Federal Reserve & Interest Rates

Tuesday, the Federal Reserve announced the results of Monday’s $50 billion Term Auction Facility (TAF).  This is the eighth TAF since the program was initiated back in December 2007.  The total amount that has been awarded as short-term loans to bidding banks is $260 billion.  This is an ongoing program that will continue until credit liquidity is stabilized.

Over $88 billion in bids were submitted on Monday, with $50 billion worth approved.  The stop-out rate for these 28-day credits (set to settle tomorrow, March 27th) is 2.615%.  This is the lowest rate the Federal Reserve has offered since the TAFs began.  There were 88 participants in the propositions.

The lending was initiated in December as part of the Federal Reserve’s effort to stop the effects of the credit crunch stemming from the sub-prime mortgage crisis.  Increase the liquidity in banks allows them the ability to lend to businesses and individuals for homes, cars, equipment and expansion.  The country thrives on credit, so it is extremely important to have increased flexibility in lending because the system cannot function with tight credit conditions.  That is why the Term Auction Facility was created.

The European Central Bank is taking similar actions.  Banks in need of cash flow were awarded a total of just over $77 billion in short-term loans.

We are undeniably suffering from major economic slowdown in this country. Some economists say that we are in recession, but the overall word is that this is just a slowdown.  Data suggests that there is definitely a slowdown, and whether or not we call this a recession is a matter of semantics.  Many are still not willing to call our situation a recession, while some have said that we have been in a recession for several months already.

Regardless of terminology, the economy has slowed down considerably, and there is a risk of it getting worse. If it gets worse, more will begin to say that we are officially in recession.  The Federal Reserve is not ready to call it that, and they are making as many moves as possible to avoid it, including Term Auction Facilities.  Hopefully, the TAFs will keep credit loose enough to keep credit conditions from becoming to tight.

The Federal Reserve has reduced the interest rates to the lowest point in three years, with yesterday’s cut being 75-basis points. What does this mean for consumers? The rates only directly affect the amounts that banks have to pay to borrow on a short term basis. As a result, the banks may eventually choose to reduce the interest rates that they charge borrowers. The downside to lower interest rates, however, is that interest bearing accounts consumers are using to save money will earn less.

Borrowers with short-term adjustable rate loans and credit cards will probably begin to see a reduction in monthly payments and interest charges. Those that have good credit will benefit the most from this. Short-term loans like personal loans, auto loans, and equity loans, may actually see a visible difference in their monthly billing statements. Those with adjustable rate mortgages may also see lower payment requirements. Borrowers with poor credit, high revolving balances, and habits of defaulting or only paying the minimum, may not see the benefit of the rate cuts.

Those trying to save money through interest bearing accounts may be a bit disappointed. Money market accounts and certificates of deposit (CDs) accounts will not be yielding as much as they were even a couple of months ago. Savings accounts may not offer the same interest earning appeal as they did before. There are still some internet banks that offer higher rates that could benefit those who are looking for a higher interest yield on their savings. Even though there is a higher return on many internet banks, rates are lower for those accounts than they once were.

The other downside for consumers is the risk of inflation. When rates are lower, it leaves room for pricing increases. Prices may begin to rise again, even though they held steady on average last month. Addition cuts may trigger further rises in costs. Meanwhile, savings accounts will be bearing less, as I mentioned.

Overall, debt will be easier to pay back, while saving money for the long term will be a bit more challenging in the months ahead.

The Bush Administration is instituting a new plan to help homeowners who are facing foreclosures. The new plan, called Project Life Line, will affect a great deal of borrowers that are in danger of losing their homes.

The plan specifically addresses every homeowner who has been delinquent 90 days or more. The Treasury Department, and the Department of Housing and Urban Development are announcing this morning. Serious delinquencies headed for foreclosure will be paused for 30 days so that borrowers can communicate with lenders to work out more affordable payment terms. All foreclosure activity for these homeowners will be suspended for a month, including all stages of foreclosure.

Mortgages held by six major chain banks are already a part of Project Life Line. These are Bank of America Corp., Citigroup Inc., Countrywide Financial Corp., JPMorgan Chase & Co., Washington Mutual Inc. and Wells Fargo & Co. Other lenders will hopefully become involved in the plan as well.

This plan will affect a broader base of home owners that last year’s Hope Now plan. There was a series of criterion that had to be met to qualify for the assistance program. With the new Project Life Line plan, anyone who has defaulted 90 days or more qualifies.

Home prices have been falling and those who borrowed against their equity expecting to sell or refinance now owe more than the worth of their homes. Even those individuals will excellent credit ratings are struggling with high payments. Many adjustable-rate mortgages set up low payment plans for the beginning of repayment, but require higher payments down the line. Since home values have gone down, refinancing would come up short of what borrowers in these situations now owe, and payments still tend to be unmanageable.

With this foreclosure freeze, many borrowers that are in trouble will hopefully be able to work out affordable plans or refinance their mortgages so that they can keep their homes. The six major lenders will be very busy for the next month, as the Project Life Line plan appeals to a broad base of homeowners at this point. Combined with rate cuts and the new fiscal stimulus plan, the rapid increase in the number of foreclosures may slow down. The combination of these positive moves is a step in the right direction.