What Nobody Will Say About The Subprime Mess

By Keith Fitz-Gerald
Contributing Editor

I've been waiting for a few weeks to see if anybody will say it – and, not surprisingly, nobody has.

So I will.
The truth about who caused the subprime mess.

In my humble opinion, it was the Fed. Sure there were contributing parties, so I’m not pointing the finger solely in Washington’s direction. But they clearly should bear the brunt of the blame here. As for the rest of the hyenas, they, too, should get some of the blame, since everybody from the borrowers to the mortgage lenders piled on over the past few year. As for Wall Street, together with the international banking community…don’t even get me started: Greed, as so many investors discovered, is not “good.”

As the sole agency responsible for maintaining an orderly and functional marketplace, the Fed is the one body that truly could have taken control and nipped this in the bud.

Instead, they let it build.

Former Fed Chairman Alan Greenspan is on record as calling the mortgage market a “powerful stabilizing force” in 2002. Then, in 2004, he went further by noting that that adjustable rate mortgages were great for consumers because they saved on interest-rate costs and prepayment penalties. Then, in 2005, he noted that new subprime loan products were a good thing because they showed innovation in the marketplace [To see what Greenspan had to say about the Fed’s role in the bull market of the late 1990s, click here].

This last item is particularly galling because 2005 also saw the first big issuance of subprime mortgages – a record $625 billion worth.  The data was apparently so far out of whack that the Fed apparently thought it was a mistake because it was so high.

Shades of Gordon Gecko anybody?

However, I don’t write policy, and hindsight is 20-20.

So let me say that I’ve always believed in free markets and I continue to believe in them. I’m particularly frustrated by recent Fed actions and I have been for several years. The Fed has tacitly stood by as the world built up an incredible asset bubble that some estimate is in the tens of trillions of dollars and which has been expanding since the late 1990s. Then, by keeping rates so low for so long, and then by encouraging people to scavenge the equity from their homes, the Fed allowed it to slither unencumbered into the housing market, where – until recently – it was fed like some sort of ravenous python.

Why are they surprised now that the once tiny garden snake has become a trillion-dollar monster and turned on them? I’m not.

You simply cannot reasonably interfere with normal market adjustment mechanisms via policy level decisions and expect things anything even remotely resembling normalcy. The markets depend on give and take and clearly there was a lot more “taking” in the past few years than giving.

So why should we bail the greedy guys out by providing excess liquidity?

I don’t think we should. My own belief, and I’ve been on record for several years saying that this was coming, is that the Fed should have initiated a “Volcker-style” torpedo to literally reign in a burgeoning asset bubble, identified as early as the late 1990s, when Big Al Greenspan so famously coined the term “irrational exhuberence.” The Fed missed another chance in 2005.

Would this cause a market crash?

I doubt it, but a severe correction would be in order.

But you know what? At the end of the day, we need a massive correction; and studies show that periodic corrections are actually good for the longer-term returns because it washes out the speculative money before the market indices retrace their highs.

My point is that the Fed’s been sticking its nose into places it shouldn’t be for too long now. Price/Earnings Ratios are artificially high around the world, and the excess liquidity they’ve helped provide is now a fact of life that we will have to deal with…and that will make solid returns that much harder to achieve…and keep.

Breaking up the old boys club would be, I submit, good for investors…at least serious ones anyway…and I’d love to see it happen.

About the Author

Keith is a seasoned market analyst and professional trader with more than 37 years of global experience. He is one of very few experts to correctly see both the dot.bomb crisis and the ongoing financial crisis coming ahead of time - and one of even fewer to help millions of investors around the world successfully navigate them both. Forbes hailed him as a "Market Visionary." He is a regular on FOX Business News and Yahoo! Finance, and his observations have been featured in Bloomberg, The Wall Street Journal, WIRED, and MarketWatch. Keith previously led The Money Map Report, Money Map's flagship newsletter, as Chief Investment Strategist, from 20007 to 2020. Keith holds a BS in management and finance from Skidmore College and an MS in international finance (with a focus on Japanese business science) from Chaminade University. He regularly travels the world in search of investment opportunities others don't yet see or understand.

Read full bio