Personal Finance Blog by Debit versus Credit

Fed Cuts Rates to 1%

October 30, 2008 | Filed in: Economy | 3 comments

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Many of you may have heard by now that the Federal Reserve cut their key fed-funds rate to 1%, bringing it in line with the lowest level that it’s ever been at. Interestingly enough the last time that the rate was at 1% was within this decade - from June of 2003 until June of 2004. Even more interesting is that many people and economists have laid partial blame for the housing crisis on this low rate, essentially saying that the fed made money too cheap and caused people to be greedy and take unnecessary risks. If all of this is the case, then what of this time? Will having such a low rate now cause unexpected hardships in the near future? Besides that what does it mean for me and you now that the fed funds rate is at 1%?

Let’s look at the facts…

First of all a description of what the fed funds rate is, from CNN Money.

The fed funds rate is used to set rates for a wide variety of consumer loans, including home equity lines and credit cards, as well as for many business loans.

You’ve likely heard of the prime rate.  The prime rate changes in line with the fed funds rate.  It is almost always 3% higher than the fed funds rate, which would put the prime rate at 4% sometime in the near future.  Almost all of the banking products that you use are based on the prime rate.  Both deposit accounts and loans change along with a change in the fed funds rate (and therefore the prime rate).  You can expect savings rates of all flavors (cd’s, money markets, savings) to drop and on the flipside you’ll likely see some loan rates to drop as well.

Keeping all of that in mind let’s take a look at what the lower fed funds rate is likely to do for the economy.  There are two options.  It will do nothing, as in not help at all, or it will hurt the economy.  There is no other option.  It most definitely will not help matters at all.  Why?

The problem with the current credit crisis is not that loans are expensive.  They’re actually pretty inexpensive.  At the credit union I work at an auto loan starts at about 5.5% and if you look at bankrate.com the national average for an auto loan is about 6.5%.  No, loans are not expensive, banks are just unwilling to lend, especially to each other.  They are afraid that if they lend out too much of their cash that they could end up in an illiquid situation and go bankrupt just like Lehman Brothers, WaMu or any of the other failures we’ve had as a result of this crisis.

One economist said it best, as quoted again from CNN Money.

“The latest Fed move is not going to hasten the economic recovery by a single day or accelerate the cleansing of bank balance sheets,” said Bernard Baumohl, executive director of The Economic Outlook Group. “What is needed more than anything else at this stage is simply patience.”

Be Patient Mr. Bernanke, Be Patient World.

This thing is not going to fix overnight.  There is no easy fix.  The fed funds rate at 1% won’t do a single thing to fix it.  So why lower it?  It’s probably purely psychological, and at this point it shouldn’t do much harm but I’m afraid the problem is that they won’t raise rates until the crisis cleans out completely, at which point it may be too late.  By then there may have begun another lending bubble.  Let’s hope Bernanke is smart enough not to let it come to that.

In the meantime let’s all practice a little patience, shall we?  It is after all a virtue, and shouldn’t we all strive to be virtuous?  If we were you can bet we wouldn’t be in the mess we’re in right now.

Tags: Credit Crisis, Federal Funds Rate, Federal Reserve, Prime Rate

Finally! No New Rate Cut!

June 25, 2008 | Filed in: Personal Finance | No comment

Ben Bernanke and the Fed decided today to leave their federal funds rate at its current level of 2%.  They’re finally starting to worry about inflation and seem to think that there is much more upside risk (by inflation of course) than downside risk (recession and a slowing economy) at this point.  I’m inclined to agree with good old Bernanke on this one.  Although I’ve been thinking that this was the case over the past several rate cuts that the Federal Reserve has made.

The question that I’m asking at this point however is: is it too little and too late?  I’ll admit that the financial markets have been arduous lately.  I know this more than a lot of people, because I work at a credit union in Phoenix, AZ.  I’ve seen the massive slowdowns and read about the increasing loan delinquencies and writedowns that are taking place.  This with a relatively small (relatively speaking) and very conservative credit union with around $3 billion in assets.  Things must really be difficult for a lot of the larger financial institutions.  It’s obvious they are actually from the constant news of new write-downs.  This so-called recession has even taken from us one of the largest investing companies in the U.S., Bear Stearns.  Things are definitely crazy, but have these huge rate cuts been helping?  Or have they actually been hindering the recovery process?

These Things Take Time

Anyone who’s studied even the most basic of economics knows that market changes don’t happen overnight.  They also don’t happen in a week, or even a month.  Large changes in the financial markets can take months and even years to happen.  Keeping this in mind, one would ask why the Fed cut rates twice to a total of 1.25% percent over a matter of about a week and a half not too long ago?  These things take time, right?  So why so much over such a short amount of time?  I understand their reasoning.  They were hoping to restore confidence to the financial markets… specifically the stock markets.  Something that’s not exactly in their job description.  However I won’t go into that as it’s a completely new topic.  My point in bringing this up is that I’m actually fairly convinced that these large and frequent cuts have done much more harm than good.  All opinions are welcome on the matter, and keep in mind that I am no economist and this is only my opinion.

Have you seen the price of oil lately?  Or the consumer confidence index?  They’re at an all time high and low, respectively speaking.  Obviously there are many factors going into these things, but it’d be foolish to assume or to say that these fed rate cuts have nothing to do with it.  I’m of the opinion that because of the .75% emergency rate cut that the Fed made back in January, followed by the .50% percent cut a week later that consumer confidence was actually hurt.  As a generally uneducated crowd when it comes to finance and the ways of the financial markets we sort of come to expect what’s normal.  What’s normal to us are small and steady rate changes.  .25% here and there up or down are pretty normal in our eyes.  Naturally when we see a much larger change that was initiated by an emergency Fed session we’re going to think something bad is going on.  Self-fulfilling prophesy is a relatively common term that floats around in economics.  In the case of these ridiculously large cuts by Bernanke and company this term might be applied.  As consumers we noticed large emergency cuts and naturally starting to believe that things were much worse than we had previously thought.  Naturally this caused us to become skeptical of the whole situation and we began being more careful with our money.  Self fulfilling prophecy?  I do believe so.

What I’d Like to See

I’d love to see a rate increase in the next few months.  Inflation is going to be a huge problem if the Fed doesn’t do something to try and combat it.  Keeping rates steady will hopefully stop any more increases in the level of inflation, but it’s not going to cut it down.  Not at all.  

Tags: Federal Funds Rate, Federal Reserve, Rants, rate cuts