SeriousBull

Should the Fed cut interest rates?

On Tuesday, December 11th, the Fed will convene its Open Market Committee and decide whether or not to cut the US Federal Funds and/or Discount rate another time. Purportedly, any affirmative decision will be to thwart Recession and help mitigate the Sub-prime mortgage crisis.

The Recession question is directly related to interest rates–inject liquidity to stimulate business and borrowing and presto, businesses and consumers respond! But maybe not this time. Why? The overhang of the Sub-prime debacle can not be fixed by a series of interest rate cuts because amortizing a 30 year mortgage at a one percent or so lower rate feels good, but falls miserably short of addressing the real problem.

The problem as its framed by Secretary Paulson and Fed Chairman Bernacke is to provide greater liquidity to the markets to make debt trades clear. But as they are witnessing, no one wants the toxic waste of a sub-prime mortgage backed by unknown, perhaps highly overvalued, collateral. Moreover the real problem is the impact on the nation’s banks capital reserves. Cutting the Discount rate helps liquidity, but as we saw with Citi Bank, the Fed doesn’t lend Reserve Capital. Indeed, for example, the 4.76% retained earnings requirements for loans at the Federal Home Loan Banks must be capital put up by the banks themselves. That’s why Citi Bank took a loan shark deal at 11% to shore up its capital. The point is that such a highly leveraged system must find new capital in the face of deflated asset values. Therein lies the real challenge for the Federal Reserve and Treasury.

Secretary Paulson proposed a super sub-prime mortgage fund to aggregate and hold these securities. One must ask if the banks being solicited made him aware that they could hardly write down to zero all their sub-prime loans as they account for a good measure of their capital? We must guess that this important obstacle may indefinitely delay its implementation?

Meanwhile, market analysts are screaming “they know nothing, nothing!!” But we suspect they actually do know more than they are saying. They have cut interest rates as an appeasement measure while they contemplate what for Christ’s sakes to do next.

While we wait for a solution the problem is not going away. Indeed it is getting worse, and maybe out of hand. Now we have Money Markets imploding and soon it will be Pension accounts at state retirement plans. And what about Fannie Mae, Freddie Mac and Ginnie Mae? These entities guaranteed some huge but unknown amount of this toxic waste. They are all too silent on what’s awry in their coffers. Our view is that this debacle will become difficult to contain if much more news creeps out (by year end?) as it must by public disclosure.

The psychology of the consumer is meantime taking a hit. The Fed and the Markets are trying to make an assessment of what’s up ahead by watching Retail spending. Housing starts and durable goods already tell the story as do the early deep discounts of Retail merchandisers and their December sales forecasts.

So what should the Fed and Treasury do? We’ll this is where the solution is also a problem. But since 67% of the US economy is driven by consumer spending we suggest that the Fed do something to extend the consumer’s spending longevity like cap credit card interest rates at 12-15%. This would literally halve the cost consumer’s are paying to finance their living and Christmas giving. (But alas, banks short on capital need all they can gouge.) Next, the regulators must get a handle on the actuality of bank reserves. It’s looking more and more like a graduated disclosure policy to spread risks across time is the implicit, albeit unstated, regulatory policy. What must happen NOW is a mandated factual and swift recognition of losses. Anything less is fraudulent governance that we sense the savvy investor has already anticipated as the partial fix.

So where is Congress amidst all this mess? One feels a bit like they’ve deferred comment because it isn’t their job. Oh, there’s the MOC posturing that they want to help the homeowner from losing their home. But let’s face it, Greenspan even admitted to dishing out BS to the Congress to keep them intentionally in the dark and so far as we know, few of them noticed. The fact is that the homeowner now losing their home is one who speculated that a variable rate mortgage would save them money, but also speculated that their home values would continue to increase at unreasonable annual appreciation rates. Now that their bet went wrong, those that made traditional down payments and who didn’t take the speculative bet should bail them out? Sounds like “da socialism” to us. We must wonder just how much longer the fifty percent of those working can afford to pay for those who don’t? The questions go on and on, but one thing is sure, a tipping point must assuredly could come when tax paying citizens are asked to additionally pay higher taxes to fund government pensions and bail out the failure of oversight that this Sub-prime debacle almost certainly guarantees.

November 30, 2007 - Politics