Fed Rate Cut Will Not Solve Problems in Housing
Sep 19, 2007 -- In a panic-induced move, the Fed made the decision yesterday to cut the target for the fed funds rate by 50 basis points. The action was meant to forestall the adverse effects of the current credit crunch and housing downturn, but will in fact do very little to save housing.
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Fed's Target Rate: 4.75 Percent
After keeping rates steady since June of 2006, the Fed made the aggressive (and downright silly) decision to slash the 5.25 percent fed funds rate by 50 basis points.
Prime Lending Rate: 7.75 Percent
In response to the Fed rate cut, many major banks dropped the prime rate from 8.25 to 7.75 percent on certain consumer loans and home equity lines of credit (HELOCs).
New Mortgage Rate: ???
Who knows? The Fed's key rate is merely a short-term target rate. Just because policymakers cut this rate, it doesn't mean lenders will follow suit and lower mortgage rates on 30-year fixed rate mortgage loans. Last week, the average mortgage rate was 6.31 percent. What it will be next week is anyone's guess.
Winners: Banks, Real Estate Agents, and Builders
Let's assess the true beneficiary of this rate cut: Wall Street and the financial institutions that bet the house on subprime/ARM loans.
Wall Street has been rallying around a fed cut for awhile now. When the Fed's move was announced yesterday, the Dow Jones industrial average soared, posting the biggest one day point gain in over four years.
'It was everything the market had been begging for for weeks -- and more,' said Richard A. Weiss, chief investment officer at City National Bank in Los Angeles.
Investors and banks are certainly in a begging position at this point. Surging defaults have shaken the security of everyone who has a stake in the subprime market. Investors and banks alike have been backing off.
In a statement, the Fed admitted the cut was intended to get lenders to ease the credit-freeze and begin lending again, as tight restrictions have 'the potential to intensify the housing correction and to restrain economic growth more generally'.
But banks and investors weren't the only ones rejoicing at the news yesterday. Agents and builders were also buoyed. Lower rates mean the possibility of more buyers. In an interview with Bloomberg, the CEO of mega-giant homebuilder Toll Brothers joyfully proclaimed that 'Our boy has righted the ship'.
It is obvious why builders, agents, banks, and investors are happy right now with Fed chairman Ben Bernanke and his 'boy wonder' antics, but it is important to remember that not everyone is a winner when the Fed makes a rate cut.
Losers: Savers, Mortgage Borrowers, and the U.S. Dollar (In Other Words, Everyone Else)
Responsible savers will see a negative impact on interest earnings as a result of the Fed rate cut. Short-term CDs will no longer pay off like they once did.
A slashed rate could have a negative effect on borrowers from a long-term standpoint as well. Long-term mortgage rates (like those for 30-year fixed rate loans) are not set by the Fed, but rather the marketplace itself. When investors worry about inflation (which is what the Fed should be worrying about) long-term interest rates go up.
If investors are concerned the rate cut will increase inflation pressures in the near future (which they are) long-term interest rates could go up and put the housing market in an even worse bind.
There is also a chance that banks won't even pass the short-term savings on to borrowers. The rate cut gives banks the opportunity to play catch-up. Greedy lenders and other lenders who are trying to rebuild their financial standing will probably not be in a hurry to lower interest rates.
If there was a big loser in all of this though, it would have to be the U.S. dollar. The dollar fell to a record low against the euro, and tumbled in comparison to several other currencies when the Fed made the announcement.
In short, the Fed's decision was irresponsible. Bernanke has shown that he is no better than Greenspan. If our policymakers continue to follow this path, you can kiss the value of your hard-earned money goodbye.
(To see a brief summary of how the collapse of the dollar will affect the U.S. in coming years, check out our recent interview with DollarCollapse.com.)
