May 24, 2022

WELCOME BACK, CARTER: The Economic Doom Loop Has Begun.

If interest rates are less than inflation, it makes holding cash a losing proposition.

But in this environment, raising interest rates will cause a cascade of problems. The higher interest rates will slow the economy and cause unemployment. It will also swallow up tax revenue as the government has to pay interest on its massive debt. But more critically, it will increase the rate of default on home mortgages. Those defaults will make mortgage-backed securities less valuable and more unpredictable. That’s how the 2008 housing market seized up.

Thus, the doom loop.

The more the Fed props up the mortgage industry, the more it encourages inflation. The more inflation increases, the more urgent it becomes to stop printing money. When the printing press stops and interest rates rise, those MBSs likely will turn toxic again, freezing the market at the exact moment the Fed needs buyers for its bonds.

Related: Is The Housing Crash Starting?

More: Jim Geraghty asks, “We must wonder if, on the horizon, the U.S. is facing runaway inflation, unprecedentedly high energy prices, a recession, a labor shortage, a crashing stock market, lingering supply-chain problems, and the bursting of a housing bubble simultaneously.”

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