Federal Reserve & Interest Rates

There are several mixed messages regarding whether or not the United States is facing a recession. We need to take an objective look at the economic factors, and understand that the data speaks for itself.

President George W. Bush recently made the statement that “Recent economic indications have become increasingly mixed.” His statement cannot be more accurate.

On the one hand, we have the sub-prime housing market slowing down the economy overall. Problems that stem from the decline of this market include tightened liquidity in the markets and bank lending ability, low consumer spending, increased unemployment in real estate, construction, and housing related retail. On the other hand, employment in most service-producing industries moved up, production in high tech industries increased modestly, and an increasing demand of exports has offset the higher cost of imports due to the declining dollar. The unemployment rate has held steady, as some businesses are profiting, and housing related business are slipping.

So, are we in a recession already? According to several economists, yes, we are already in a recession.

The dictionary definition of recession is “A period of slow economic growth,” according to Webster’s New World Finance and Investment Dictionary. If I use this definition, I would have to honestly admit that we are facing a recession right now. If you take a look at the minutes from the last FOMC meeting, there is plenty of economic slow down going on.

The chief economist of investment bank Merrill Lynch, David Rosenberg stated, “According to our analysis, this [recession] isn’t even a forecast any more but is a present day reality.”

Expert Martin Feldstein says that we need some serious tax cuts and further interest rate cuts by the FOMC. He isn’t convinced that we have hit a total ‘recession’ and more actions can help avoid it. He does, however, admit that recession is likely.

Whether you believe there is a recession happening now, or there will be one soon, doesn’t matter. The fact of the matter is that our economy is not as resilient as it once was, and it is starting to hit all of our wallets, bank accounts and investments. This year could take a turn, but it will take at least several months before there is enough positive economic data to restore the strength and growth rate of the U.S. economy.

The Federal Reserve Board of Governors has an open meeting today at which they will propose amendments to the Truth in Lending Act (TILA). Focus will be on Regulation Z of TILA, which contains most of the specific compliance regulations for lenders. The issue at hand is the warding off of abusive lending practices.

There are several amendments that are being discussed at today’s meeting. They include:

-Improving the screening process to help lenders better determine the borrower’s ability to repay loans.
-Prohibiting or limiting loans that do not require proof of income.
-Requiring lenders to ensure that borrowers have budgeted for taxes and insurance payments (especially sub-prime borrowers)
-Prohibiting penalties for prepayment on loans (for sub-prime borrowers)
-Regulate advertising, offers, and ‘teaser’ rates to limit confused or otherwise mislead borrowers.

The Board of Governors will discuss and vote on these issues at there meeting today. After public discussion, and perhaps further research, these amendments will go into effect. These adjusted regulations are being proposed in the hopes that there will be less foreclosures in the future.

At present, banks are already encouraged to work with borrowers as much as possible to avoid unnecessary foreclosures. As of today, we are still staring recession n the face. Stock market performance yesterday left much to be desired.

The President declared a mortgage freeze that will hold initial adjustable mortgage rates at the starter rates for five years. This will only affect sub-prime borrowers, and save them on interest.

The Fed is working to make sure that all borrowers fully understand the terms and conditions of their loans. Hopefully the amendments to Regulation Z will thwart abusive lending practices, and less people will have overwhelming debts that they can’t keep up with. Ultimately, the effort should help to slowly boost the economy over the long term.

The Federal reserve Board of Governors approved a new plan to “help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress.” This arrangement, called the Term Auction Facility (TAF), along with Foreign Exchange swap lines, is set to take effect Monday, December 17th.

“Each TAF auction will be for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate). The first TAF auction of $20 billion is scheduled for Monday, December 17, with settlement on Thursday, December 20; this auction will provide 28-day term funds, maturing Thursday, January 17, 2008. The second auction of up to $20 billion is scheduled for Thursday, December 20, with settlement on Thursday, December 27; this auction will provide 35-day funds, maturing Thursday, January 31, 2008.”

According to the press release, third and fourth auctions are planned for mid January and January 28, 2008. Bids will be submitted by depositories through their local Reserve Banks. The minimum bid rate is to be figured at the OIS, overnight indexed swap, rate relative to the maturity of the credit being auctioned.

The Bank of Canada, the Bank of England, the Swiss National Bank, and the European Central Bank are all involved in the effort to address the elevated pressures in short-term funding markets. The U.S. Federal Reserve has arranged for FOREX swap lines with the European Central Bank and the Swiss National Bank. Basically, securities can be used as collateral for liquid funds for lending purposes.

The swap lines are approved for six months, tentatively.

The mortgage problem is expected to only get worse. Another 500,000-700,000 foreclosures are anticipated. If the value of homes drops more than 30%, there could be more than 20 million homeowners with negative equity.

Recession is still a looming fear. It is time to buckle down on spending, pay back as much debt as possible, and hold on tight. It is going to be a bumpy ride in 2008.