Should We Fear Our Fear of Recession?

Predictions of a recession for the U.S. grow. Some say we're already in a recession. Calls for action are growing louder. The financial markets clamor for interest rate cuts, and Fed governors wink and nod accommodatingly. Proposals for fiscal stimuli are made--and then taken seriously. The Treasury Secretary calls for more interest rate relief on adjustable rate mortgages--this time on mortgages for prime borrowers who have the means to pay. It's hard to predict exactly what will happen in 2008. But it's easy to predict that a messy situation will be made messier.

Let's take interest rate cuts. Will they help? The history of the last 15 years of monetary policy teaches that interest rate cuts tend to fuel asset bubbles. Interest rate easing in the late 1990s inspired the stock market boom of that era, which eventuated in the stock market bust of 2001-02. To combat the fallout from the stock market bust (and the 9/11/01 bombings), the Fed dramatically lowered interest rates again, only to fuel the real estate boom and bust of the 2000s.

Interest rate cuts now may provide momentary relief for bank balance sheets. But will they really boost lending and spending, and save the U.S. from a recession? Mortgages are much harder to come by, because credit standards are actually being applied to borrowers. Lowering mortgage rates by a quarter or half point won't make someone who has no documented income or assets any more creditworthy than before. And if your credit card's interest rate was lowered by a percentage point, how much more will you buy now that rate is 18% instead of 19%?

Let's look at how extra credit generated by interest rate cuts might to be used to speculate in assets. U.S. assets, like stocks and real estate, aren't likely candidates for the next round of speculation. Been there, done that. What's more probable? Think about commodities like oil and gold. Or foreign stocks, which have been on a tear the last few years. Speculation in commodities and foreign stocks, however, wouldn't do that much for Americans. Will much of the benefit of the Fed's interest rate cuts flow overseas?

Fiscal stimuli are another hot topic. One proposal is to give all taxpayers an additional $500 (or $1,000 for those who are married, filing jointly), along with their refunds. The flow of this additional cash is meant to goose the economy. But it may not come soon enough, or be large enough, to have a major impact. And it could divert funds away from real needs that the government should address--say, health care for children or vets.

Treasury Secretary Paulson proposed last week that prime adjustable rate mortgages be frozen at their initial rates, like his proposal for certain subprime mortgages. Let's remember that prime mortgages are for people who can afford to pay them, including the increased monthly payments. Why should people who have the ability to pay get a break? Many of these borrowers have upper middle class or higher incomes. Should the government invade the sanctity of contracts to make the well-off even more well-off?

Recessions are part of life in market based economies. They serve as a mechanism to counter bad economic decisions. If people are held to the consequences of their bad decisions, they'll learn not to make them. Political considerations, of course, impel governments to try to insulate people from the consequences of their bad economic decisions. Capitalism is harsh, and there's a case to be made for government softening its harshness. But there's a point where the great and all powerful government turns out to be a little man behind a curtain; and we'd be better off not believing in him.

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