Thursday, November 01, 2007

Fed up with the Fed
The Federal Reserve May Be Hurting Us More Than They Think

Yesterday--Halloween--the Federal Reserve Board of Governors decided to lower the prime rate by an additional 1/4 point--bringing the total reductions to 3/4 point in merely six weeks time. This is a pretty dramatic and scary action in the realms of monetary management. Similar reductions have occurred in the Fed Discount Rate and the Fed governors have also seen fit to pump literally hundreds of billions of dollars into the money supply over the last few months. All the while, bankers, hedge fund managers, and traders clamor for more.

All of this gives Huckleberry some pause... and a little additional clarity is, I believe, in order (see previous post).

The Fed is not being encouraged to lower interest rates because they are too high. Rather, rates are being lowered because the spread between the cost of funds paid by financial institutions and the interest rates that they are charging their customers is too small.

This applies to Subprime Mortgages, Credit Cards, and all riskier loans. The subprime mess--arguably at the root of all this consternation--has been caused by banks, brokers, and hedge funds not charging enough to cover the amount of risk already incumbent upon the borrowers that they have courted--proving once again that denial of risk does not mitigate it. Since (in most cases) contracts prevent the unilateral and/or unscheduled raising of interest rates, the only way the Fed can bail out these select financial institutions and companies is by lowering the cost of funds to provide some room for them to absorb the losses that should have reasonably been expected in the first place. The Fed is the only available source for this bailout because those loans--once touted as the belle of the ball--now have their blemishes on full display and the private equity markets no longer think that they are very pretty at all. Again, this should have been fully expected with a little math and due diligence evidently missing from their efforts to date.

Credit cards are in the same boat, but are even riskier. As the economy worsens/slows credit cards are usually the first to feel the default pinch. Prime credit cards are likely to remain in the same interest rate range and the lower credit (riskier) credit cards are likely to push up a bit to protect the banks from losses (the only thing worse than less profit at a bank are more losses).

But Won't My Payments Go Down Now That Rates Are Lower?
Not likely. This current round of rate cuts is designed to protect financial institutions--not consumers--and therefore consumers should not anticipate interest rate relief will be felt in their monthly loan payments. In fact, consumers will likely suffer higher costs overall as the dollar concurrently weakens and inflation bares its teeth. Statistically the argument can be made that mortgage and credit card payments were not high enough to cover the inherent risks. The current reductions show every indication (to this author) of being earmarked to stem the flow of blood on Wall Street.

This little insidious protection racket shifts the costs back onto the consumer-at-large in the form of lost buying power (inflation) and economic turmoil. The prevailing thought seems to be that it is better to squeeze a few drops of blood from each of us rather than take the heads (and robust profits) from the subset of us who wear pin-striped three-piece suits. The Fed obviously believes that they are choosing the lesser of two evils. I think that they are incorrect and that a greater evil is being done on many fronts.

Certainly more to come....

Be well,

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