The Walrus.biz

Fed cuts interest rates: now what?

The market opened today with an unexpected announcement from the Federal Reserve: a reduction of its federal funds rate to 3.5 percent from 4.25 percent. That amounts to the steepest decrease since 1984. Most major banks reduced their prime lending rates by the same amount shortly after.

Who will this affect, and how?

The picture I link to below, courtesy of the Wall Street Journal, illustrates how each party is effected. It mentions an earlier rate cut but all of the factors remain the same:

Click to see an enlarged picture

Now, here is where I decide to rant for a bit.

Part of the reason we are entering troubled economic waters is the availability of money in the last 6 years. The mortgage industry issued money to whomever it deemed worthy without doing better checks into whether or not they could get repaid. They did this because much of the money being issued was now being raised through mortgage bonds instead of their own cash reserves. They weren’t risking their own money so it was more advantageous. Historic low interest rates meant homeowners could cash out enormous amounts of home equity to pay for goods and services. That helped our consumer economy stay strong while the underlying fundamentals in the economy were adequate at best. When the mortgage well ran dry and consumers were tapped out of disposable income to help fuel the economy, stock markets began to shake. In the last few weeks, they rattled. And around the world in the last few days, they dropped. The move by the federal reserve is an attempt to lower borrowing rates by banks, which theoretically pass the savings onto consumers, and thus allow people access to “cheaper” borrowing. The idea is that the more Americans can borrow, the more they will spend. That’s the exact reason we got into this mess to begin with. Most Americans now have a negative savings rate. That’s correct, we borrow more than we save! Our indebtedness to banks and credit card companies can only fuel the economy so long before massive waves of bankruptcies and foreclosures halt the unparalleled economic growth we have seen in this country over the last 50 years.

While it’s not doomsday, we have serious problems and too many wrong answers.