Why the Mortgage Crisis Continues

Fed Chairman Ben Bernanke was quoted yesterday on Yahoo! Finance as saying the nations mortgage crisis is continuing. Why is the mortgage crisis continuing and not ending? Because the Federal Reserve is not taking the appropriate steps to end the mortgage crisis.

The Federal Reserve was created back in 1913 to deal with financial crisis like the current mortgage crisis. The Federal Reserve Act states that the Federal Reserve was created "to furnish an elastic currency". In other words the Federal Reserve was created to replace any money that might be lost from the economy during a financial crisis. Prior to the Federal Reserve's creation financial crisis would occur and money would be lost from the economy. The lost money in the economy would cause people to stop or slow their spending of money and economic contractions, or recessions, would occur.

Congress created the Federal Reserve to replace any money lost in the economy from financial crisis ("to furnish an elastic currency") and thereby prevent the slowing or stopping of personal spending so that economic growth could continue on and contractions or recessions would not occur.

The current financial crisis in the mortgage arena has caused most financial institutions to take massive write-downs which has caused money to be lost from the economy. If the Federal Reserve had done what it was created to do and replaced all the money lost from the economy from the massive write-downs the mortgage crisis would be over. The fact that the mortgage crisis is continuing is proof the Federal Reserve has not replaced all the money lost from the economy.

When the East Asian Financial Crisis occurred back in the late 1990's I wrote a letter to the then Secretary of the Treasury and explained to him that the crisis was the result of the countries involved having foolishly removed massive amounts of money from their economies to try and maintain fixed exchange rates. I explained that the crisis would end as soon as the economies involved replaced all the lost money. Within weeks of my letter the countries involved replaced the lost money and the crisis was over. The same is true today in our economy. If the Federal Reserve replaces all the money lost from the economy from the write-downs by financial institutions the mortgage crisis will be over.

Further proof that Federal Reserve has yet to replace all the lost money is provided by looking at Personal Consumption Expenditures (PCE). In a normal low inflation environment PCE will historically rise by roughly 6% per year or .5% per month. According to the Burueau of Economic Analysis in December of 2007 PCE rose by just .3% and in January of 2008 PCE rose by just .4%. For those two months PCE rose by just .7% or around 30% below normal. People are not spending money at normal rates because of the money lost from the economy due to the mortgage crisis. If and when the Federal Reserve replaces all the lost money, people will once again spend money at higher levels and the crisis will be over.

As I have pointed out in the past and continue to point out today the fact that the very same people who caused the mortgage crisis to occur in the first place by massively raising short-term interest rates over a short time frame are the very same people who must solve the crisis is troubling indeed. But the mortgage crisis will end if and when the Federal Reserve replaces all the money lost in the economy from the massive write-downs taken by the financial institutions (the Fed can lower interest rates to zero and still not solve the crisis if they do not replace the lost money). Until that occurs the Federal Reserve is failing miserably in the role it was created for in the United States Economy.