"Deflation is a Powerful Force" - Alan Schwartz
CNBC - "Moves to boost the U.S. housing market could fuel the next credit bubble", warned Alan Schwartz, the former head of Bear Stearns, which crumbled during the 2008 subprime mortgage crisis. Earlier October, the U.S. Federal Housing Finance Agency stated plans to once again allow Americans to buy homes with deposits as low as 3% to help improve the declining housing market. Right now, borrowers must have a down-payment of 5% to qualify for a mortgage.
Schwartz, who is now executive chairman at Guggenheim Partners, warned that this proposed move could send the U.S. economy into a credit boom, like the one witnessed before the financial crisis of 2007-08. "When you give credit to people with very low down payments, and they can walk away from their mortgage, that is sowing the seeds of the next cycle," Schwartz told CNBC.
The U.S. Mortgage Bankers Association predicted there would be $1.19 trillion in mortgage origination during 2015, which is a 7% increase from 2014. "The U.S. economy became extremely dependent on credit and there is a desire to go back to being very credit dependent," Schwartz added.
The subprime mortgage crisis saw several major U.S. financial institutions completely collapse in 2008, which led to Bear Stearns's sale to JPMorgan Chase. The crisis was set in motion by a huge decline in home prices, which was devastating for banks that had loaded up on mortgage-backed securities in the preceding years. "What I learned from the crisis is that as you get older, you get more used to the risks you have seen before—or think you have seen before," Schwartz told CNBC on Monday. "We saw another cycle coming and we assumed we would be able to handle it, and sometimes what you assume from the past is very different from the future. So it teaches you not to get complacent about the risks you think you have already seen."
Schwartz also warned that "deflationary pressures were the greatest risk facing the global economy". "Deflation is a very powerful force. It is rearing its ugly head again and we still have not conquered it," he told CNBC. Declining inflation has proved very problematic in the euro zone, where inflation came in at 0.3% in September compared to 1.1% the same period a year before.
Like European Central Bank President Mario Draghi, Schwartz stated that euro zone countries needed to handle the problem through fiscal policy, rather than relying on central bank stimulus measures. "It is a demand issue," Schwartz told CNBC. "I think the monetary policy of the ECB is appropriate; I think they are going to have to figure out other policies, fiscal policies, to get things going."
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