Sunday, August 03, 2014

Inexplicable Federal Reserve interest rate policy

From this perspective, the U.S. Federal Reserve Bank's virtual zero interest rate policy makes little sense and is restraining economic growth.  This opinion is not coming from an economist who is trained to focus on academic and detailed market data so these thoughts may be questionable to some, but it is also not coming from a specialist who is blinded by anything outside of his or her small area of expertise.

Currently the Federal Reserve is committed to a Fed Funds rate of between 0 to 25 basis points for the foreseeable future.  If this is meant to continue to insure the solvency of the banking system, it makes no sense.  Banks are almost uniformly profitable now and have adequate to strong capital positions.  Any bank that actually needs this level of Fed Funds rate should be shut down, merged into another, or have a wholesale change of management.  The historically steep yield curve that has been created is no longer necessary.

If this low Fed funds rate is meant to create an incentive for credit creation, it is not needed.  Few banks are likely making credit decisions based on cost of funds, because cost of funds, whether overnight or two year or higher is minimal by historic standards.  Banks are making credit decisions based on their more rigorous credit analysis and the regulatory scrutiny that they remain under that makes them minimize any risk taking.  While the Obama administration encourages more lending by the banks, the Obama appointed regulators are discouraging it by their petty and short sighted view reflected in their audits.  In addition, with the major regulators and federal prosecutors on this never ending binge of extorting money from banks for past actions, some actions clearly wrong and some not so clearly at all(some of the latest charges are related to loans sold to the FHA in 1999, that's 15 years ago, and one could ask how the supposed mortgage experts at this HUD cabinet office could only discover these issues now).  Banks get stung by the regulators and cooperate, and then get stung again.  This is the reason for the unprecedented number of homes being bought today being cash only deals, meaning no debt. Buyers that have the money can't or don't choose to get loans at times due to the banks' and the borrowers' fear of the harsh and out of control behavior of the regulators.

Would raising interest rates gradually and minimally over time hurt the housing market or capital investment spending due to higher interest costs for buyers or investors.  This is possibly a contrarian  thought, but it may do exactly the opposite of that.  If prospective home buyers have been on the fence about making any long term commitment, or if mid-size commercial enterprises have been undecided about adding that new warehouse, service center, or factory, the thought of or fact of modestly rising rates may shake them into action.  For those thinking of buying homes, in most areas of the country rents have been going into the stratosphere as allowed, slowly but surely.  With the prospect of higher mortgage rates over time, those prospective buyers could be, may likely be, motivated to get off their ass and act now, buy something while mortgage rates are still near these historic lows.  This could create a more active housing market, not one that is impacted negatively.

For small commercial and industrial companies the same thought process applies and then some.  Get in on these still low rates now and don't wait for possibly a time when rates will, as they almost definitely will, eventually get higher.  Whatever they build now will serve as collateral for their loans, and with any inflation that accompanies somewhat higher rates this would be, to use a cliche, a win win situation for them if they act at the right time.

If this speculation is by any chance correct, those who worry that a modest rise in interest rates would negatively impact equity markets by raising the discount rate are right only in the short term.  Traders who have a one or two day mentality might push the market down temporarily, but if the initially small rate hikes led to more growth vibrancy in companies and in housing, the equity market would flourish over time.

Then we move on to the disgraceful impact that the Fed's far too longstanding policy has had on people who want to save for the future, for those living on fixed incomes, and for retirees.  Safely saving for retirement, for children's education, and the future had until recent years been one of those American "values" that was held dear.  That has been demolished by the Fed's policy, and the only way to get any return on one's savings is to invest in stocks, real estate, or other assets with a higher degree of risk.  As said in an earlier post, the long held value of compound interest is lost on investors today, and it is really just a myth to younger working people who have watched their parents, friends, and relatives live through recent times.

Most financial planners, when analyzing a middle to upper middle class client's portfolio, encourage them to set aside anywhere from two years to five years of readily liquid and stable assets to be able to maintain a necessary lifestyle and withstand unexpected events like job losses, expensive or disabling health issues, the need to assist an ailing or impoverished parent or child, or broader economic events that have radical effects, such as a bubble busting recession, a geopolitical crisis that paralyzes international trade for some period, and we must now even include a tragic weather event that is devastating to some area of the country.  Now those recommended asset positions just sit there losing money on an economic basis, since they earn almost nothing and any knucklehead knows that the government's inflation figures are understated for a variety of reasons that can't be delved into in this ever lengthening comment. The most recent inflation figures from last week were at 1.6% which by itself indicates a meaningful economic loss to those holding readily liquid and stable savings when the yield on a two year treasury is 0.446%.  To many who are not economists that understates the economic loss.  Do the people who develop the models for these inflation calculations go to the grocery store, heat or air condition their homes, have the ever increasing costs of home insurance, or send their kids to college.  Apparently not.

Someone please give one good reason that a layman can understand to explain why interest rates must stay at these ultra low levels.  The Fed should beware.  They are a proxy for the government's view of the market, but if the market changes its tune and sends rates up sharply it will be out of the Fed's control, as in the late 1970's/early 1980's, and the economic effects could be as damaging as anything that we have just seen in the so-called Great Recession.

That may seem unlikely, but the future is an unknown.  Don't tell the headline seeking pundits and those who promote their own portfolio positions that fact.  They want people to think that they know.



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