The Truth About Interest Rates

Most economists, like most Americans, have cheered the rate cuts as medicine that hopefully will work and a reaction that might not do much harm. Interest-rate cuts do have a dark side.

It’s generally assumed that all things being equal, lower short-term interest rates are better. But this view is simplistic and arguably wrong. Lower rates are a help to people with credit card and margin debt, as long as the savings are passed along and don’t end up in banker’s pockets to help fund their adventurous position. Thanks to Mr. Bernanke and a reasonably cooperative Congress, many people facing resets on adjustable-rate mortgages will see less severe rate hikes. Lower rates are not an blessing for everyone. People with money in the bank or investments in Treasury bills and other short-term securities will see incomes reduced. Retirees and others on fixed incomes, such as pensions, lose out every day.

In general, lower rates are a help to borrowers, but an affliction to lenders. When people “lend” money, they usually see this as an investment. The lower rates go, the more the financial system discourages hard-working Americans from investing and saving dollars, and the more Americans are rewarded for borrowing and living beyond their means.

When Americans are discouraged from saving, they have two alternatives. The first is to start spending. This is why lower rates lead to higher prices. You can think of each rate cut as sending an electrical jolt to every American: Live better! Spend more! If you max out your credit cards and your home-equity credit, who cares?

The other option is for people to convert their dollars to another currency. When the Fed cuts rates, it is also saying, “Dollars are a poor investment; try the euro on for size.”

The dollar has plunged to an all-time low against the euro and to the lowest level in years against the Japanese yen. Commodity producers around the world are boosting prices to compensate for what they perceive to be the dollar’s shrinking value. Prices are up. Value is down. Hyperinflation is in the mix.

Don’t Be Spooked, Don’t Give Up

Federal Reserve chairman, Ben Bernanke, urged banks to prevent deeper damage to the economy by continuing to raise capital despite losses from the credit crisis. “Firms are hunkering down,” he told a conference in Chicago. “They have at least partially replaced the losses with new capital raising, but not entirely. They are being rather conservative in making new loans, which has implications for the broader economy.”

Mr Bernanke and the US Treasury secretary, Henry Paulson, have repeatedly said firms should keep increasing their funds, seeking to alleviate the impact of the credit crunch.

Raising investment capital is the only real hope that bankers have. The measures produced by the Fed are temporary in nature to sustain the banking economy for the short-term. Some banks, like CitiBank are seeking to sell off assets to raise the needed capital.

Once again, let the buyer beware. Using a general aggregrate statement about investments/assets is not a safe business, even at fire sale prices should that happen. A qualified investor will need every shred of knowledge to make a reasonable choice. Bank marketing has proven deceptive. Since the market belongs to the buyers, finding good investments (once again by highly qualified knowledgeable investors) might not be as difficult as it would seem.

U.N. Says World Economy on Brink

The U.N. says the world economy is “teetering on the brink” of a severe downturn.

The U.N.’s mid-year economic projections blamed the downturn on further deterioration in the U.S. housing and financial sectors in the first quarter. The U.N. said the U.S. problems are expected to continue to be “a major drag for the world economy” into 2009.

Looking beyond the financial and housing market, you can find strength. Consumer staples and energy are economic hot spots right now. Whether these hot spots are really good for the economy or not, in times of prosperity and decline, investors can always find a way to make a buck.

The United Nations is really good at spending other peoples’ money. Naturally, they are very concerned during a global downturn because money is harder for them to get.

Home Today, Gone Tomorrow

Apparently Sheila Bair, noble FDIC chief, likes to engage in wishful thinking like the Federal Reserve. The difference is that Ms. Bair isn’t getting much respect or cooperation. Let’s face the facts: she doesn’t have much cash behind what she says.

She stressed the need for consumers to contact counseling groups and lenders to make an effort to prevent foreclosures. At a recent foreclosure prevention event she attended in California, Bair emphasized that policymakers need to better address the plight of home buying consumers. “I think we miss the human side of how this is impacting borrowers,” Bair said, criticizing efforts by some policymakers to cast troubled borrowers as investors or speculators.

One small item that Ms. Bair is ignoring is that there is not a system in place where you can grab fist fulls of housing loans and magically change them. Each loan is separate and specific, magnified by the fact that most loans have been stuffed, sorted and bundled into hundreds of thousands of bond securities that are privately held by just as many investors. The nightmare is intense and unrelenting.

In fact, if homeowners refuse to answer the phone or reply to past due mortgage statements, little can be done on the part of the banking community. Foreclosures will happen in these circumstances.

The human side is that foreclosures require the cooperation of both sides. Bankers and home buyers must be intensely interested in keeping the loan alive. Wholesale loan modifications are not a possibility in sound or unsound finance.

Housing Crisis Over?

If the Wall Street Journal says it, it must be true! The brilliant economist and author Cyril Moulle-Berteaux declares that “most people forget that the current housing bust is nearly three years old.” He bases the supposition on evaluation of latest trends.

He’s right that affordability ultimately created the mortgage bust. How high can real estate prices go while undergoing the intense misuse and abuse of the banking community? Affordability was created by “false affordability” through unsound practices. You cannot finance the world in a never-ending upward spiral.

The doctor of Wall Street declared that “the boom made housing unaffordable for many American families, especially first-time home buyers.” The fact is that abusive and overextended lending practices lead to the fall of the market. The availability of easy lending has been a large factor in the overheating and self-destruction of the market.

He correctly asserts, “During the 1990s and early 2000s, it took 19% of average monthly income to service a conforming mortgage on the average home purchased. By 2005 and 2006, it was absorbing 25% of monthly income. For first time buyers, it went from 29% of income to 37%. That just proved to be too much.” The problem is that over-financing through abuse and predation extended the reach of the market, but could not sustain the housing economy. That over-financing is what destroyed the bubble and brought the system to its knees.

The “new system” was built on the idea that financing a home was possible every few years or so to avoid the pain of the abusive and predatory practices that the industry and the consumer grew to accept as normal: an everyday part of the business world. A return to that time is impossible and the same mentality unwise.

It’s nice to see an optimist in the world. He just needs to take off his rose-colored glasses and see the fruit that past policies and practices have borne instead of evaluating the symptoms.

Paper Tiger Taxpayer Bailout Plan at 1.7 Billion

The taxpayer cost of the mortgage refinancing should be limited to about $1.7 billion according to U.S. government sources. The problem is that few that qualify will actually be helped.

The proposal, authored by House Financial Services Chairman Barney Frank, passed the House with a 266-154 margin, with 39 Republicans joining virtually all Democratic House members to support the measure. The Bush Administration and many members of Republican leadership oppose the bill and are proposing other measures.

Congress feels that the country should be reassured by this paper tiger measure. The reality of the plan dictates otherwise. Very few at-risk homeowners will be able to get help. Because of the limited scope of the proposal, the cost to taxpayers is projected at less than $2 billion. The Congressional Budget Office is content with the limited exposure.

1. The plan dictates that the Federal Housing Administration would guarantee a new loan if a mortgage holder accepts a write-down of at least 15% of the property’s current appraised value. The plan does not address the real crisis in any real measure.

2. Nearly a million home buyers will be blocked from help because they have second mortgages. Second mortgage lenders are in danger of losing most, if not all of their money. As a result, they may not agree to the refinancing.

3. Roundly 500,000 home buyers have problems such as job loss, illness or divorce that make it impossible to afford even lower payments of a refinanced loan which will disqualify them.

4. Almost one million home buyers might choose not to use the program because of the costs involved to get the government guarantees. Government guarantees under the plan include a promise to share any future gains in the home’s value with the FHA.

5. Government experts estimate that 35% of those who get help under the program will still fall into foreclosure.

Almost a year has passed since the reality of the subprime mortgage disaster became apparent. The government has taken responsibility, while continually failing to develop a reasonable plan to resolve or resist the current foreclosure crisis. The bankers that played a major role in the debacle have failed to support countermeasures and have failed to work diligently to avert the situation staring them in the face. Instead, in typical measure, bankers and business aligned with the industry have depended on others to bail them out of their own folly as the national economy crumbles.

Citibanks’ Magic Move

Citibank excitedly announced that it will sell off almost 1/2 billion in bank assets immediately. Citibank and bankers worldwide are looking for good news under any rock they can find it. In this case, shedding whatever they are holding of value is a new way to create capital.

New CEO Vikram Pandit and much of the media tried to put a positive spin on the latest move by the megabank. We can be comforted to know that when Saudi Arabia no longer considers additional investments a reasonable proposal that banks have assets to dispose of to keep themselves solvent. The New CEO has a plan to move more assets in the future. Mr. Pandit says the assets are aggressively priced as the company seek risk reduction.

Bankers and other investors should take serious care of their enthusiasm as Citibank seeks to divest themselves of risky investments that they hold at reduced prices. This sounds akin to paying for shooting yourself in the foot. Perhaps someone with financial literacy will find a few deals though. Making money from subprime securities is an especially risky move for anyone but the most crafty investor with money to blow. Pandit has the audacity to try.

Bailout or Not to Bailout?

Americans remain split on whether homeowners about to default on their mortgages should receive special treatment to help them keep their houses. Opposition to bailing out homebuyers is growing. The problem has been facing the government and the Federal Reserve for quite some time and they have been quite poetic about it as they waited for banks to react. Reaction time of the banks has been slow to non-existent. Banks have taken two approaches. Either banks have elected to allow homeowners to stay homes during an extended foreclosure process or the banks have reacted in the traditional way by foreclosing in the traditional way knowing that the government will bail them out.

Some say that the Bush administration intends to fix the subprime credit mess by keeping people who weren’t creditworthy in debt longer and rendering signed contracts meaningless. This theme operates on the presumption that all contracts were realistic, unpredatory in nature or that homeowners deserve to get what they signed for.

Others see most homeowners as innocents that were conned and coerced into signing contracts that were not only predatory, but immoral and even stacked against the homebuyer.

Jon Markman says, “It’s as if the Federal Reserve and U.S. Treasury believe the best way to treat heroin addicts is through long-term, government-supplied crack.” As a critic of bailing out homeowners with subprime mortgages, he must know that his statement cuts both ways very cleanly for both bankers and homeowners.

Let’s get honest. Why should anyone bail out any part of a for profit money-making system? The government thinks that it adds up to confidence and security along with belief in the system. The government has already moved to cover the sins of the banking system. Should it move to do any less for bilked homeowners?

The other question that nobody is asking is whether the bailouts are expected to prolong the economic recession or to shorten it or whether bailing out bankers is good for business in other than the most short-term scenario. In fact, the Federal Reserve doesn’t openly recognize the problem that bankers have created through their own greed. Instead, they choose to blame the problem on the “lack of financial literacy”. The problem is that with all the financial literacy in the world, nobody really knows the answer. Economic theory has diverse and varied opinions even within the Federal Reserve and the global bankers.

Of course, the real problem is that many Americans don’t want “irresponsible homebuyers” to get anything they won’t get. Without question, at least a few homebuyers were less than honest when they signed the documents for their new home. The government is not suggesting that these people get a handout or a helping hand. Many of them have already lost their homes and some are out on the street as you read this text.

The government has been taking the approach that they are willing to help responsible homebuyers that are creditworthy. Creditworthiness is the determining factor. Otherwise, it’s out the door Buck! Considering that dumping otherwise honest homebuyers that actually can afford to buy a home is the wrong thing to do for the nation’s health, helping homeowners to stay in their homes due to predatory and unsound contracts is a sound idea.

Whether you choose to bail out everyone, the bankers, the hapless homebuyers or nobody at all isn’t even academic. Nobody is knowledgeable enough to figure it all out with 100% accuracy. The variables are immense if they are truly considered. Since financial literacy and people being who they are is the problem, the problem boils down to emotion, the idea of good business and making the “customers” happy.

So what does Dr. Manning think? I’m retired and nobody is asking. I do have a few more thoughts though.

Fact 1: Jealousy is a terrible problem in America all the way around.
Fact 2: There is always a price to pay.
Fact 3: Crooked bankers haven’t paid their price yet. (a reminder)

Some Say Inflation No Big Deal

Some are saying that inflation is of little or no importance and that the credit crunch should be first priority. “Inflation rates are expected to remain high for a rather protracted period of time before gradually declining again,” European Central Bank President Jean-Claude Trichet said at a press conference. That is the line many central bankers are saying.

As painful as higher prices are for Americans, there’s reason to believe that economic weakness will be a heftier burden for the economy as the year goes on. Some economists and bankers readily acknowledge that the national economy hasn’t taken the hit yet.

Banking standards are tightening and less money is going into the economy, instead being used to shore up the banking system. The Federal Reserve has nearly exhausted the ability to lower interest rates in the opinion of many.

Falling home prices are good for buyers, but steep drops portend lots of trouble for the economy. There are reasons to be concerned about government financing companies, Fannie Mae and Freddie Mac. The recession could lead to growing job losses and growing defaults, which will push on the companies’ equity cushions. Shareholders could be wiped out with a 5% drop in mortgages, creating the need for a government bail-out. These agencies have had all kinds of trouble with bookkeeping in the last few years which could result in larger problems.

Real inflation rates have averaged at 10% for the last thirty years even though the Fed and the government has continued to insist on 3%. Now that inflation is really out of control and close to 20%, the American public can easily see the effects on prices and the general unrest of the economy. Your can thank greedy bankers, mortgagers and runaway investors for overheating and breaking down the system for everyone on a global basis. Since rising prices are a product of inflation, you can bet that inflation is important after all.

Nobody is talking about devaluation of currency, which is as large of a problem as inflation.

Wall Street and Forced Public Disclosure

The Securities and Exchange Commission, previously caught unaware by the collapse of Bear Stearns, is mandating that all investment banks disclose their capital and liquidity levels later this year.

“One of the lessons learned from the Bear Stearns experience is that in a crisis of confidence, there is great need for reliable, current information about capital and liquidity,” stated SEC Chairman Christopher Cox. “Making that information public can certainly help.”

Wall Street doesn’t like the bright lights. After the announcement, the five biggest firms had their largest share price declines in a month. The SEC already collects certain information, but doesn’t make it public. Whether public disclosure helps or hurts will only be revealed when it happens.