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Stock Market Panic:
What Happens Next?
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Expect the Federal Reserve to cut key interest rates at least one more time before the year is out. The central bank's widely expected decision to lower the benchmark federal funds rate for the first time since June 2003 -- this latest move reduces it by a half percentage point to 4.75% -- will soothe the ailing economy as banks follow the Fed's lead and cut their prime and other lending rates charged to individual and business borrowers.
Lower rates will also make life less onerous for many homeowners. Some holders of adjustable rate mortgages (ARMs) will see their interest payments ease as a result of the Fed's move -- very welcome news for borrowers who are unable to refinance into a fixed-rate loan when their ARMs lose their low introductory rates. Meanwhile, rates on home equity lines of credit, which are typically tied to the prime rate, will also fall, easing the strain on homeowners' cash flows. The Fed, prior
to this rate reduction, had left the fed funds rate unchanged since June 2006 and had raised it 17 times in the two years before then.
But the Fed's actions won't solve all of the housing market's problems. Oversupply of unsold houses, combined with the tougher standards for getting a mortgage that lenders have adopted this year, will continue to sap the market, leading to further average declines in home values. That's likely to continue well into next year, until the oversupply is largely worked off. The National Association of Home Builders' just-released member survey portrays a housing market that is in the worst shape in 16 years. What's more, builders think it'll be even worse six months from now.
The Fed's latest rate decision is good news for credit markets. In addition to the decrease in the federal funds rate, the Fed also lowered its discount rate by a half percentage point to 5.25%. This move, which follows a half-point reduction of the discount rate a month ago, is aimed at unblocking the flow of funds in the credit markets by making available affordable liquidity to banks. By doing so, the Fed is implying that investors are still shying away from the credit markets, particularly any loans backed by assets such as mortgages and credit card debt.
Banks have had trouble issuing commercial paper to raise short-term funds because investors don't want to touch any backed by mortgages -- or any other asset, for that matter, given uncertainties in the financial markets. The Fed is essentially now giving banks a cheap way to borrow the funds they need, and the Fed will accept some asset-backed paper as collateral. This will also prompt the banks to start buying asset-backed securities again from big businesses that also need them to finance purchases and investments.
Activity in the commercial credit market has been virtually at a standstill since early August. Carl Tannenbaum, chief economist with LaSalle Bank, says, "We've gone from a flood [of credit] to a desert." If this were to continue, it would put a serious damper on the U.S. economy and could well push it into a recession. The Fed is hoping that its latest move keeps the recession specter at bay.
The next 30 days will be key, as commercial paper sellers who have backup agreements with banks may dump the problems on the bankers' doorstep. About $650 billion in commercial paper will hit maturity in the 30 days alone, creating a major test. If lenders balk at extensions, the Fed may cut rates again.
Already, some want the Fed to signal more rate cuts ahead. That would help, but market watchers say that this credit crunch is like a fever that needs to run its course. Mike Moran, chief economist with Daiwa Securities America, says, "The Fed can't bring that about. It will take time for the financial markets to sort it all out."
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POSTED BY: Rodger M Mitchell (September 19, 2007 06:31 PM)
Once investors realize the interest rate cut does absolutely nothing to stimulate GDP, which ultimtely is the basis for the stock market, the market will drop like a stone. Never in our history, has a rate cut improved GDP. It can't. Only the addition of money can stimulate GDP.
This means the government must cut taxes and/or increase spending, i.e. increase the deficit.
Did you know:
1. All money is debt.
2. A growing economy needs a growing supply of money.
3. Therefore, a growing economy needs a growing supply of debt.
Presidents Reagan and Roosevelt learned that. They increased the deficit and stimulated the economy.
President Clinton learned it the hard way. He ran a surplus and introduced a recession, which President Bush cured by increasing the deficit.
Learn from history.
Rodger Malcolm Mitchell
www.rodgermitchell.com
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