Sunday, 28 June 2009

Dr Woods: Does the FED lowering the interest rate causes a decrease in lending standards?

The answer is, ceteris paribus, no.

The great historian, economist and best selling author Thomas E. Woods made a great apparence on the Howard Monroe radio show.

As always, Dr Woods was a great guest and a strong and articulate defender of liberty and truth against Leviathan.
One bit though I disagreed with.

He mentioned that he didn't think that programs such as the Community and Reinvestment Act did much to create the sub-prime crisis, and that the effect of the FED credit expansion has the effect of lowering banking lending standard by itself.

He gave the example of a sport manager that is suddenly forced to hire few more players, and will then pick lower caliber players that he has already, since, obviously, the best players were already chosen (I'm paraphrasing).

This analogy is missing an important part: The manager has now more money to hire players, and can then chose players that are as talented, but would not have been interested in joining the team at the wage that the manager was previously offering.

This is precisely the effect of the FED: interests rate are now lower, so demand for loans is increased, and the point is that new credit-worthy customers are now demanding those low interest loans too, not only sub-primers.

I do believe that the FED credit expansion would have caused a bubble and a crash no matter if the regulators didn't pushed the bank into lowering their lending standards, but it probably wouldn't have concentrated the bubble in the retail housing sector as much as we have seen.

It would have been a bit more spread in other sectors.

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