Federal Reserve & Interest Rates

Governor Kevin Warsh, member of the Federal Reserve Board since February of 2006, delivered a speech on Financial Market developments on Friday to the State University of New York at Albany’s School of Business.

He opened with warm greetings, as he was born and raised in Albany, New York. He briefly reflected on his growth in his recent position as Special Assistant to the President for Economic Policy and as Executive Secretary of the National Economic Council (since 2002).

After briefly addressing the general responsibilities of the Federal Reserve as a whole, he proceeded with his discussion on current issues. He made the introductory point, “While the subprime-mortgage markets showed some of the earliest and most pronounced indications of weakness, I believe that problems afflicting the subprime-mortgage markets served more as the trigger than the fundamental cause of recent market turmoil and economic uncertainty.”

Governor Warsh went on the explain the responsibilities of the Federal Reserve, monetary policy, and the current market conditions. He says that the subprime lending was the spark but not the cause of the recent economic instability.

He ascribes the cause to a combination of things. One main argument that he presented was the high performance of the market in June. He stated that investors become overconfident in the high performance, and consequently made decisions that were not as secure as they seemed on the surface. He explained, “High levels of confidence, perhaps even complacency, were also observable in the behavior of many financial intermediaries.”

Governor Warsh did make it clear that there was an investment pullback of investors in “a broad range of structured products, even though unrelated to mortgages.”

The increase of mortgage delinquency rates also contributed, as we know, and Warsh says, “…it may be that investors fundamentally lost confidence in their ability to value a broad range of assets, particularly those that rely on robust securitization and secondary markets. Moreover, uncertainty about the ability of large financial institutions to fund their commitments eroded confidence in counterparties more generally.”

Warsh did not claim that the Federal Reserve has all the answers regarding the path of our economy. “How quickly markets normalize may depend on the speed with which investors and counterparties gain comfort in their abilities to value assets.”

He concluded with the intent of the Federal Reserve to make moves that are with the interest of creating long term economic growth, and their continued efforts to access each new development as economic uncertainty still looms.

Governor Kevin Warsh offered an expanded view on the contributing factors of economic conditions. He is a proud member of the Federal Reserve and plans to serve his full term, until 2018.

GET THE FULL SPEECH HERE

There are some concerns about the record lows of the Foreign Exchange worth of the dollar. The United States currency has been weak to the Euro in particular for quite some time, reaching an all time low with the Euro valued at $1.40.

There are a variety of factors that have contributed to the falling value of the dollar. The most obvious contributing factors have been the long term tax cuts, energy prices and the war in Iraq.

The Euro is reaching all time highs, and some are saying that it is not so much that the dollar is slipping, but the Euro is rising. While that has been a struggle for years, there is a rise in the Canadian dollar as well. For the first time in about 30 years, the Canadian dollar valued at a 1 to 1 ratio with the United States dollar.

The recent rate cut by the Federal Open Market Committee has little to do with the continued slip of the dollar. For the time being, it was still a necessary move to keep the United States economy, not necessarily thriving, but more like staying afloat with a life preserver on.

The facts and figures show that under the current presidency, compared to the previous one, the economy has been on a downward slope. “Clinton did in fact produce favorable results in jobs, unemployment, national debt, poverty, and important economic factors like property ownership. Under the Bush Administration, every indicator but Productivity has slipped significantly.”

The comparison of the economic performance of the past is neither here nor there, but the fact of the matter is, things are pretty vulnerable at this point. Chairman of the Federal Reserve Ben S. Bernanke stated in his recent testimony on Subprime mortgage lending and mitigating foreclosures that “Recent developments in financial markets have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.”

In his speech, he reviewed most of what we already know. The lenders have suffered losses and the Federal Reserve are investigating lending practices. The Fed is encouraging moves that work with borrowers to help avoid delinquency and unnecessary foreclosures.

The only thing we can do now is wait. I hope and pray that the economy holds up. The strong implications of instability of the economy and the possibility of recession still linger above our country, and it is rather unsettling.

Yesterday at the Federal Open Market Committee (FOMC) meeting to major cuts were made. The long awaited federal funds rate was reduced by ½% and an additional ½% cut was made to the discount rate, which was also cut back in August.

The FOMC made this decision largely because of the risk of recession. According to yesterday’s statement, the action was intended to prevent the adverse effects on the overall economy. It was to stop problems “that might otherwise arise from the disruptions in financial markets.” The FOMC also stated that the move would “promote moderate growth over time.”

While market performance is on the rise, “the Committee judges that some inflation risks remain…” They have to deal with one problem at a time.

The FOMC will be keeping a close eye on inflation in the coming months. If there is another action that can be taken to keep pricing down, they will certainly consider it.

There are some questions about how this will affect borrowers. Apparently, this cut will liquidate the markets and keep the economy out of a recession for now, but it is highly unlikely that banks will be lowering the interest rates on loans, mortgages and credit cards. While a good move for the general economy, borrowers aren’t getting direct relief from high rates.

The economy, while quasi-stable at this time, is still in need of help. Remember, the major cause of the market downfalls was the fact that there is a severe amount of sub-prime mortgage lenders losing investments on individuals who just can’t afford their payments. With foreclosures still at an incline, something more direct will have to be done in the future.

The problem is not, however, being ignored. Earlier this month, September 4th, the following statement was released:

“Federal Financial Regulatory Agencies and CSBS Issue Statement on Loss Mitigation Strategies for Servicers of Residential Mortgages

The federal financial regulatory agencies and the Conference of State Bank Supervisors (CSBS) on Tuesday issued a statement encouraging federally regulated financial institutions and state-supervised entities that service securitized residential mortgages to review to determine the full extent of their authority under pooling and servicing agreements to identify borrowers at risk of default and pursue appropriate loss mitigation strategies designed to preserve homeownership.

Significant numbers of hybrid adjustable-rate mortgages will reset throughout the remainder of this year and next. Many subprime and other mortgage loans have been transferred into securitization trusts that are governed by pooling and servicing agreements. These agreements may allow servicers to contact borrowers at risk of default, assess whether default is reasonably foreseeable, and, if so, apply loss mitigation strategies designed to achieve sustainable mortgage obligations. Servicers may have the flexibility to contact borrowers in advance of loan resets.

Appropriate loss mitigation strategies may include, for example, loan modifications, deferral of payments, or a reduction of principal. In addition, institutions should consider referring appropriate borrowers to qualified homeownership counseling services that may be able to work with all parties to avoid unnecessary foreclosures.

The statement, which was issued by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the National Credit Union Administration, and CSBS, is attached.”

Hopefully, the strategy will help lenders to identify borrowers at risk of foreclosure before delinquency, and therefore help people retain ownership of their homes. This will in turn help lenders to maintain the return on mortgages, and keep the overall economy out of a credit crunch.

With the next scheduled FOMC meeting more than a month away, it is in the hopes of everyone that this action will stabilize the economy and promote future growth.