Time for central banks to let the market go

Photo: JOHN THYS/AFP/Getty Images

Last, week, the European Central Bank (ECB), the Federal Reserve and other central banks flooded markets with cash. Then on Tuesday, the ECB infused another $500 billion into the market.

The banks are trying to alleviate a credit crunch and restore confidence in world markets after the fallout from the subprime mortgage market spread to the wider economy earlier this year. On its face, that’s a good thing. But if you ask me, this needs to stop. Why? The market needs to correct itself. The central banks have to come to terms with the fact that a recession is possible if not likely no matter what they do. Here are a few reasons to let the markets be:

Wall Street is not going to be happy not matter how much cash is infused or how low interests rates go. The Fed’s rate cut on Dec. 12 is the perfect example of how spoiled Wall Street has become. It gets a cut, and it trades the market down 300 points because it wasn’t big enough. This follows an autumn during which the market traded up irrationally on hopes of a rate cut. Wall Street needs to start expecting that the good times it has had over the last few years can’t last forever.

As interest rates go down, chances of inflation go up. Despite news that inflation was flat in November, there is a real risk that prices could rise if interests rates keep getting cut and if oil prices stay high. The Fed acknowledged this risk in a statement accompanying its latest cut. And the Fed apparently had no problem with subprime borrowing when the market was up. It didn’t act then. It shouldn’t act now.

Buyer beware. Investors bet on instruments backed by subprime mortgages because they were risky; they could make a lot of money or lose a lot of money. For a while, they made buckets of money. Now, they’re losing it. It is not the job of central banks to bail out that made bad investments.

Buyer beware II. The same principle applies on the homeowner side, apart from those who were suckered into these kinds of loans (and now it looks like the right kind of protections are being put in place). Many subprime borrowers were homeowners who wanted to upgrade to a bigger house or borrow against the value of their house. They took out these loans betting that the value of their homes would continue to rise. When housing prices started to plateau and eventually decrease, these owners got stuck with payments they couldn’t make. Others should not have to pay for their mistakes.

Recessions are painful, but, just like good times, they don’t last forever. They’re an ordinary part of the market cycle. The actions by the ECB and Fed are simply prolonging the inevitable, whether it be a recession or simply a brief correction. Either way, it’s time to let the market take its natural course.