Fed Cuts Interest Rates; A Good Idea?

The Federal Reserve cut interest rates in the hopes of stimulating the markets and increasing liquidity in credit markets. In the past, I've counseled that dropping interest rates was a good idea, but now I'm having doubts.

I think one of the more overlooked areas as to how and why the 2008 toxic paper crisis spiraled out of control has to do with those incredibly low interest rates. In the wake of the 9/11 terrorist attacks, the Fed began a series of rate cuts, which was designed to foster confidence in the economy and to encourage economic activity. It also meant that interest rates for mortgages would drop to historic lows. This came at a time when Congress was pushing for still more affordable housing to subprime borrowers. Since they didn't have available capital to put down 20% for standard 30 year mortgages, they were steered into adjustable rate mortgages - 3/1, 5/1, and 7/1 ARMs. That means that when those initial super-low rates ended, the mortgage rates would jump - sometimes by shocking levels. We're in the midst of a continuing readjustment period, and in many areas, higher property taxes combined with readjustments of the interest rates on ARMs meant that people were seeing their monthly costs increase by 25%, 50% or more. It was simply unsustainable.

Now, there may have been good reasons to push the interest rates higher from mid 2004 through 2007, including inflation concerns and possibility of a terrorist attack that would have required the fed to consider additional rate cuts to stimulate the economy - giving the Fed breathing room to operate in a crisis, but it appears that the incredibly low rates from 2001 through 2004, subsequently followed by the sharp increase in rates played an important role in this crisis - and the blame for both decisions rests with Federal Reserve Chairman Alan Greenspan.