911, Subprime and the Zero Bound: How the Terrorists Really Are Winning

Its an uncomfortable thought, to be sure. But reality is not rooted in our personal comfort levels and an honest assessment of the situation says that, while Osama bin-Laden certainly could not have imagined it would actually work out this way, the attack on 911 really did strike a far more serious blow to our nation’s economy than we knew.

Certainly it was the stated goal of al-Qaeda to disrupt our financial centers. Certainly, we know that this much happened at least for a few days: the Stock Market stayed shuttered for several days before finally reopening and air travel was disrupted for a full day. But what followed was a very clear overreaction on the part of the Federal Reserve, knocking interest rates down to never-before-seen levels, bottoming out very near to Paul Krugman’s “zero bound” even before our current economic crisis. And interest rates never really did get back to pre-911 levels, or even half that.

The actual sub-prime mortgage fiasco, however, was not of post-911 origins. It’s origins are rooted well before 911 in the mid-90’s when a President Clinton looking to find ways to work with an intractable Republican Congress signed deregulatory laws that removed fetters in place since the Great Depression. And the derivative markets feeding off mortgage-backed securities was gaining a healthy head of steam well ahead of President Bush’s election.

But look what happens when you put together a down economy, an increasingly hungry securities market based on mortgages and an extremely low interest rate! There is no other sector of the economy that improved so much or displayed so many pro-political statistics than the housing sector throughout The Aughts. Every single Bush SOTU address hyped the increasing numbers of home owners. Fanny Mae and Freddy Mac took steps to actively encourage lower income home-ownership – indeed, as has been their charter for decades. And in the midst of this, what possible reason did anyone have to raise interest rates? Sure, it’s a proof against inflation – and what gains the interest rate made were precisely for this reason – but pressure to keep the markets happy and the good news coming made the White House extremely interested in convincing the Fed to keep the rates as low as possible.

Neither do I especially blame the Bush White House for this: we see now in the Obama Administration what happens when the economy dives. The simple lizard brain of politicians has to find that prospect unacceptable when an easy solution is at hand.

But now that the derivatives bubble has burst, a recession falls upon us as many such recessions fall upon us. Though undoubtably, it is a much bigger recessionary event than any I’ve ever seen in my lifetime. And in such a recession, the solution to the problem is easy: have the Fed lower interest rates. Lowering interest rates makes borrowing money more attractive, businesses make capital investments, spend money, hire workers and before you know it, the economy is back on track. Lowering interest rates also tends to lower prices on consumer goods, making purchases easier for consumers and the lowered interest rates encourage them to buy houses, cars and televisions. All good news for an economy in trouble.

Except there’s no place for interest rates to go: they’re up against a nearly zero-percent interest rate and cannot possibly go lower. The primary tool in the fight against a recession is completely robbed from us. We are not powerless to stop the rising tide of unemployment nor to hold ourselves up against the looming threat of deflation that economists worry is the next step. But we certainly are without our best set of tools, and we certainly won’t be getting out of our current economic hole for a reasonably long period of time. I’d be amazed if we got anywhere near 5 percent unemployment in the next three years, though I’m not an economist.

And so I suspect that writers of history books a century from now will note with diminishing counter-argument that the events of September 11th were hugely developmental to the dark economic “Great Recession” or “Depression” that we now live in.