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Did the Fed get it right ?
September 19, 2007 | posted by: Andrew C Maleski

As you have probably heard on September 18, the Federal Reserve cut the federal funds rate (the rate banks charge to loan funds to one another overnight) from 5.25% to 4.75%. This rate is tied up closely to the prime rate (the rate the banks charge their best customers). Following the Fed's move the banks cut the prime lending rate from 8.25% to 7.75%. Mortgages, home-equity lines of credit, credit card rates, certificates of deposits all can be affected by changes in short-term interest rates.

Are these changes are going to save the sagging housing market? I seriously doubt. They may bring some temporary relief to borrowers anticipating rising payments on their adjustable-rate mortgages, but they will not change the general trend of aversion to risk in the banking system. We know that many lenders made bad loans. However nobody knows what is the loss exposure of the institutions (hedge funds, pension funds, investment banks) holding trillions of dollars of mortgage backed securities. The underlying assets (non-performing or soon to be) will cause some more panic in the stock market in the near future.

The interest rate cut may make the lending environment more borrowers friendly, but the tougher qualifying criteria for new mortgages instituted recently by many lenders will stay with us. Therefore, forget about easy and super cheap money for real estate in the near future. Lenders know that many marginal borrowers overextended themselves in the past. Too much speculation drove real estate prices high that they became out of reach for many even well to do buyers.

Prices of assets in the U.S and around the globe have risen much faster than wages and rents. These bubbles fueled by cheap and easy money can not be sustained even with the recent interest rate cut.

The lower interest rate will not help much to those who are facing foreclosures or lay-offs. Additional FHA (Federal Housing Administration) guaranties proposed by Congress and offered to borrowers in trouble are too little and too late. The foreclosure tsunami may temporarily slow down, but it is still imminent in those mostly inflated areas including our sunny Southern California.

Sellers may be getting a false impression of dramatic improvement in the marketplace but buyers are already in different state of mind. They are saying: we intend to vote with our wallets and until the prices come down further our wallets are going remain closed.
As the result the volume of real estate sales will remain low in the foreseeable future which will cause even more foreclosures.

Did the Fed get it right? The bubble is still deflating but the pace might be slower, giving some people impression of false security. This patient is still sick and the recent medicine may only bring him some temporarily relief.

Copyright Andrew C Maleski 2007. All rights reserved.

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