Personal Finance Blog by Debit versus Credit

Why Another Rate Cut Could Do More Harm Than Good

November 17, 2008 | Filed in: Economy | 1 comment

If you like this post then please consider subscribing to my RSS feed. You can also Subscribe to Debit versus Credit by Email and have new posts sent directly to your inbox.

It’s clear that the root cause of the financial difficulties that we’re facing in the United States is not related to credit being too expensive. It’s quite the opposite in fact - credit is cheap right now but many banks are actually cutting back on lending. So what gives? Why are we sliding into a recession when the Fed has done just about everything that they could to avoid the “r” word?

To be honest with you I don’t truthfully understand everything that’s gone wrong to put our nation and the world in the situation that it’s in. It’s been a long and a drawn out process that some say has been 25 years in the making. Therefore it’d be near impossible for me to cover such a heavy topic on a blog.

Another Rate Cut May Be Near

Something did catch my eye while I was skimming the financial headlines that’s basically directly related to this current crisis and I want to talk about what I read and what I think about it. The Federal Reserve of the United States recently alluded to the fact that they may be making another rate cut in December.

What?

Didn’t we already establish that credit is not expensive? If you remember the last time the Fed cut rates to where they are at now I complained about the rate cut. I was a little annoyed, but to be honest now I’m upset. I think the central bank has forgotten some important details about the current crisis. They’ve forgotten that the American consumer has a great deal of influence in the state of the economy.

Let’s talk about this. I want to hear your opinions and I want your feedback, but more importantly I want to tell you why I think that another rate cut would be foolishness of foolishness.

Why Another Rate Cut Won’t Do Any Good

Another rate cut truly won’t have any affect on how willing financial instituations are going to be to lend money to one another. They aren’t likely to lower consumer loan rates. They will however have a near-immediate impact on consumer savings rates. You think your savings and cd rates suck now? Another rate cut will drop those even more.

It seems to me that these cuts are being made on a purely psychological basis. Almost as if they’re saying that they’re willing to do anything to get the economy back on track. That’s great and all, but is this really going to excite the average consumer? Are they going to see another rate cut and sigh a sigh of relief thinking that their money is going to be safe and we won’t go into a deep, dark recession? Not likely.

Uncertainty Leads to a Recession

The cause of just about any recession goes far beyond actual slowdowns in lending and consumer purchasing. It’s almost always intensified by uncertainty.

People are afraid right now. Truly afraid. If that’s the case then does it seem best to drop rates? I’m actually of the opinion that leaving rates the same could be more beneficial than a rate cut.

The news reports rate cuts nowadays as if they are some sort of super relief element used by the Fed to stop a recession dead in its tracks. Therefore the consumer thinks that a recession is a likely scenario. They stop spending and they start worrying. Suddenly we’re facing a recession. Why? Self fulfilling prophecy.

My Hypothesis on the New Psychology of Rate Cuts

I’m proposing then that a rate cut is more devastating (psychologically) to the average consumer in times of financial crisis than it would be to leave rates the same. By cutting rates the Fed is signaling that they’re afraid and they don’t know what’s going to happen. Let’s leave rates alone for once and see what happens.

You never know.

Tags: Economy, Federal Reserve, Rate Cut, recession, saving

The Bailout of Fannie and Freddie: Redux

October 2, 2008 | Filed in: Miscellaneous | 5 comments

You may remember the post I published a month ago which was about the government bailout of Fannie Mae and Freddie Mac and what it might mean to us as the American people.  I haven’t made it a habit to revisit old posts often because a large amount of my content is focused more on timeless financial advice.  However while I was reading back through some of my old content today this post caught my eye and I thought it might be fun to revisit it, especially on a day where our government may pass an extraordinarily large bailout package to prop up the U.S. financial system.

Expect To Pay More In Taxes

The first point that I made was in reference to the sheer size of Fannie Mae and Freddie Mac and how taxpayers are likely to be ultimately responsible for any losses taken on by our government with the privatization of these two mortgage giants!  Here’s what I said in early September:

Fannie Mae and Freddie Mac are HUGE companies. They alone service over half of the mortgages in the U.S. They have trillions of dollars worth of liabilities as well. In fact according to the former president of the Federal Reserve Bank of St. Louis, William Poole, they have up to $6 trillion dollars in liabilities (as reported by the Wall Street Journal Online). He believes that it would not be unreasonable to assume that they may end up taking a loss on as much as 5% of their loan portfolio which would provide taxpayers a burden of some $300 billion dollars.

Unfortunately it’s much too soon to make any educated assumptions about how well I did (or rather Mr. Poole did) on this prediction.  I’m going to stand by Mr. Poole and agree with him that Fannie and Freddie are likely to end up taking a loss of at least 5% on their current loan portfolio.  The problems in the housing market haven’t hit rock bottom yet and this will lead to an increased number of foreclosures and, therefore, bad loans.

Mortgage Rates May Finally Drop

The second point I made was in reference to mortgage rates at the time and the likelihood that they were going to drop.  Here’s what I said last month:

The rising level of defaults on mortgages over the past year or two has forced Fannie and Freddie to get more defensive and stop buying up so many mortgages. This has led to an increased risk for mortgage originators, as they might not be able to sell off their risky loans. It has also decreased the amount of cash flowing through the mortgage market and as such has had a strong effect on mortgage rates. Because of the increased risk and the limited capital mortgage lenders have been forced to raise mortgage rates and keep them high. Now that the U.S. has virtually guaranteed the success and liquidity of Fannie and Freddie mortgage originators are likely to have a less difficult time securing cash and selling off their loans. This should lead to a drop in mortgage rates over the next six months or so.

Six months may have been too conservative an estimate.  Mortgage rates actually dropped almost overnight, by about half a percent.  They’re still hovering around six percent (which is what they dropped to after the Fannie and Freddie takeover) and are likely to stay there for a while longer.

Start Investing Now If You Haven’t Already

We’re really starting to get to the meat of this stuff now.  It’s interesting how right after this bailout investors were sure that things were finally starting to get better.  Check out what I had to say then, paying special attention to the bold text:

The markets rebounded on Monday with the Dow Jones Industrial Average ending up almost 300 points (or 2.59%). Investors are excited about the future now that they don’t have to worry about Fannie and Freddie. If the Treasury Department and Paulson are right (and I personally doubt they are) then this bailout should fix everything. After all the housing market is the primary cause of the “recession” that we are currently facing. By shoring up the two largest mortgage companies and providing much-needed capital to the mortgage industry they’re hoping to end this downturn once and for all. Things aren’t quite that black and white however but we’ll come back to that in the next section. In the meantime for the purposes of investing they (the feds) may be right about one thing. By taking over Fannie and Freddie they should increase investor confidence and lower mortgage rates. This should have the effect of a declining bear market if not the return to a bull market.

The heading to this point was the same as the heading above… a recommendation to begin investing.  Considering that it’s nearly impossible to time the markets right, I’m fairly confident that if someone had taken $1,000 dollars and put it into an index fund it would be a great time to start investing.  Sure we’ve had some ups and downs over the past month but overall the markets have been trading mostly sideways since then.  Truthfully in my opinion no time is better than the present to begin investing.  If you haven’t done so yet, then why not start now?

I want to concentrate on the bold point in the quoted paragraph above.  As you can see I predicted that the bailout of Fannie and Freddie would NOT fix the markets like Paulson and the Treasury were predicting.  In fact they were far from right on this point, as if any of us need to be reminded that the government is most likely going to be investing around $700 billion dollars in the financial system over the next several weeks.  I said it here first folks, the Fannie and Freddie takeover would not fix our problems - ready for another one?  Neither will this $700 billion bailout.  It’ll help, there’s no denying that - at least not in the short term.  However it’s not going to fix things overnight, or even over the course of several months.  We still have an underlying problem that is directly related to an OVERSUPPLY of housing in the U.S.  There just aren’t enough potential homeowners to fill all of the houses.

The Financial System Is Nowhere Near A Full Recovery

It’s important to remember that this financial turmoil that our economy is facing was not created overnight and it won’t be fixed overnight either, no matter how hard Bernanke, Paulson and Washington try.

It is true that the primary cause of the economic turmoil that the U.S. is currently facing is due to the uncertainty in the mortgage markets. It’s also true that the decreased cash flowing into these markets due to Fannie and Freddie’s cutbacks was having a negative affect on the entire market. However one would have to be naive to assume that by taking over Fannie and Freddie and providing capital to the mortgage markets that this mess will clean up quickly. The fact is that homeowners are not walking away from their houses because their mortgage lender was unable to sell their mortgage to Fannie - they are walking away because they are upside down on their houses they are unable to afford the payments. Losses will continue to come. The process may be slowed down and stopped sooner than it might have without this bailout (due to the increased affordability of purchasing a home) but unfortunately home values have not reached their lows, as most would-be homeowners are not ready to jump into the market even with today’s home prices!

The fact is that homes are STILL unaffordable in many markets across the U.S. Homeowners are losing money and are bailing ship which is slowly decreasing home prices but we still have quite a ways to go before the buyers start to line up. Bailout out Fannie and Freddie may help some, but as I stated already, the financial system is nowhere near a full recovery.

The point is that we’ve got to be patient and focus on the future and not so much the present.  Things will get better - they always do - but in the meantime it’d be smart of us to take advantage the great investing opportunities that this bear market is providing.  But be smart and don’t rush into anything without some good research.  Good luck out there!

Tags: Bailout Nation, Economy, Fannie Mae, Freddie Mac, Investing Tips, Rants

The Economy’s In Shambles, So What Do You Want To Know?

September 29, 2008 | Filed in: Personal Finance | No comment

There’s been a lot of crazy stuff going on out in the world lately.  We’re facing wars and economic issues and even weather phenomena.  Sometimes it’s hard to focus on what’s important when you are bombarded with different forces in every waking aspect of life.  It may be difficult to concentrate on your financial situation and your future with so much going on in the present, but it’s important now more than ever to make sure that your house is in order, so to speak.

With that being said, today is my wife’s birthday so I’ll be taking the day off in order to treat her to her every desire.  I’d like to make productive use of the time that I’m away from my computer, so I thought it might be a good idea to have a question and answer session.  You ask the questions - anything related to finance, investing, business, the economy, etc - and I will supply the answers.  And if I don’t know the answer right away I will try to research it and find it.  So hit me with your best shot.  I’m looking forward to answering your questions, whatever they may be.

Tags: Economy, Investing, Personal Finance, your personal finance questions

« Previous page 1 2 3 4 Next Page »