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The Amateur / Vad Yazvinski5/6/2008 12:01 AM ET

The high risks of low interest rates

When interest rates are lower than inflation, we're bailing out Wall Street at the expense of retirees and working people trying to save money. That's not sustainable.

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"The only real mistake is the one from which we learn nothing." -- John Powell

Hopefully, anyone who has read my previous articles or my biography knows that I despise all forms of socialism, and as a rule I don't put trust in a government's ability to accomplish anything productive.

But the scary part now is that I am starting to believe the recent actions taken by the Federal Reserve in the United States are starting to resemble a very unique form of socialism that could be defined as simply dangerous or even borderline reckless. This does not bode well for the long-term health of our economy.

Excessive government interventions such as aggressive, unnecessary interest-rate cuts, unnecessary bailouts of private companies and implicit government guarantees for the riskiest players in the economy (investment banks) are outrageous and will not go unpunished in the long run.

It is also becoming clear to me that the widespread belief in the Federal Reserve's powers to magically guide the economy out of recessions is quickly starting to undermine the fundamental basis of our market-based capitalism. In a true capitalist society, market participants should be expected to receive a return on their capital that is directly related to the level of risk they are willing to take. And excessive risk has to be punished by failure; otherwise, the whole system fundamentally breaks down -- period.

Negative returns for most

I don't know how anyone could say that this is still the case. With short-term risk-free Fed interest rates of 2%, firmly below the inflation level of roughly 4%, most of the nation's worker-bee savers are being severely punished by negative returns on their hard-earned money. This Fed-induced redistribution of real wealth from retirees living on fixed incomes and low- to middle-income workers, who keep most of their savings in money market and other low-yield investments, to debt-hungry spenders of all income levels is not only unfair but also dangerous.

Why in the world would anyone save money and earn a negative real-interest rate, when it is easier and more pleasant to simply borrow all you can and then enjoy a lifestyle you never really deserved?

Why would you try to earn a "normal" return on your money in the stock/bond market, if you could add a 20/1 leverage, put only a modest amount of your own equity at risk and go for an all-or-nothing bet?

With this kind of leverage you can make 20 bets using the same amount of equity, and if one or two deals blow up, you are still guaranteed to make enough money to buy a new house in Greenwich, Conn., every few years or so. The only market participants who suffer in this case are once again the "sucker" savers. What a joke.

Wall Street's entitlement mentality

For the first time in my life, despite being a ruthless capitalist, I feel that some of the "blame Wall Street" whining in the media is justified. In a country that prides itself on being the mother of true capitalism, the always-low-rates-entitlement mentality of the financial-services industry is quickly becoming an incurable disease. I am not sure how we ended up here in the first place, and who exactly is to blame for this nonsense, but this dangerous game of musical chairs is starting to look awfully scary.

Banks and financial institutions that just yesterday were screaming that they were duped into lending at outrageously low interest rates are now once again willingly lending to many of the same players -- at rates that not only don't compensate them for taking on the actual risk but in many cases are below the inflation rate. Yes, you heard me correctly: The banks are that dumb.

Continued: Another credit crisis on the horizon?

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