Wednesday, March 19, 2008

It doesn't add up

The Fed struck again yesterday afternoon with another .75 percentage point haircut for the Fed funds rate. Since August, this rate has fallen from 5.25 to 2.25 while inflation has risen from 2.5% to well over 4%.

Mungowitz will probably kick me off this blog for beating this particular horse so often, but I think this is bad policy. The only thing I think these rate cuts have done is reduce the greatly feared ARM re-sets that were on the near horizon. However, we now pretty much know that the real problem for homeowners is not payment re-sets, but that home prices have fallen (or stopped rising) enough to make their positions negative. We have too much housing still at too high a price and the price re-set is slow. One thing that would help would be to stimulate the demand for housing with lower long term interest rates, but the current Fed policy of allowing inflation to rise has 30 year mortgage rates "stuck" well above 6%.

In sum, while I applaud the lender of last resort actions the Fed has been taking, I see little good and a lot of ill coming from these unrelenting Fed fund rate cuts. They won't stave off a possible recession, nor will they solve or notably improve the housing crisis. They will push up inflation and keep long term rates higher.

3 comments:

Norman said...

That's pretty much what I've been wondering about this, myself. So is this a case of my macro education not being the same product as what Dr. Bernanke taught at Princeton, or is it just the political pressure?

br said...

Why wait for housing prices to adjust? Just lower the value of the dollar so that a 500 sq ft condo in NYC is really worth $500K.

I just read Bernanke's textbook, and his actions don't seem consistent with it.

There are two governmental controls to spur the economy - (1) rates and (2) deficit spending. Greenspan and Bernanke have been telling congress for years to save for a rainy day. That rainy day is here, and we're broke. Bernanke's pushing the gas pedal all the way to the floor, but there's no fuel in the tank.

IMO, we just have to cross our fingers and hope some scientist will invent something really valuable like the pc or the internet or engines that run on air or water.

Anonymous said...

One thing that would help would be to stimulate the demand for housing with lower long term interest rates, but the current Fed policy of allowing inflation to rise has 30 year mortgage rates "stuck" well above 6%.

The 10 year note is about 3.4%. So don't you think the "stuck" mortgage rates have more to due with a risk premium than inflation expectations?