The Federal Reserve entered a new era Tuesday, lowering its benchmark interest rate virtually to zero — for the first time in its 95-year history — and declaring that it will now fight the recession by pumping out vast amounts of money to businesses and consumers through an expanding array of new programs.
Q: What's the good news in the Fed's actions?
A: The Fed's decision to nudge its key fed funds rate to a range of zero to 0.25% — along with its plans to buy securities that are backed by mortgages — should mean lower consumer interest rates, particularly mortgage rates. Low mortgage rates mean that more people can afford to buy houses, which will help revive the moribund housing market. A drop in mortgage rates will also allow homeowners to refinance their loans at lower rates, easing some of the burdens of their debts. Low rates also make it cheaper for companies to borrow and expand. That, in turn, is a powerful economic stimulus. Most major banks, including Bank of America and Wachovia, lowered their prime lending rate to 3.25% from 4% Tuesday.
Q: What's the bad news?
A: The Fed wouldn't lower rates this far and signal its willingness to take a host of unconventional actions if the economic situation weren't so dire. The nation is entering the 13th month of a recession, and the unemployment rate hit 6.7% in November, up from 4.7% a year earlier. The Fed is worried about an extremely severe recession and the outlying possibility of deflation — a persistent decline in prices. In a deflationary period, the value of assets falls, but debt payments become more onerous. At this point, deflation is not a major concern. But the Fed is monitoring conditions.
A: The Fed wouldn't lower rates this far and signal its willingness to take a host of unconventional actions if the economic situation weren't so dire. The nation is entering the 13th month of a recession, and the unemployment rate hit 6.7% in November, up from 4.7% a year earlier. The Fed is worried about an extremely severe recession and the outlying possibility of deflation — a persistent decline in prices. In a deflationary period, the value of assets falls, but debt payments become more onerous. At this point, deflation is not a major concern. But the Fed is monitoring conditions.
Q: Aren't such low rates and policies inflationary?
A: In theory, they can be. But at the moment, inflation is deader than King Tut. The government's consumer price index fell 1.7% in November, the second-consecutive record decrease.
A: In theory, they can be. But at the moment, inflation is deader than King Tut. The government's consumer price index fell 1.7% in November, the second-consecutive record decrease.
Q: Will lower rates hurt the U.S. dollar?
A: They did on Tuesday: The dollar weakened against the euro and Japan's yen. Should those countries lower their interest rates, however, the dollar would likely rebound. Money typically flows to the currencies with the highest interest rates and the greatest safety.
A: They did on Tuesday: The dollar weakened against the euro and Japan's yen. Should those countries lower their interest rates, however, the dollar would likely rebound. Money typically flows to the currencies with the highest interest rates and the greatest safety.
Q: The Fed has never targeted an interest rate range before. Why now?
A: More as a practical matter than anything else. A zero-percent interest rate is hard to achieve. The range gives them a small margin of error. Further, as the Fed has dramatically expanded lending to financial firms and its balance sheet, it has also become harder to manage the funds rate.
Q: Does the Fed have a target in mind for mortgage rates?
A: No, but there's little doubt that the Fed would like lower mortgage rates, which is why the Fed is considering buying mortgage-backed securities.
If banks can sell their mortgage loans to investors — including the Fed — they will have more money to make new mortgages. A senior Fed official, who would not speak for attribution, told reporters Tuesday that it could be self-defeating for the Fed to set a target for mortgage rates. Instead, the Fed will monitor housing and economic developments to determine future actions.
Q: What does this mean for savers?
A: Lower returns. Rates on bank CDs and money market mutual funds closely follow the fed funds rate. Money funds, which invest in short-term, interest-bearing securities and distribute the income to investors, might be particularly squeezed. The average taxable money fund aimed at individual investors charges 0.86% a year in expenses. Three-month Treasury bills yield 0.03%.
Q: What is the Fed trying to do?
A: The Fed is pulling out all the stops to revive business and consumer lending and get the economy moving. The central bank is particularly focused on the wide difference, or spread, on interest rates between supersafe Treasury bills, for example, and market-based loans for autos, homes and other purchases.
Fed officials think the wide spreads are due to a lack of liquidity, as lenders pull back. They hope that by flooding markets with cash, using such strategies as buying mortgage-backed bonds, they can bring interest rates down and relieve such pressures.
The Fed has so far confined its programs to making loans by using high-grade securities as collateral. It could consider dipping into some riskier markets going forward, but only with backing from the Treasury Department to absorb some losses.
In summary, if you are a homeowner that has been waiting to refinance your home, now may be the perfect time! And if you are a home buyer, now may be a good time to lock in!
article courtesy of USA Today
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