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Fed rate cut a case of good news/bad news
By Shelia Watson
Contributing Writer
The half-point cut in interest rates by the Federal Reserve on Sept. 18, the first rate cut since 2003, is a good news/bad news scenario, said Tim Koch, a finance professor and chairman of the department of banking, finance, insurance and real estate at the University of South Carolina.
“If you’re a borrower and have a loan priced off the prime rate, it’ll go down, and that’s inherently good,” he said. “If you’re a saver and pulled some of your assets and CDs, then with the rates going down, you’ll be worse off. So the borrowers benefit and the savers lose.”
Koch, who holds the Moore School’s South Carolina Bankers Association Chair of Banking and who has written two textbooks on banking, said the larger concern is what the rate cut portends for the overall economy.
“In terms of policy rationale, it’s a little worrisome, because the Fed wouldn’t have done this unless (Ben) Bernanke and his group believed we were in real trouble and probably getting ready to fall into recession,” Koch said. “They’re trying to pre-empt it by delaying or mitigating the slowdown.”
Nevertheless, the news was greeted with joy on Wall Street, where there was a 3.5% surge in the S&P 500 stock index, a jump of 336 points for the Dow Jones Industrial Average and a 70-point increase for NASDAQ in the first four hours after the announcement.
Koch said the reduction in interest rates will benefit housing overall, although the effect will take place over a long period of time and is not likely to be the boost that is hoped for.
“Here’s a different take on this situation: Basically, Bernanke and his group have bailed out the risk-takers,” said Koch. “So if you’re a private equity company, a hedge fund or a speculator, you win. Bernanke has made it so you can escape with minimum loss. All those whose lives are tied to speculation, they’re loving this because they’re winning. But ultimately this will produce higher inflation down the line.
“The problem is that if you bail out the risk-takers, you lose discipline in the market and you encourage risk. Now, Bernanke knows this. So that tells me that he and his group must have believed that the risks to the economy dominated or swamped any concerns over giving in to risk-takers.”
Bernanke did, in fact, have such concerns. On Sept. 20, two days after the rate cut, in testimony before the U.S. House of Representatives Financial Services Committee, he said global financial losses from the credit crisis had “far exceeded even the most pessimistic estimates of the credit losses on these loans.”
At the same hearing, U.S. Treasury Secretary Henry Paulson said the administration would consider allowing the large mortgage companies Fannie Mae and Freddie Mac to temporarily buy, bundle and sell as securities “jumbo loans,” or those that exceed $417,000, in order to infuse liquidity into the overburdened mortgage market.
Bernanke’s explanation and Paulson’s suggestion come on the heels of a move by the House to take the mortgage crisis in hand. The House passed H.R. 1852, an updating of the National Housing Act that would enable the Federal Housing Administration “to use risk-based pricing to reach underserved borrowers.” The bill, which would expand federal backing of mortgages to help homeowners struggling to avoid foreclosure, passed the House 348-72.
A similar measure is being considered in the Senate, which, the week before, passed spending legislation that included $200 million in aid for groups that offer counseling and information to help homeowners with high-pried mortgages avoid foreclosure.
The number of foreclosure filings was twice as high in August as it was at the same time last year and jumped 36% from July, a trend that signifies the inability of many homeowners to make timely payments on their mortgages or to sell their homes in the midst of a national housing slump. California-based RealtyTrac Inc., which tracks data in the real estate industry, counted 243,947 foreclosure filings in August, compared to 113,300 in August 2006. July foreclosures totaled 179,599.
Many of the loans held on the foreclosed homes were adjustable-rate mortgages issued in 2005 and 2006 during the height of the housing boom.
“In South Carolina, businesses and individuals tend to be a little more conservative, so any impact will be less pronounced here,” Koch said. “But we still have a lot of speculative investment. For instance, with coastal development, instead of a severe downturn, it will slow down less quickly, but the rate cut won’t save it in any classic sense.”
Koch predicted that the housing situation will continue to slow for a while.
“But that’s not a bad thing,” he said. “It’ll get rid of excess inventory, and lenders will be less willing to advance credit today unless the borrowers are strong, but again, that’s not necessarily a bad thing.”
Koch pointed to a “big-picture view.”
“Countrywide (Home Loans) is a huge mortgage company, and it used to make one in five mortgages that are known as ‘exotic contracts,’ things like adjustable-rate mortgages and interest-only loans,” he said. “A lot of lenders did not do their due diligence as lenders, so a lot of people have been buying more home than they can afford.
“Wall Street calls these ‘Ninja loans,’ meaning you can have ‘no income, no job, no assets,’ and it’s no problem; you can still qualify. But that’s just feeding the addiction. And everybody’s guilty here. The question is who’ll benefit now if they lower rates and the lenders don’t learn the lessons?”
Koch noted that with the rate cut, some people will be able to afford their homes when they couldn’t otherwise.
“And of course, it’s a good thing for them,” he said. “But this is obviously not a win-win at all.”
The real question, he said, is where things will go from here.
“We’ll keep tracking, but when we look at employment and housing and things like that, it’s a long lag,” he said. “If we get into worse inflation, we’ll really be in a box.
“You know, some people are calling Bernanke ‘Helicopter Ben,’ because they see him flying around dropping money on those with problems,” he said. “That description is pretty good. As for as whether this is the best thing for the economy, time will tell. For now, this we know: Inflation will go up, so we’re probably just borrowing against our future.”
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