Here’s a thought- cheap money is not always a good thing.

Today, one of the major financial houses on Wall Street, Lehman Brothers, filed for Chapter 11 bankruptcy.  Not a good thing.  And, it’s a result of the housing crisis as well.

Let’s turn the clock back a few years.  Interest rates were at about 12%.  People had bought homes, but were in foreclosure, because they could not keep up with the payments.  They bought property on variable interest rate products, and as rates increased, they ended up owing more than the property was worth, and they lost these homes and investment properties because they simply could not afford them.  A lawyer I worked for before I went to law school owned many of these properties with his friends, and rented them out.  When interest rates went down, he refinanced or sold many of them, making a nice profit for himself and his friends.

This is what happens when interest rates are high.

When interest rates are so low there is essentially no interest, where can you invest your money?

When the same sort of housing boom and bust happened when interest rates were at historic lows, there’s no way to flex.  You can’t have negative interest…. then you are paying people to take money from you- not a really good idea.

At high interest rates, there was still some flexibility in the market.  Rates could go down.  You could play with rates and things would remain pretyy stable.  Now that interest rates are so low, there’s no give left in this lever to controll our economy, other than to jack up rates.

If interest rates go up, people swimming in debt will get seriously hurt.  If interest rates go up, people will also have to be more fiscally responsible, and the necessity and incentive to save will also go up accordingly.

Interest is merely the “price” of money.  When gas prices went up, people had to adjust their budgets and behavior to accomodate for this price hike.  Likewise, a raise in interest rates long ago would have avoided some of this silly housing crisis, and have made both borrowers and lenders more cautious with their money.  Instead, people have been spending money like drunken sailors in a new port of call, whether they had any or not.

As painful as it will be, the only way I see out of this financial mess is a gradual, even clockwork raise in interest rates, giving people the ability to prepare and adjust for the coming changes.  Oh, and a nice helping of economics and finance in our highschools would be nice, too.

What do you think?