Fed drops discount rate 1/2 point
[photopress:images_1_2_3_4_5_6_7_8_9.jpg,thumb,alignright]For the detail, see this CNN article.
Some highlights from the article:
“The Federal Reserve, reacting to concerns about the subprime lending crisis that’s rocked financial markets in recent weeks, Friday cut its so-called discount rate half a percentage point, to 5.75 percent.”
“But one economist suggested that the Fed’s discount rate cut has more than token significance. David Wyss, chief economist with Standard & Poor’s, said the cut could help convince banks it was okay to keep lending to companies or consumers that actually are creditworthy. “This is an important move. It’s not just a symbolic action. The Fed is telling banks that the discount window is open. Take what you need,” Wyss said.”
“…the central bank’s next scheduled meeting is Sept. 18. According to federal funds futures listed on the Chicago Board of Trade, investors are betting that it is all but certain the Fed will cut the federal funds rate by at least a quarter of a percentage point.”
There was an excellent live interview with Donald Trump talking about the drop. Hopefully that will come up on the internet soon. In it he urged people to work with their banks during this time, and also indicated that a second 1/2 point drop in September is his suggestion and hope for the economy.
About the Author: Ardell DellaLoggia
- Author's website: http://www.realtown.com/ardell/blog
- More posts by ARDELL
- email the author
This is truly a shocking development. As recently as June, interest rates were up a healthy amount, GDP growth was projected to rise and the yield curve had recovered from its inversion.
Now we’re seeing emergency measures just to keep the financial system functional. Not a good omen by any stretch of the imagination.
I’m heading off to Pike Place Market’s 100th Birthday celebration, but here’s another good article from 25 minutes ago.
This move was to keep at least one, maybe more, bank solvent.
There was a run on Countrywide Bank yesterday, and it had to turn away some depositors. There are rumors that WAMU is in trouble as well.
This is very, very scary news. Bank runs are no laughing matter, and very hard to stop once they get started. Ben had to act to avoid bank runs.
A silly question: are mortgage rates tied directly to Federal reserve interest rates? I know that treasuries can move in opposite direction of the Fed funds rate for long periods of time.
If the Fed does actually lower interest rates substantially, I wonder if that would give any help to borrowers? I don’t think it would help people who no longer meet the tightened lending criterion (which isn’t a function of rates, to my knowledge).
Sniglet, it’s not a silly question at all. Mortgage rates are not tied directly to the fed reserve interest rates. Home equity loans are tied to the Prime Rate which is based on the Fed Funds rate.
It’s hard to say what will happen when/if the Fed lowers the funds rate next month (or sooner). Often times, by the time the Fed makes a rate adjustment, it’s all ready been anticipated by the traders and therefore there’s no big rate adjustment to the consumer. When the Fed moves and it’s not what the market was speculating, then you see rates increase or decrease.
The people who no longer meet the tightened guidelines are either out of the market or are paying a much higher price to stay in.
The next 30 days (and longer) will be very interesting to say the least.
“Home equity loans are tied to the Prime Rate which is based on the Fed Funds rate.”
That’s true, but a risk premium is added to the home equity loan. Given the current state of the markets, it remains to be seen whether an increase in the risk premium will cancel out any decline in the underlying interest rate.
Sorry Rhonda, but this is a little confusing.
“Mortgage rates are not tied directly to the fed reserve interest rates. Home equity loans are tied to the Prime Rate which is based on the Fed Funds rate.”
If the “Prime Rate” is based on the Fed Funds rate then wouldn’t that imply that mortgages ARE tied to the Fed interest rates? Or is the Prime rate only “loosely” based on the Fed rates? Aren’t the “Fed Fund rates” and “Fed rates” the same thing?
Would I be correct to infer that mortgage rates don’t change due to alterations in treasury yields since they are based on the Prime rate (which you said is based on the Fed rates, NOT treasury rates)?
Yikes! I am reposting since my previous note used someone esle’s ID. There is something fishy with this message board, but oh well…
================
Sorry Rhonda, but this is a little confusing.
“Mortgage rates are not tied directly to the fed reserve interest rates. Home equity loans are tied to the Prime Rate which is based on the Fed Funds rate.”
If the “Prime Rate” is based on the Fed Funds rate then wouldn’t that imply that mortgages ARE tied to the Fed interest rates? Or is the Prime rate only “loosely” based on the Fed rates? Aren’t the “Fed Fund rates” and “Fed rates” the same thing?
Would I be correct to infer that mortgage rates don’t change due to alterations in treasury yields since they are based on the Prime rate (which you said is based on the Fed rates, NOT treasury rates)?
I see Rhonda posted starting a new thread here, so I’ll just answer the confusion above. There are two Fed rates. Fed Discount rate which dropped today and will come up for review again on September 18th where it is expected to drop again. Then there is the Fed funds rate next month, which should drop given the Discount rate dropped. The funds rate dropping will be more significant.
I agree with Rhonda that the next 30-60 days will be interesting and hopefully bring better news than we’ve been hearing for the last 60 days.
In other words, today’s news is a good sign, but not much more than that. Still, a good sign is better than nothing and the markets responded well today.
Very recently, the FED had a meeting and mentioned that only a “calamity” would make them lower rates.
This bank run is the “calamity”, and is not good news, IMO.
For the FED to do this just a week or so after they just met means that they have no credibility, or they are having to react to some very scary financial data.
A good sign? A good sign for what?
I am far more worried about housing and the economy in general now than yesterday. Far more.
How could it be a good sign that the Fed had to (and I mean had to) respond to an imminent failure of the largest mortgage lender by dropping the discount rate?
I suppose it’s a good sign that Ben didn’t let CFC fail, but it’s a far worse sign that he had to do an emergency cut of the discount rate at all.
Thanks, Ardell. Just trying to help out while you were at Pike Place Market.
It’s obviously good news guys, the markets reacted accordingly, all the news services are reporting positively. I thought the bad news was Bernanke replacing Greenspan in the first place. Glad he’s getting into gear.
[...] It was all over the blogs and eenie meenie mineie mo… Ardell gets the link love for Fed drops discount rate 1/2 point [...]
Ardell,
Now you give a RA about banks?
What – exactly – is the “good news” in all of this?
– That 1 or 2 West Coast banks are on the verge of insolvency?
– That 1 or 2 of the New York biggies are in really big trouble with their derivatives?
– That most of the mid-sized banks which make most of their money churning out mortgage dreck can’t syndicate any of that crap?
– That the FED is in panic mode?
– That the only bounce the markets have had, prior to today, came from a thrice discredited rumor that Fannie was going to take on more loans?
– That Countrywide had come out with their 10Q for the spring quarter and told everyone they had almost $50B in liqidity, but yesterday had to take out an $11.5B loan at 450bp ABOVE their lending rate and that they are shutting down a major lending division?
– That Countrywide is having a good, old-fashioned bank run?
A 50bp cut in the discount window, and another 50bps in the funds rate will do nothing to solve our problems. The markets will become more disorderly and force more people to sell this rally. It will probably go for a few days or over a week, but it will end. Everyone knows the 9/18 cut is coming…(that’s not good).
The doctor issued a script for illiquidity, but the problem is insolvency. Why insolvency? Because you can’t run an economy on a never-ending speculative frenzy that needs the finance mechanism to run harder and harder just to make the scheme stay liquid.
Every day we get another turd or two surfacing in the punchbowl. All that happened today was that Bennie spiked it with another liter of vodka.
If you want to have a big drink, be my guest.
Panic now. Beat the rush.
The only thing that bugs me about that quote, is that I didn’t think of it first.
What a thing of beauty!
I clearly don’t have as much faith in Bernanke as I did in Greenspan, but at least he’s waking up. Clearly the market and every economic writer of the day is happy with this news.
The best part of being in Seattle is that the efforts to help the rest of the country to bail out of serious problems, helps keep us from getting into them at all.
I’d love to see mortgage rates get under 6%. Wouldn’t you?
Ardell,
You said that just to bait me into going insane, didn’t you?
Uh, lowering the interest rates in the current situation runs the risk of inflation and cratering the dollar (which has already slid a long way versus other currencies). If you think we are having problems now, wait until the Chinese, OPEC, Europe, et. al. decide that they don’t want to hold dollars.
Reflating the bubble now just means that when it blows up again after trashing the dollar, we can have a first-class depression instead of the recession we currently seem to be heading towards. People don’t buy houses in depressions.
E,
I didn’t know you needed bait to get there
kpom,
You know we all want 30 year mortgages back under 6%. Then we can say rates will never be this low again…HA!
You’re not going to bring me down guys…I can see it now. A month away and the funds rate will go down, another month and the discount rate will go down again then the funds rate again. All I want is rates back to where they were 3-4 months ago. Not asking for much.
Ardell,
Post #19 – LOL
#20 – Keep dreaming. It’s not a problem with liquidity. It’s about insolvency. That insolvency came from the drunken speculation and misappropriation of capital that descended from artificially low interest rates.
I know the hangover is going to suck. Getting drunk isn’t going to help.
E,
The problem is much more complex than that, and reminds me of a time when several large banks came close to folding during the double-digit days. Those who called the high at 9% and locked in long, only to be stuck totally invested at 9% when short rates went to 17%, nearly folded.
The Feds have the ability to interfere for a reason. Bernanke is finally waking up and realizing that his job is not to sit and watch what happens when he does nothing.
The best article on the real crux of the issue is hidden behind Inman’s subscripton veil and written by Lou Barnes. I can’t link to it because of the veil, but here are a few key quotes:
“By yesterday, the 90-day T-bill, the ultimate safe-haven, fell to 3.45 percent — a gap so wide below the Fed’s 5.25 percent rate indicates systemic collapse in progress. Today’s cut in the “discount rate” allows banks to borrow from the Fed against AAA-rated assets, which put a floor under the financial system, in particular commercial paper and corporate finance, but did absolutely nothing to thaw the mortgage freeze (which is oh-by-the-way spreading to commercial mortgages).”
The widening spread was forcing the banks into dangerous territory. The Fed was quite simply not doing its job. It really is a tale of two men, Greenspan and Bernanke. Greenspan moved into high gear in 1987 after Black Monday, and learned that his role was not to “let market forces prevail” and watch what happens. Bernanke is getting this same lesson now. So like many others writing yesterday, I am encouraged. A Country with a Chief Economist who thinks his job is to stand back and watch, is a scary thing. At least he’s showing signs of willingness to take on the role he is charged with.
“The bubble zones would have survived the removal of the bad ideas, as of the end of July, and probably found a way to muddle through the subprime resets ahead. They will not survive this degree of credit starvation. They have a month, maybe two; and this time the economy will not be spared the consequences.”
The above paragraph describes us, so something had to give. We were too close to “checkmate” for the key player to stand around with his thumb up his butt.
“These troubled mortgages (together with the good ones) are always held with borrowed money. Some borrowed from depositors or owners of life, pension or annuity policies, most from institutions; some borrowed long term, some short; some borrowed on prudent leverage, some on high leverage. Most of the troubled mortgages are held in securitized form; absent an agency guarantee their credit attested only by S&P, Moody’s and Fitch, and most of the structures new since 2000 and untested.
The rating agencies grossly overrated the securities. The light of this cold dawn came gradually, beginning in late 2006, and the market reaction was a gradual withdrawal of the worst mortgage ideas. On Aug. 7 the Fed met, and pronounced the economy in good shape. Two days later the mortgage market froze solid. The Fed has injected cash every day since, to no effect, panic spreading to other markets.”
The key sentence up there being “The rating agencies grossly overrated the securities.” This mixing of A paper, with paper that never belonged in with the A paper in the first place, made the whole pool of investments suspect, and froze up the system. It wasn’t so much the quanitity of it, as the commingling of it.
“The solution is going to require federal intervention, and that’s going to require a victory of prudence over market-solution hard-heads. One idea: re-underwrite the $4 trillion to common-sense Fannie standards (forget size and details: is this “A” paper, or not?). Lord knows, there are plenty of underwriters standing around with nothing to do. Then the loans could be valued and traded, but running the securitization sausage machine in reverse may be impossible. Another idea: form a modern version of the Resolution Trust Corp. (which ‘88-’92 received and re-sold the wreckage from S&L portfolios, a tremendous success) to buy and re-market illiquid loans and securities.
Whatever: get going. Two weeks of Fed band-aids have burned precious time.”
While I agree with kpom’s comment #18 to some extent, once you build a dam to hold back flood waters, you have to maintain that dam. Greenspan did…Bernanke wasn’t. Bernanke finally figured out that the dam wouldn’t hold without his efforts at maintaining and patching and repairing. He thought it might be better if the dam just broke. He finally got grabbed by the short hairs, maybe by someone who got tired of him looking down from a helicoptor waiting to see what would happen if the dam broke. Probably someone who didn’t share his motivation.
To me his motivation was simple. He replaced Greenspan and wanted to be the opposite of Greenspan. He’s finally understanding that he can’t come in behind Greenspan and be so totally different that the dam just breaks under his watch. That is the good sign. Bernanke finally “getting it”. We all think it’s too late, but “better late than never” is all we’ve got. He can’t make up for lost time and this is no panacea, but it’s all we’ve got.
Ardell –
I get wanting rates to go back down, but your comment in #20 doesn’t make sense to me. The funds rate has been 5.25% since July of last year. From a funds rate perspective, today is just like it was 3-4 months ago. The difference is an increase in risk premiums, not the funds rate – and since risk spreads had gotten ridiculously narrow over the past few years, I’m not sure there’s much Ben can do to stuff that Genie back in the bottle. And repeated drops in the funds rate will only have the effect of killing the $ and making everything we import (especially oil) much more expensive. Careful what you wish for.
Deejayoh,
Hopefully my long comment #23 sheds some light on my comment #20 in a broader sense.
Your “stuffing the Genie back in the bottle” is similar to Lou’s “running the securitization sausage machine in reverse”.
Stop-gap measures buy time. When all you’ve got to work with is “too little too late”, Rolling rates back to the 5/1 at 5.75% will release some of the pressure while the real solutions, which will take much longer, are being worked through. That is my hope.
It’s going to be a long winter this year. Winter always brings out the uncertainties, as winter is always the weakest link in the chain. What happens in the first quarter of 2008 will be the only measure of where we really are, and that’s a long way away. If panic builds from now till year end, next year is going to be a disaster. A dip in the rates is the only thing that can save us from that.
Markets are always a mix of emotion and fundamentals. Something has to bolster emotion, while they work on the fundamentals. Rates going up vs. down to stable, is the fuel that ignites panic. Those who just bought say, “I’m glad I bought before this happened”. But the confidence all lying in those with hindsight, isn’t going to help anyone.
When everyone’s afraid to go in the water, the season ends whether its hot or not.
Drawing from the resources of my experience, I remember the day someone underestimated the margin for error when banks stopped matching actual debits and credits. They thought the cost of scrutiny was worth saving, and the margin for error would stay the same. It didn’t. That’s what is happening today with A paper being commingled with B and C paper, all marked as A.
E,
The reason I don’t give a RA about what the banks do is because I expect them to screw up. I spent 20 years in “the banks”. I also know what happens when they do screw up. Someone steps in. Sometimes too late for there not to be damage. But the sky doesn’t fall in, or at least there are measures in place to make it so…unless good people do nothing.
Lets see where the Feds go from here.
The Fed has only one tool: modify the rates.
It’s the wrong too for the job at hand, Ardell. “High” rates aren’t the problem here. Using that tool will do more harm than good, imho.
The Fed was created in order to restore confidence in the banks. This is not a banking problem. We aren’t in “It’s a wonderful Life.” The world has changed, and it’s changed for the worse. We need no structures and regs to handle this situation. Global structures, because this is an international problem.
When the hordes realize Ben is impotent, it will be worse than not dropping the rates at all.
er.. “new structures,” not “no structures”! I’m not that laissez-faire.
Glad you made that correction from no to new…that’s my point biliruben. We need a stop-gap measure to support everything while developing and implementing those “new” structures. If the new ones never materialize, then we need to rely on the old ones, to some extent. Maybe Greenspan supported everything too much, likely that’s true. But the answer isn’t an about face total shift just because the player changed. That was a mistake. Now it’s a mess.
We are not the World. We are the United States of America and the U.S. needs to protect its citizens first and foremeost. Not have them take the hard knocks while we play global economy and experiment with “new structures”. We need to do both. Lower the rates to ease the panic and look for bigger and longer term solutions, at the same time.
Ardell,
The problem with the banks is a matter of solvency, not liquidity.
The FED is using a liquidity solution to fight an insolvency problem.
Eleua: Ardell, your house is on fire.
Ardell: I don’t give a rat’s ass about the fireplace. Look at my granite countertops.
E: Your house is on fire. That trumps granite countertops.
A: I worked for the Fire District for 20 years. They always overreact. Boy, is it hot in here.
E: Ardell, your house is on fire and you are going to get lifelasting scars and tissue damage.
A: You don’t understand fire. Granite doesn’t burn. What are those sirens I hear?
E: The counters that support the granite do. Get out of the house.
A: The Fire Dept will save me. There is a hydrant 1/2 mile away and they have a 1/4 mile hose. Is someone barbequeing?
E: I’m outta here. I hope your insurance is paid up. In the future, don’t play with kerosene and matches.
A: Stay on topic. Granite sells. I’m thinking about upgrading to stainless. Why is everything orange?
Just a second here: I don’t understand the point of this thread. Isn’t Puget Sound real-estate doing just fine? I haven’t heard any of the Raincity contributors mention that the mortgage security/real-estate drama gripping places like California or Florida are having any impact in our area.
Ardel has explained that all she needs to do is shift some customer to FHA and VA loans. She has also pointed out that very few of her customers use any of the exotic loans that had become so popular.
Who cares whether other areas of the country are feeling some real-estate stress if our region is doing just fine? If most of the purchasers in the Puget Sound are able to just switch to making large down-payments on compliant loans now that some programs are discontinued, then why should we worry about any of this?
“The bubble zones would have survived the removal of the bad ideas, as of the end of July, and probably found a way to muddle through the subprime resets ahead. They will not survive this degree of credit starvation. They have a month, maybe two; and this time the economy will not be spared the consequences.”
We fall into that “they have a month maybe two” category. October through December are always rough months. With some downturn in interest rates, we could ride it through and spring back in January, as usual. But this was not an “as usual” year.
I have said many times that 2007 was a year of continuous January. More cherry picking than usual. More hesitancy. More fearfullness. Interest rates going up did not go unnoticed. Interest rates going up never goes unnoticed.
If you simply read everything from last year August through December, it was a rough ride. This year will be the same as last year. Question is, will Jan 2008 through July 2008 pull out the same way. No one ever knows until January hits. If there is panic set in between now and then, we’re less likely to have a 2008 like 2007. Lower rates could be the key.
Ardell, what you seem to be missing is that the Fed sets short term rates, not mortgage rates. In the last month, short term rates actually fell due to fllight to quality as the market began to panic, yet at the same time mortgage rates and risk premia increased substantially. The fed can lower short term rates all it wants. That’s what Japan did and where did that get them – into a 15 year defaltionary spiral, that’s where. The Fed lowering short term rates won’t lower mortgage rates or unfreeze a credit crunch caused by too many lenders making bad loans when investors no longer want to buy them. In fact, be carefule what you wish for, as has been pointed out above, the Fed by lowering rates can in fact make things far worse than better by doing so. There’s a raging fire and all the fed has to fight it is a hammer. Then next leg down occurs in the next couple of months when people realilze that the Fed can’t solve this problem and in fact can and will make it far worse.
Be sure to read Nouriel Roubini’s take on the prospects for the Fed’s actions to have the desired effect:
http://www.rgemonitor.com/blog/roubini/
From Roubini: “… Equity markets have moderately rallied today…at this point what the Fed will do in the next few weeks and months may be too little too late to prevent a US hard landing.”
Jay,
Everyone agrees, including Roubini, that it may be too little too late. But Roubini saying “too little too late” suggests they should have done more and earlier…doesn’t it?
I didn’t miss that yesterday’s actions don’t translate to changes in the mortgage rate. Still, my wish for rates to get back to where they were earlier this year is more realistic than some people’s wish for housing prices to get back to 1990 levels…don’t you think?
Ardell,
Why is expecting a large drop in home prices unrealistic? Is it as unrealistic to have expected the crazy post-98 run-up in prices? I am paraphrasing Peter Schiff here. Unless there is a fundamental reason why housing has to be so much more expensive in such a short period of time, why would this crazy run up not run in reverse. Sure, it may not play out exactly in reverse but its plausible that it might.
SS,
I’ve seen prices go up 100% and down to a 50% increase. $200,000 homes went up to $400,000 and then down to $300,000, correcting at a 50% increase. That was in the 80s and elsewhere. Then they went back up past $400,000 after 98.
Where the person loses me that says 1990 pricing is, if you look at my 16% appreciation post, the condo that is now $175,000 or so was $40,000 in 1990. I can’t see prices rolling back from $175,000 to $40,000. Can you? I can clearly see a correction, but not back to 1990 pricing.
Ardell,
I can see a rollback to inflation adjusted prices from before the current runup. Its hard to say how quickly that would happen but it is plausible based on a return to a sanity in lending.
So, given those one bedroom condos, where would that put pricing in your wildest imagination? Hold a sec and I’ll get the link.
I could see them at $150,000. I could even see them at $120,000. But not pre-run up of $65,000. So far they just keep going up. When people were asking in the $170s this year I couldn’t believe it.
First of all, the discount window is always open. Second of all, the window is only used by the institutions that are really screwed. Why would you borrow money at 5.75 percent when the rest of the market is getting it at 5.25? The move by the FED is merely symbolic, it will do nothing to save lenders that have exposure to sub prime loans.
The only reason that the market reacted in a positive manner is that they now feel that the FED is more likely to bail them out despite the fact that if you have been reading the FED minutes, you would realize that all their language is to the contrary. They still maintain that inflation is their biggest concern and that the overall economy is still doing well.
I don’t believe the FED will cut rates until it is painfully obvious we are in a recession. They most certainly aren’t going to cut rates to save Wall Street, hedge funds, and the real estate community. Once the GDP numbers turn negative (which I believe they will shortly) look for a FED cut. Any cut before then would signify panic.
Ardell, having spent time in the financial industry, I really hope that your analysis runs a bit deeper than interpreting “too little – too late” to mean that the Fed should have cut earlier and more. The current problems are due to earlier bail out rate cuts by the Fed (Greenspan) creating our current Moral Hazard speculative financial and real estate environment. Roubini is saying we are headed for a hard landing (recession). Lowering rates earlier might have prevented it but that still does not make it the right thing to do if it perpetuates and magnifies the corruption of free markets and rewards reckless speculation and misallocation of capital. When you reflate recklessly you debase the currency. The end result will be far worse than facing a needed recession to clear out the excesses. Regardless, whether right or wrong, whether the Fed eased early or late, enought or too little, whether we have a recession or not, the unwinding of the credit crunch + mortgage crisis + real estate bubble will run it’s inevitable course. A recession will just speed up the outcoume. The smart money has known this for months, that’s why spreads began to widen early. It just takes a while for the mainstream media, retail investors, and everyone else to figure it out. Regarding how low prices will fall (ie, to 1990 levels) I won’t predict that one way or the other. However, history (ie, Japan’s experience) shows clearly that even more extreme outcomes are well withing the scope of possibility. Before you decide what the outcome will be, just remember to look through the windshield instead of the rear-view mirror…
[...] Published by Rory at 4:00 pm under General Real Estate News and Info, Mortgage and Finance Take a Deep Breath, Countrywide isn’t Chrysler Fed drops the discount rate 1/2 point at Rain City Guide Mortgage mess creates lending drought. Proof that Countrywide is just fine: A Billion Here, A Billion There How to pay off your subprime mortgage. Plus funny real estate agent “code words” [...]