Subprime mortgages—loans which banks make on highly favorable terms to potential homeowners with weak credit histories—became common in recent years, but a rash of recent defaults has sent the mortgage industry into turmoil.
Amidst worries that the mortgage crisis could be causing a general economic slowdown, many argue that an interest rate cut is in order to push the economy back on track. But others say the Fed should not bail out a small segment of investors for their “greed and stupidity.”
Harvard instructors including Warburg Professor of Economics Robert J. Barro and Baker Professor of Economics Martin S. Feldstein ’61 said they support a lower interest rate, even though such action can push up inflation.
“The most important thing [the Fed] does is respond to major financial crises,” Barro said, “Inflation is OK right now, and the economy is weakening...I think he should lower it.”
Feldstein argued for a large rate cut at a widely-watched Federal Reserve conference in Jackson Hole, Wyo., on September 2.
“The economy could suffer a very serious downturn” if the housing market remains weak, Feldstein said, according to a Wall Street Journal transcript of his speech. “A sharp reduction in the interest rate, in addition to a vigorous lender of last resort policy, would attenuate that very bad outcome,” he added.
But there is discord in the academic community.
Senior Lecturer on Economics Jeffrey Miron feels the rate should be left alone because Bernanke has long emphasized the importance of controlling inflation.
“While I don’t have all the information [Bernanke] has, I think the inflation targeting approach is a reasonable goal,” he said. “Focusing on maintaining low and stable inflation rate leads to more certainty and predictability in the economy.”
However, while Maier Professor of Political Economy Benjamin M. Friedman ’66 understands this outlook, he stressed in an e-mailed statement that “it’s important to remember that there are worse things than 2 percent inflation, and from time to time we have them.”
Miron also expressed less sympathy than others for the subprime lenders and borrowers, who he suggested are playing the roles of both perpetrator and victim in the current crisis.
“The subprime event is not that big a deal. It’s a small part of the economy. There will be some foreclosures, banks will lose money. That’s life. That’s capitalism. They took risks, and they lost. Policy should not bail out people for greed and stupidity, or their risk taking.”
But Barro characterized the subprime lending fervor of the last few years in a more positive light, calling it a “major anti-poverty program” and a “positive movement.”
“It was really a boon in terms of lower-income people getting homes, which they wouldn’t have been able to do otherwise,” he said.
Miron said he worries that compassion for the subprime borrowers will lead to an unwarranted rate cut.
“One rate cut often leads to another,” he said. “I’m nervous that the Fed is using [the current volatility] as an excuse to bail out the subprime [market].”
—Staff writer Maxwell L. Child can be reached at firstname.lastname@example.org.