy. Either the economy¹s long-term prospects will get worse or 
rates will rise. In either scenario, housing will weaken.²

The real estate slump will seriously dampen consumer spending and further shrink
the already miniscule US GDP (1.9%) This will undoubtedly have the added effect 
of curtailing foreign investment, putting more downward pressure on the 
floundering dollar and triggering a round of hyperinflation. Ultimately, the Fed
will be forced to make one of two choices: either lower interest rates and forgo
foreign investment ($2.5 billion a day) or keep interest rates where they are 
and accelerate the collapse of the housing market. There is no ³third² option.

Most analysts and traders believe that Fed Chief Bernanke will follow the 
well-worn path of Dr. Weimar and begin ³hurling bundles of greenbacks from 
helicopters² rather than allow the economy to grind to a halt. Hence, we are 
likely to see the further ³debauching of the currency² sometime in the very near
future. As Stephen Jen, the chief currency economist at Morgan Stanley, said 
recently in an article in the New York Times, ³All the policy makers still 
believe in the possibility of a dollar crash. It¹s still lingering out there.²

No doubt, Fed-master Bernanke will work towards that goal by keeping the 
printing presses humming along while praying for the elusive ³soft landing.²

The Fed¹s Plan to Reshape American Democracy: "One bubble after another"

As a privately owned organization the Federal Reserve cannot be expected to 
operate in the public interest. The Fed¹s views on policy are primarily shaped 
by elite opinion, which favors a small group of powerbrokers at the top of the 
economic food-chain. The Fed¹s power to manipulate interest rates and increase 
the money supply, allows it to engage in ³social engineering² which merely 
reinforces its own class interests. This, in fact, is what Jefferson intimated 
when he warned that if ³private banks² were allowed to control the issuance of 
currency, than they would inevitably ³deprive the people of all property until 
their children wake up homeless on the continent their fathers conquered.²

That shift in wealth is underway even as we speak.

These massive equities bubbles (stock market and housing), which have had such a
devastating effect on working class people, are the predictable result of a 
class-based orthodoxy. They inevitably widen the chasm between rich and poor and
strengthen the power of the ruling elite. It is crazy to think that they are 
merely ³accidental².

The upcoming recession is the direct result of policies which originated at the 
Federal Reserve and which were intended to create a crisis. It is a clear 
attempt to change American society on a structural level by exacerbating the 
divisions in wealth. The expansion of debt invariably strengthens private 
ownership and enhances corporate profits. It also weakens democratic 
institutions and national sovereignty.

Democracy cannot long endure when the money supply and interest rates are 
controlled by privately owned banks. Their behavior is guided by self-interest 
and profit and is hostile to liberty and the equitable distribution of wealth. 
The policies of the Federal Reserve are transforming the country in a way that 
will eventually make democracy in America unworkable. We are becoming a de facto
aristocracy and will continue along that path until the ³issuing power of 
currency is taken from the banks and restored to the people, to whom it properly

The Federal Reserve System was established by President Woodrow Wilson in 1913. 
Wilson bitterly regretted his foolishness from the very onset and said in his 
book, The New Freedom:

³I am a most unhappy man. I have unwittingly ruined my country. A great 
industrial country is controlled by its system of credit. Our system of credit 
is concentrated. The growth of the nation, therefore, and all of our activities 
are in the hands of a few men. We have come to be the worst ruled, one of the 
most completely controlled and dominated governments in the civilized world. No 
longer a government of free opinion, no longer a government of conviction and 
the vote of the majority, but a government by the opinion and the duress of a 
small group of dominant men.²

As millions of people lose their homes and life savings from the crashing of 
Greenspan¹s Housing Bubble, we should reconsider Wilson¹s words and make a 
concerted effort to dump the Federal Reserve.

Mike Whitney lives in Washington state, and can be reached at: 

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