Everything You Need to Know About the Fed's Rate Cuts

by: Markham Lee October 31, 2008    
Markham Lee

Markham Lee

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The graphic below contains all you need to know about the Fed's rate cuts over the past year:

 

Graphic Courtesy of the WSJ

Notice how the Fed's rate cuts have had little effect on mortgage rates and corporate bonds rates? Thus lending credence to my theory from last year (after the first rate cut) that the rate cuts would have little impact on the credit crunch since it was a function of loan losses, bad risk management, investors losing money, derivatives abuse, etc, as opposed to being a function of high interest rates.T

Taking it a bit further: you can cut interest rates to zero and it won't change the reality of overleveraged and undercapitalized banks that are facing escalating loan losses, or a nation full of borrowers that are either overleveraged (in general) and/or struggling with mortgages they can't afford.

Not to mention the fact that it's illogical to think that you can solve a problem that was partially caused by low interest rates with low interest rates.

Now I suppose you could interpret this to mean that things would be markedly worse without the Fed's rate cuts. You could also say that the Fed simply misinterpreted the impact of their rate cuts on the credit crunch; after all weren't the rate cuts supposed to make mortgage rates fall, give relief to ARM borrowers, etc?

Either way the Federal Reserve and Wall St. have both become over dependent on rate cuts as a way to generate growth, and now with interest rates at 1.0% maybe both parties will begin to focus on the economy's actual problems instead of hoping rate cuts will magically fix things. 

Of course we have a nation of analysts, pundits, politicians and policy makers who can't seem to tell the difference between a root cause problem and a symptom, so perhaps I'm being too optimistic.

You can read more here.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

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This article has 3 comments:

  •  
    Oct 31 10:44 AM
    Hi Markham, mortgage rates are usually (I say usually as in this marketplace - other factors are involved) a reflection of the Bond Market...not the Fed Rate...they work inversley...the Fed Rate cuts will reflect in Equity Lines etc...mortgage world is Bond market...mortgage backed securities...which are not exactly having people line up to get...

    Can you help me understand - the chart and how it reflects to mortgage rates?

    Thank you :)
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  •  
    Oct 31 11:01 AM
    This cut brings my equity line down to 4.5%...since this is my only debt,it helps me....used it to update my 40yr old house,now I wonder if it was the right decision..
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  •  
    Oct 31 11:50 AM
    The reason mortgage rates have increased is due to the increase in interest rate volatility. A mortgage is not just a bond but a option as well. Volatility increases the value to the borrower and decreases value to the investor. Interest rates fall, borrowers refinance into a lower rate mortgage and pay off the outstanding balance. This prepayment risk reduces value of mortgage securities, thus higher interest rate is needed to offset the risk that the "option" will move in the money and the borrow will exercise it.
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