PUBLIC RADIO'S MARKETPLACE COMMENTARIES:

Broadcast May 12, 2004

The End Of Easy Money

Last week’s report of 288,000 new jobs in April, comes on top of reports of higher commodity prices, and, of course, a $500 billion budget deficit as far as the eye can see. Put it together and what does it all spell? Inflation. It’s almost a certainty now that the Fed will begin raising short-term interest rates by the end of June. Not by much at first – maybe a quarter of a point in June, another quarter during the summer, another quarter of a point in October. But make no mistake. The big squeeze will begin shortly. The days of easy money are coming to a close.

Here’s the problem. Countless Americans are addicted to easy money. And so are the banks that have been pushing people to borrow more and more. With money now so cheap, and capital markets so efficient -- lenders linked by computer to automated loan-approval systems that give the nod almost instantly -- just about anybody has been able to get a loan for almost anything.

Interest-only loans that change every month; no-document loans allowing borrowers to take the money without proving their incomes; no-ratio loans, regardless of monthly income; mortgages that don’t require mortgage insurance; and, of course, adjustable-rate mortgages. The Mortgage Bankers Association says the share of home buyers taking out adjustable-rate mortgages jumped from 13 percent last July to 32 percent in March.

So what happens when the big squeeze begins, and the era of easy money is over? Monthly payments on all these new lending instruments head north at precisely the same time as American consumers are also paying higher prices for gas at the pump, for health care, for college tuition, and for a lot of other things. Paychecks, meanwhile, aren’t rising nearly as fast. Average hourly wages, adjusted for inflation, are going nowhere.

If the big squeeze happens too fast, a lot of people get squeezed so hard they can’t meet their payments. And this means banks get stiffed – left holding a lot of assets whose value isn’t nearly what it was in the era of easy money.

So the Fed has decided to move gradually. The idea is that borrowers and lenders have to be weaned off their dependence on easy money, step by step.

But the Fed may be wrong about this. It’s a well-known tenet of psychology that many addicts can overcome their addictions only by going “cold turkey.” In other words, if they’re really going to mend their ways, both borrowers and bankers need a hard dose of reality. Gradual rate increases may just prolong the pain and avoidance. The Fed should raise rates to where they ought to be, period.