CFAH

Six weeks ago the Federal Reserve cut both the benchmark interest rate and the discount rate by 25 basis points (a quarter percent) while signaling that further cuts were unlikely. Our questions at the time: “Will the cuts help revive our national housing market? And of course, what impact (if any) will the cuts have on mortgage rates closer to home?”
Today the the Federal Reserve cut both the benchmark interest rate and the discount rate by another 25 basis points. And it looks like we have an answer (at least to question number one):

The economy is faltering after a third-quarter surge as house prices drop, consumer spending slows and banks tighten lending standards for even their best customers. Chairman Ben S. Bernanke has struggled to insulate the economy from financial- market instability since the central bank began reducing borrowing costs in August.

“Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending,” the FOMC said. “The committee will continue to assess the effects of financial and other developments in economic prospects and will act as needed to foster price stability and sustainable economic growth.”

And related to our question number two (regarding local rates):

Because banks are protecting capital, lending has been cut and concerns about counter-party risk are higher. About 40 percent of lenders have increased their standards for the most creditworthy borrowers to qualify for a so-called prime loan, according to a Fed study in October.

Interest rates for jumbo 30-year fixed-rate mortgages are about 6.68 percent, a spread of 92 basis points over non-jumbo loans of $417,000 or less. A year earlier, the spread was 36 basis points, and last month it was 57. A basis point is 0.01 percentage point.

Fed Lowers Benchmark Rate by a Quarter Point to 4.25 Percent [Bloomberg]
The Federal Reserve Cuts Benchmark/Discount Rates By 0.25% [SocketSite]

Comments from Plugged-In Readers

  1. Posted by Dave

    So how high will crude future hit?… I am guessing $110….
    and this cut isnt the end folks…

  2. Posted by Rillion

    Ouch, the stock market was obviously pricing in a half point cut with some hope for something even bigger.

  3. Posted by otto

    I just got a jumbo 30 yr fixed for 1 pt and 6.25% (w/ 20% down), that was before the cut.

  4. Posted by dub dub

    Time to update your hilarious rent-versus-buy spreadsheets 😉

  5. Posted by mktwatcher

    Interest rate cuts are not going to magically return the giddy feeling of housing wealth and home equity gains that fueled consumer spending for the last 5 years. Recession is inevitable and probably necessary to correct some of the imbalances.

  6. Posted by Satchel

    mktwatcher,
    You are absolutely right that interest rate cuts will do nothing to help housing in the long run. The Fed knows this. They, in conjunction with the banks, are only looking to slow the decline, and most importantly to stretch out the losses in mortgages (and attendant derivative instruments) so that banks do not suffer runs, thereby becoming insolvent on a cash flow basis (they are already insolvent on a balance sheet basis, as is Fannie and Freddie).
    Since 2000, $10 trillion of phantom bubble wealth has been created in the housing market. Mortgage debt over this period has doubled. Economics will win (it always does) and by my rough calculation $6-7 trillion (in real terms) of housing “wealth” will simply disappear. My guess is that by stretching out the decline (and letting inflation work its magic), the banks and investors will absorb no more than $1 trillion of this real loss, leaving the rest to be distributed among the homeowners and homedebtors of America. People with a lot of equity in their homes will suffer the largest loss of real wealth. Anyone who is underwater on their home today should simply walk away. All the bailout talk should be examined in light of this type of analysis.

  7. Posted by Trip

    What the Fed said today was that it is not going to cut interest rates to prop up the housing markets. See Fed’s comments:
    http://www.federalreserve.gov/newsevents/press/monetary/20071211a.htm
    The Fed expressly stated that it continues to have serious concerns about inflation and it is not going to continue to cut rates and thereby increase inflation. That is why the market tanked on the news of today’s cut — especially banks and lenders.
    Is there enough free cash and strong credit available to SF would-be buyers to put down sizable down payments and qualify for expensive jumbo loans with tighter lending standards? Maybe. But since such a huge percentage of recent SF purchases were made with funny loans that are no longer available, the evidence would appear to indicate that the pool of buyers is smaller with the resulting downward price pressures.

  8. Posted by Foolio

    Hey Satchel,
    Agree in part with you…although if the idea was really to stave off runs they probably should have taken 50 basis points off the discount rate, to help with liquidity. But that’s admittedly a pretty big step.
    I wonder what the reaction’s gonna be to this in the boardrooms. I bet 50 basis points was baked into a lot of deals that are shooting to close year-end.

  9. Posted by Jimmy (Bitter Renter)

    Does anyone still believe that mortgage rates and the Federal reserve rate are correlated in any meaningful way?

  10. Posted by mktwatcher

    Agree with Satchel. Hey, Paulson is a Goldman guy so his lens for evaluating this crisis is likely to be oriented to the view of the investment banks and cdo pricing. Just about the only aspect of a plan that makes any sense is to try to avoid a shock to the economy and instead allow a bit more order to the deflation of the bubble.
    I continue to believe that the signs of erosion will continue to build into 08 for SF real estate. Beyond those who used non-traditional financing, there is simply the concept of ” I will stretch myself now and grow into the payments via salary and equity gains”. Those who stretched will increasingly feel the pressure. Evn if a small percentage of owners are in that situation, I fail to see how a suitable climate for a return to price growth can be created without them and the alternate financers.

  11. Posted by Satchel

    Foolio,
    They have to balance risks of “runs” (we’re really talking about forced asset price declines here in the “shadow” banking system – think asset-backed commercial paper, leveraged loans, CDO and other enhanced structures, etc.) with the dual concerns about (1) a run on the dollar, thereby cutting off external funding possibilities, and (2) literally running out of ammunition (they want to dribble a long series of rate cuts to keep suspense and anticipation as high as possible).
    It’s a tough line to walk. In essence, as I read on a blog somewhere, when you are driving the American Sheeple (or any other cattle-like mass of people), always remember the first rule: NEVER PANIC THE HERD. In the end, though, the Fed will fail, for about 15-30 TRILLION reasons. The ratio of debt to GDP is so high in the US (at more than 350%), that the productive capacity of the economy is no longer capable of servicing it at positive real returns. We need to liquidate about $15-30T of debt in order to bring this ration into some sense of balance (to around 150-200% from around 350% now). Since investors won’t lend at negative real returns, now we are totaly dependent on keeping the illusion going – allowing us to simply roll over the debt. Hence, the terror that the ilusion is cracking. Forget about equity prices and SF real estate prices – the 10 year treasury and the exchange value of the dollar tells the tale.
    No question plenty of board rooms were counting on Uncle Ben to deliver something more than this lump of coal.
    Sadly, a recession is EXACTLY what we need. The deeper, the better, especially because it will be faster that way. In recessions, the misallocated capital gets liquidated, freeing up the productive capabilities of an economy to put its resources towards something with real returns. It’s been very obvious for YEARS that borrowing to “invest” in consumables like housing was a recipe for disaster. Now, we desperately need a wipeout so that those lessons are learned. The best definition of recession that I ever heard: “Recessions are when capital is returned to its rightful owners.” No more $30K per year housing “millionaires” ($100K per year in the Bay Area).

  12. Posted by greaterfool

    Going in this morning, the Funds futures market was pricing in 100% chance of at least 25 bps and 28% chance of 50 bps. So yes, there was some disappointment over only getting 25 bps, but it wasn’t really a surprise. There was more disappointment over 1.) only moving the discount 25 bps (although the Fed may be giving up on the discount window actually being used) and 2.) the language. There’s no formal bias- not a neutral directive, but certainly not a bias towards easing. The disappointment over the language of the text was the most significant. The market’s take-away from this is that the Fed is too slow and patient and behind the curve and will need to ease more later. The better part of another 25 bps was priced in going out into next year. There was some disappointment also over not doing anything to give confidence about liquidity going through year end.

  13. Posted by scurvy

    Dave, why stop at $110? If $110, why not $125? Seriously, what’s a few million between traders? I trade crude futures BTW.
    Rillion, yeah it was pretty obvious on the street that the market needed and demanded its 50 bp crack fix. There were signs all over for the past 2 weeks, you just had to keep your eyes open.
    greaterfool, the feds funds markets never get it right. Everyone wanted 50 bp and was pissed when we didn’t get it. Had nothing at all to do with language.
    Nothing major happened today, just some profit taking. No key levels were breeched, no trendlines were broken, and volume was not particularly high. It was just simple profit taking. It did kill the prospects of a Santa Claus rally, but we’ll still march back up to 1560 and probably hit 1600 before we’re done distributing this to joe 6 pack. Will it happen in 2007? No way. We’ll still get there without a doubt, it will just take a bit longer than expected. Fund managers no longer have the validity to pull out all the stops for a year end rally and try to pull even with the SPX. They’re all underperforming this year and will get squat for bonuses — equity guys are hurting this year.

  14. Posted by FSBO

    scurvy – thank you for your valuable comments. Do you much of a chance of bigger market decline and/or recession in 2008?

  15. Posted by scurvy

    FSBO, I’m more of a trader than an analyst so I’m not big on predictions. I trade what I see, not what I think.
    That said, I bet that we slowly trudge to new highs in the first part of the year. After that we slowly start distributing which will easily be masked in the tape action. Just watch for the VIX to start ticking higher on market “up days.” It’s a sign that the big money guys are buying index protection as they start to unwind a lot of plays. Start selling VIX puts in the 11-13 area once we start heading up past 1525 again; they’re a great way to hedge a long portfolio.
    I don’t think we go down hard in 2008. It’s an election year. Stock prices really are cheap (across the board not in certain cases). Too many people are willing to bottom fish in out of favor sectors (housing, banking, retail). I think we chop and churn for most of the year. It will be a fantastic year for iron condor selling. No selloff, no runup. Running in place, yes. It will be more of a market of stocks than a stock market.

  16. Posted by Unowho

    Aren’t you supposed to say somewhere “not investment advice” or “past performance is no quarantee of future returns”?

  17. Posted by ex SF-er

    we’ll soon see if “greenspan’s conundrum” works in reverse as some have hypothesized
    From 2003 to 2006 the Fed Funds rate went up 4.25% (from 1% to 5.25%) at the same time the Fixed mortgages went up less than 1.5%
    now we’ll see the reverse… Fed Funds rate will continue to drop, punishing savers…
    it will be an interesting intellectual exercise to see if the relationship holds and mortgages DON’T fall much with the Fed Funds Rate, due to increased risk premiums.
    only time will tell.
    what is clear: the market is held up only by the addiction to cheap/free money. it is only held up NOMINALLY, not in real dollars…
    oh well… I wanted to add 5 years to my retirement date… 🙁

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