The Federal Reserve Interest Rate Manipulations from 2000-2007 and the Housing Mortgage Crisis of 2008

INTRODUCTION The confluence of Federal Reserve interest rate fluctuations, recessionary pressures, and rise in price of oil, between 2000-2008, have been three of major factors causing decline of housing sector and mortgage market crisis of 2008. The effect of interest rates has affected other areas such as student loans (Nealy, 2008). The impact of rise in price of oil on developed economies has also been inflationary (Lindstrom, 2006; McPherson & Weltzin, 2008). It has been shown that relationship between oil and inflation has weakened. In 1970s there was a strong correlation between price of oil and inflation rate as measured by Consumer Price Index (Investopedia, n.d.). Although correlation between rise in price of oil and rise in inflation has weakened, relationship still exists and greatly affects investor and financial expectations (Blas & Mackenzie, 2008; Uren, 2008). It has been generally accepted that Federal Reserve has attempted to control inflation. Federal Reserve Chairman Ben S. Bernanke (2003) has, in past, acknowledged this by stating the Federal Reserve, though rejecting inflation-targeting label, has greatly increased its credibility for maintaining low and stable inflation, has become more proactive in heading off inflationary pressures, and has worked hard to improve transparency of its policymaking process--all hallmarks of inflation-targeting approach. In same speech Chairman also drew connection between rise in oil price shocks in 1973 and inability to control inflation leading to disinflationary recessions of 1973-75 and 1980-82. It is this role of fighting inflationary effects of rising oil prices and fighting recession of 2000-2003 that caused Federal Reserve to manipulate interest rates that lead to housing mortgage crisis of 2008. STUDY LIMITATIONS The study focus is on interest rate fluctuations, oil per barrel prices, CPI inflation rates, and recessionary pressures over time as major stimulators affecting Federal Reserve interest rate decisions. The study does not attempt to quantify exchange rate effects of U.S. dollar on per barrel price of oil. The study does not take into account other external variables that may have also affected Federal Reserve decision- making on interest rates. In addition, study does not quantify effects of bank lending practices. The study does question wisdom of using variable rate interest loans versus more stable fixed interest rate loans, especially to low-income borrowers, but study does not address legal versus ethical lending practices of financial institutions. The manipulation of interest rates is regarded as a legitimate and necessary function of Federal Reserve System to fight recessionary and inflationary pressures. The study does not attempt to provide alternative approaches of Federal Reserve action to control these pressures. It is also beyond scope of this study to determine what anticipatory actions are necessary in timing raising or lowering interest rates. The study does not address leveling effect Federal Reserve interest rate actions have on market cycles of inflation and recessions. STUDY DATA After a year of historical prime interest rate fluctuations, 1980 ended year with a historical prime interest rate high of 21.5%. In June 2003, prime rate had lowered to 4%. The last time prime rate was recorded at 4% was in January of 1958. Chart 1 shows prime interest rate fluctuated from 2000 to 2008, as determined by Bank Prime Loan Rate over select years recorded by Board of Governors of Federal Reserve System. [GRAPHIC 1 OMITTED] It is reasonable to conclude Federal Reserve lowered interest rates in 2000-2001, in response to a perceived recession as determined by National Bureau of Economic Research and other Federal Reserve data (Business Cycle Dating Committee, 2001). …