Interest Rates and the Insanity of the Economists:
Recent reports have indicated that mortgage rates in America have fallen to below 4%, their lowest rates in years.
Conservative economists as well as those employed by the financial industry have told us that a major component of interest rates, if not the major component, is risk as reflected by the various rating agencies (Moody’s, etc.). This theory applies equally to private and governmental debt. But, at no time in recent history has the risk to lenders of default on mortgages been greater. So what’s gong on?
Simple, risk has only a small part to play in setting interest rates, except when demand is highest. Then, it becomes a legal way to set prices so that the financial institutions receive premium returns on certain loans.
So how does this translate to the governmental debt crisis in Europe and elsewhere?
We are told by these same economists that governmental default on debt will result in increased borrowing costs. Not true! The purpose of the so-called theory is to protect existing profits. Future interest rates will be set by demand irrespective of past events. While some banks my go out of business as a result of their unwise loans, the remaining banks will need to compete on interest rates to stay in business, as demand drops so will interest rates. This is more in keeping with traditional economic theory than what we are told about the impact of risk on lending by many of today’s economic pundits.
And what will the result be if defaults occur?
Well, probably the deadwood on Wall Street and the financial institutions will be walking the same unemployment lines as the industrial worker they have been so free to ridicule and fewer of the latter will be walking with them.