Federal Reserve & Interest Rates

The slumping housing market sent financial stocks tumbling today for their worst drop in nearly a decade.  The National Association of Realtors issued a report that stated sales of existing homes fell 2.6% in the month of June.

“We are faced with a considerable excess of housing units that is only likely to worsen over coming quarters, and for which there is no quick solution,” wrote Richard Moody, chief economist for Mission Residential.

About a third of sales are distressed sales, either foreclosures or short sales, in which homeowners accept less than they owe on the house, with the lender taking the loss. Many foreclosures aren’t included in the data at all because they are not sold through the Realtors’ multiple-listing service.

At this point no one knows when the housing slump will end.  A number of factors have combined to make it quite difficult for a recovery to happen.

The amount of surplus homes on the market have kept prices falling for an extended period of time.  While this would make it seem like a buyer’s market, demand remains depressed as the general economy worsens and lenders are much more careful about who they loan money to.

The financial sector has been locked in a downward spiral with the housing market as rising default rates have caused hundreds of billions in writedowns as firms have had to scrambled to raise capital.  Before it’s all said and done the final tally could reach $1 trillion.

Mortgage markets are struggling, from originators to insurers and rising interest rates are the result.  The Federal rescue plan for Fannie Mae and Freddie Mac have stopped some of the bleeding for now but while many in the government were hoping they would be an integral part of a housing turnaround that seems farfetched at the moment.

It’s quite obvious that the Federal Reserve is having a difficult time handling the twin threats currently facing the economy, recession and inflation.  This article on MarketWatch states the answer may lie in the past and how this same problem was handled back in the 1980’s.

If the Fed were to loosen monetary policy to combat recession, it would risk juicing up inflation through rapid money growth. And if the monetary mavens were to rein in money growth to battle inflation, they could very well push the already-weakened economy into a recession because of tight credit and high interest rates.

So here is my idea. The Fed should tighten its monetary policy in order to starve inflation of its fuel. Meanwhile, fiscal policy can be loosened a bit further — say by sending out another round of rebate checks - to promote growth.

It is an intriguing idea, the stimulus checks that went out in May have definitely had a positive impact on economic growth and have relieved some of the pressure consumers were feeling from rising prices.  The government would have to act quickly though and with this being an election year, who know how this would all play out.

Tax cuts will always stimulate consumer spending but if the economy has to wait until the next tax season, the current problems will only get worse until that occurs.  The other option of fiscal policy would be to increase government spending but that would also bring more headaches from the already bitter budgetary battles.

The Fed has tried to put as much of a positive spin as possible on the threat of inflation but it seems dissension is starting to grow within their own ranks as the last few interest rate cuts voted on were not unanimous.  The world’s other central banks are also quite aware of the threat of skyrocketing energy prices and for the most part have avoided cutting rates in the face of slowing economic growth.

The Fed can’t go it alone that’s for sure, something has to be done to help stop the bleeding in the housing sector which has been the cause of all our current economic troubles.

Despite the efforts of the Federal Reserve in lowering interest rates to 2%, the market has not passed on theses lower rates to consumers.  In a rate cutting campaign that began last September, the Fed has tried to stimulate financial markets and ease the credit crunch that has been gripping the economy for almost a year.

Unfortunately the housing market is getting worse and that’s not helping matters at all.  With lenders still having substantial exposure to the residential mortgage market, they are being very careful about who they loan money to these days.

Consumer interest rates remain relatively high, from credit cards to mortgage rates and consumer spending is being impacted significantly as a result.  More writedowns are expected in the upcoming quarters so troubled institutions are hoarding as much capital as possible lest they meet the same fate of IndyMac Bancorp.

Back in March many financial experts thought the worst had passed but earlier this week, Fed Chairman Ben Bernanke testified before Congress stating that downside risks to economic growth have risen sharply over the past month.  It is looking less and less likely that the Fed will raise rates in September, as many were predicting in order to finally stop some of the bleeding from skyrocketing energy prices.

It’s pretty much going to boil down to when housing recovery might be possible but with government sponsored agencies, Fannie Mae and Freddie Mac going through their own financial troubles at the moment, it’s difficult seeing them stimulating the mortgage market anytime soon until they get their own house in order.