GHEI: Bank downgrades with a twist

Europe gets one thing right when it comes to monetary policy

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News from Europe continues to be bleak. Moody’s downgraded 28 Spanish banks on Monday, not long after major financial institutions, including Citigroup, Morgan Stanley, Goldman Sachs, Bank of America and JPMorgan Chase, suffered the same fate. The markets weren’t surprised by the reassessment of the American banks, but the Spanish downgrades sent rates soaring as investors expect Madrid’s sovereign debt to drop to junk status. In other words, things are about to get ugly.

European Union leaders meet in Brussels Thursday in search of the next Band-Aid solution. German Chancellor Angela Merkel so far has firmly discounted the possibility of eurobonds, which is a way to extend Germany’s AAA credit rating to lower the cost of borrowing for the ever-expanding list of profligate countries like Spain, Cyprus, Greece, Ireland and Portugal. Italy will soon join that list. The lack of a realistic solution means things will only get worse.

When considered as one bloc, the EU is America’s largest bilateral trading partner, and economic slowdown in that crisis-wracked region puts a wet blanket on growth here. There’s one lesson we can learn from the Europeans’ situation. Their central bank’s only mandate is to control inflation. Thus, it has refused to cut interest rates below 1 percent. European Central Bank Chairman Mario Draghi has bluntly stated his belief that Europe’s problems are not monetary in nature and “it would [not] be right for monetary policy to fill other institutions’ lack of action.”

If only the Federal Reserve would realize the same is true here at home. The Fed has driven interest rates close to zero without gaining anything in terms of real output or jobs created. Unemployment remains stubbornly above 8 percent and has ticked up in the past month, after three months of lackluster job growth in the private sector.

Last week, Fed Chairman Ben S. Bernanke even announced a $267 billion expansion of Operation Twist, his scheme to sell shorter-term securities and buy long-term ones in an effort to further drive down interest rates. The ostensible goal is to encourage investment by making borrowing cheaper.

Put in place last fall, the twisted program simply hasn’t worked. The problem right now is not a lack of cheap funds. Short-term interest rates already are close to zero. Mortgage rates are at historic lows. Further quantitative easing is only going to continue to punish savers, the Americans who depend on interest-bearing securities like municipal and Treasury bonds for their income. That’s somewhere between $9.9 trillion and $18.8 trillion in holdings, according to a study for the American Institute for Economic Research. A 1 percent decline in yield on $9.9 trillion costs those savers $52 billion - enough to sustain 493,000 real, private-sector jobs. By comparison, the economy created 69,000 jobs last month.

Just as in Europe, America’s problems are fiscal and institutional, not monetary. Neither the European nor the U.S. economy will escape this mess unless the government burden on the productive private sector is reduced.

Nita Ghei is a contributing Opinion writer for The Washington Times.

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