Saturday, December 1, 2007

No lower, please!

On why lowering the interest rate is probably the worst thing that the Fed can do right now

As I can see it, if the Fed does what Wall Street is asking for it to do, there will be (at least) four major effects, half of which are "good" (depending on who you are...).

1. The trade gap will shrink from a record negative $764 billion last year. This is good for local manufacturers as that means we will sell more stuff and bring more money back here. However, some of the other effects act as a (smaller) counter-weight to this, limiting its impact somewhat.

2. Mortgage brokers and other lenders will see profits increase. This is largely because they can acquire lower risk borrowers with lower interest rates. They will also see profits rise on their currently held fixed rate mortgages. This is the primary reason the Fed would be willing to lower rates.

3. Now we start on the bad effects. First is inflation. Over the past couple months, the dollar has dropped significantly against the Euro and the British Pound (along with most other foreign currencies). This helps the trade gap, like I mentioned above, but it really hurts the consumer. I predict, especially if the Fed does a half point rate cut, that we will see oil prices over $100 within a week. Oil isn't over $90 a barrel just for giggles. It too has gone up in price with every rate cut. That will be the first one you see, but food and other imports are going to jump a bit too. Those have two things going against them, the spike in oil prices and the drop in the dollar value. Oh, and that inflation rate that is reported on monthly doesn't really reflect the inflation working class people face. Just anecdotally, my health insurance costs have gone up about 10% annually, what had been my rent (we got a house last year) had been going up 6%, gas is up, right now, 50% and like I said a moment ago, I don't expect it to come down any time soon. Heating and energy costs are up between 10 and 25% or worse from what I have been hearing. And food, or what I have been paying close attention to at least, is up about 6% too. These are the things working class people spend 70% or more of their paychecks on (most of the rest going to debts...).

4. It won't help fix the one thing that is causing the credit crunch, it will only hide it. This rate drop will not help fix the housing market in the least. Mortgage lenders are still going to be less willing to offer loans without a significant down payment. The group that was supporting the housing boom - college graduates and other first time home buyers - will still be unable to afford a mortgage. The other group supporting the housing market, speculators (i.e. flippers), will continue to lose their target customers and so fewer of them will be buying more houses. Add to this stagnant pool the expected record number of foreclosures expected in the coming months and you will see a continued drop in home prices, which will just add fuel to this fire...

At best I expect any interest rate cut to be a bandaid covering an infected cut. I just hope that the infection is taken care of before we have to cut the whole limb...

So please Federal Reserve, stop listening to crazy investors who can't see financial issues outside of Wall Street and start looking at the bigger picture. Don't lower interest rates; find ways to fix the real problem.

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