Fed cuts interest rates to 3.5%

http://news.bbc.co.uk/2/hi/business/7202645.stm

by blackswan • 19 years ago

31 45 19 years ago

news.bbc.co.uk

Dauntless5• 19 years ago

Wait for it:

...

HYPERINFLATION!

Xichekolas3• 19 years ago

Eh, main drivers of inflation right now are food and oil, neither of which is affected a whole lot by fed funds rate. Food prices are high for a variety of policy/trade/weather reasons (corn has skyrocketed due to US ethanol policy), and oil prices are high because, well, it's oil.

mynameishere• 19 years ago

Oil does not cause inflation. Genuine shortages could inch up prices, but there really are no shortages right now. The usual cause of inflation (and the only cause of hyperinflation) is always the same...

http://en.wikipedia.org/wiki/Image:Components_of_the_United_...

eas• 19 years ago

"Inflation is always and everywhere a monetary phenomenon." - Milton Friedman

hugh• 19 years ago

I don't think we're gonna see hyperinflation.

In fact, I'll bet you a million bucks we don't!

david9276• 19 years ago

75 basis points wreaks of desperation.

chime• 19 years ago

Either I'm stupid or Fed is amazingly stupid. I'm not sure which one is the case though I really hope it's me.

The reckless mortgage boom and the ensuing crisis was caused when the Fed cut rates to avoid recession and made borrowing so easy. Now to fix the mess caused by lowering interest rates, they're trying to lower interest rates?

If you're bleeding from your wrists because you slashed your wrist with a knife, you don't slash your arm higher up to stop the bleeding from the wrists. Well true, it does stop you from bleeding from the wrists but now you're bleeding from the upper arm! Of course, you can stop the bleeding there by slitting your biceps. Pretty soon you're going to have to cut off your arm to "stop" the bleeding.

How about they just let there be a recession so the organizations that were investing poorly lose money and go out of business while the investors who were smart and focussed stay in the game?

Dauntless5• 19 years ago

They expect that now when everyone is scared to st, that they will start spending like crazy? Well I somehow doubt that, especially as they didn't fix any of the problems that created the recession. Those people should be sent to jail, the dollar will soon be worthless.

But if you agree with the FED, it should be easier now to get money for your startup... even though 1 million dollars will value about 1000 euros.

comatose_kid4• 19 years ago

I don't agree. I think the Fed should have lowered rates earlier. Lower rates lead to a better lending environment which leads to economic growth. If the Fed had cut more drastically earlier, we wouldn't be worried about a recession right now. And I'll bet the dollar would be even higher, since the world likes investing in currencies that are backed by a strong economy.

There is no need to go through a recession just to make the 'organizations that were investing poorly' pay. The market won't discriminate to that degree (ie, good investments that have nothing to do with housing and have wonderful balance sheets like Apple will also go down).

If you're going to use medical analogies, I'd say that avoiding a rate cut to punish the 'bad' companies is like committing suicide to alleviate an upset stomach....

Anyways, the problems weren't caused by lower rates alone - banks weren't very good at evaluating the risk profile of the people they were loaning money to. And repackaging mortgages to sell them to the 'bigger fool' gave them little incentive to be more vigilant - in fact, it rewarded aggressive lending practices .

I think lenders are now more aware of the problems with this line of thought, which is why they are so reticent to lend now.

Hopefully the Fed will cut again at their next meeting.

Dauntless5• 19 years ago

You clearly don't know what hyperinflation does to an economy. It's not like lowering rates is a silver bullet to economic growth. Lowering rates compromises long term growth for short term growth. "Hopefully the Fed will cut again at their next meeting." ... ahhh, forget about it.

noonespecial3• 19 years ago

Do you ever think that maybe politicians are missing the boat here? With most Americans paying about 75% in total taxes (when you count sales tax, gas tax, property tax, etc etc) it seems we are always just a tiny downturn away from disaster.

If you want your people to spend money and buoy the economy, perhaps instead of making it easy to borrow what they don't have you should try NOT TAKING SO DAMN MUCH from them in the first place. Listen carefully: Money you take from the people and spend in Iraq is gone, mmkayy?

Constantly trying to balance on the razors edge of economic collapse and then issuing even MORE credit (and measly tax rebates) when you've gone too far can't possibly be the optimal implementation.

Ok, sorry, rant over.

david9276• 19 years ago

The wrist bleeding is a poor analogy, but you're right the Fed is pretty ckufing stupid.

The Forest Service used to do the same thing with forest fires. They were considered an anathema and each fire was put out the second it started until the fuel (dry brush, etc.) would accumulate to the point that a single match would give you an unprecedented, unnatural, monstrous firestorm.

We've become so afraid of an economic downturn that rates are slashed at the first chance, etc. At some point, it won't work anymore -- there's just too much fuel waiting to burn.

Put on your asbestos, kids. This one's going to get hot.

dpapathanasiou• 19 years ago

The problem is that credit assets (all those mortgage-backed SIVs & CDOs) aren't trading.

So the Fed is doing what (little) it can to encourage the market in those assets to function again.

Ultimately, though, it cannot force people to take on risks they don't want, so even a large rate cut like this one may not make a difference in this climate.

imsteve• 19 years ago

It's you.

mrtron3• 19 years ago

Interesting chart that shows the market may be worse off than expected:

http://img.photobucket.com/albums/v124/BCStud31/99problems_g...

Psyonic• 19 years ago

Funny, but problems should be on the vertical axis (99 problems...) Something like "Type of problem" should be on the bottom.

Xichekolas3• 19 years ago

I'm kinda sad you got buried for that... I laughed to no end... even if it is off topic.

mrtron3• 19 years ago

I minored in economics and had an amazing prof for monetary economics. Long story short, he worked for the Bank of Canada doing basically what your Federal Reserve chairman does.

The amount of analysis and study that goes into interest rate adjustment is mind blowing. They have 4 teams of experts running amazing models each in a specific technique, and then each team independently reports their results to the board which then decides what action to take. There is literally a mountain of data and factors that come into play.

Anyways, the gross oversimplification of the entire process across the news world today resulted in me posting a dumb (I am glad you also found it funny) picture.

edit: I feel like I am hedging my karma here against people that do not enjoy the odd bit of humour.

edit2: I just remembered a whole lecture that discussed the reason that for interest rate adjustment to work well, everyone has to have full confidence in the federal reserve. So, since confidence levels impact the effectiveness of adjustments, they were probably sitting on this rate hike hoping to do it at the standard time (which was actually bumped up), but to slow the plummeting they took action a bit earlier which may hurt their credibility and the change might not help very much.

wallflower• 19 years ago

Banks can lend out 10 times their assets. When they have to do a write-down, they are reducing their asset base (and the amount they can loan) Does reducing the interest rate help banks (because the way the Fed does it with T-bill purchases)?

mrtron3• 19 years ago

You are slightly confusing the issues at hand here.

Most of the write-downs banks were doing were related to mortgage trading they were doing, not mortgage issuing. There was not _that_ many banks involved in the sub-prime business and losing a lot directly.

Banks are quite well hedged against interest rate flux fundamentally ...since they make prime + x on loans, and pay out prime - x on balances.

Novash• 19 years ago

Ok, call me stupid. I am a coder, not an accountant. Besides, I am Brazilian so I don't even know how american economy works exactly. Can someone explain what's this fuss is all about in good layman terms?

cratuki2• 19 years ago

I'm a coder non-economist also, but have been look at this for a few months and will take a shot at explaining it.

The way the fed aim to control interest rates is via the amount of money that they issue into circulation. The problem is that when the government puts more money into circulation it waters down the value of the money already in circulation, thereby encouraging consumption and some types of investment, and punishes saving by putting money in the bank. You buy goods so that you have physicals and not money which is losing value. Thus, it's quite controversial when a government institution participates in this way in that it is effectively directing the market.

"Austrians School" economists get particularly upset by this sort of practice where a government manipulates the market in order to steer to an outcome because one of the tenants of that way of looking at the world is that free markets lead to better outcomes than when governments try to manage economies. Frederick Hayek labelled the confidence of being able to second guess the market and manage it towards a desirable outcome "the fatal conceit" and there's a great book about it. Hence the way that Ron Paul (also an Austrian) gets stuck into the federal reserve at each opportunity, particularly over stuff like rate rises.

The other aspect, and the reason that the current instability is unsettling and that governments and institutions are doing a lot more than usual to prop things up is structural.

First - let's look at an example of a crash that isn't structural. Back when the dot come crash happened it was pretty simple: a whole lot of people had invested in stock, the market changed its confidence in that stock, a whole lot of people lost money. The banks took money in and paid it out and everything was fine. The market functioned. September 11 was the same even though trading floors had been taken out. None of these things changed the nature of market dynamics.

Now one that has been structural: Friedman blames the depression on the US Federal Reserve for failing to honour its responsibility to supply liquidity to banks who were short of it (as the UK government have recently done to try and get Northern Rock through).

The problem with the sub-prime situation though is that the rot is to do with the core responsibility of banks: managing risk. Banks take money in and loan it out, and make judgements about repayment risk to make sure that they make a net profit. But the change to banking culture that led to the sub-prime crisis was this: it became popular to package debts in certain combinations and sell them off to a far greater extent than had ever been done before. So you could buy certain packages of debt that had been guaranteed to fit a certain level of exposure. Basically this represents large scale outsourcing of bank's core business. (That's a nasty way to put it though, because in fact when you loan money in any sense you're outsourcing risk to some extent and this has always happened, just not to the same extent.)

The sub-prime crisis over the last year has given everyone in the banks the jitters because they've lost some confidence in the risk assessments made by banks they have previously exchanged risk with. Worse, they're not so sure about how much other banks know about their own risk and whether they're being entirely square with the market about it. Thus they start getting very more edgy than usual about short-term loans because the other party might not know what its position is or it might become susceptible to slight changes in the economy. And now the US (where most of the bad exposure was) is slipping into recession... meaning more people will fail on their home loans...

The real problem from subprime is that if the banks stop dealing with one another, you can be certain that economic activity will decline further. This will cause less people will be able to pay their mortgages. This will cause banks who are currently on the edge to slip. In other words - ouch. If there is a crash resulting from lack of confidence it will eclipse the actual value of money lost due to dodgy loans.

Thus, from a certain perspective there is some sense in 'the people' via their elected institutions throwing money at this problem, because even though we're not individually responsible for causing it, it's possible we may be able to buy our way out of it and come out ahead of where we'd be if we had to suffer the consequences of a banking collapse. The problem is - if it is inevitable, then we will have spent a whole lot of money for no good cause.

I can't help but think that monetarists have become too clever by half, and that it would be preferable if we were to all just resign ourselves to having ten year economic cycles. Things are much more highly geared now as a result of a prolonged period of good times and if it gets really nasty there will be a lasting effect in people's psyches that actually limits our ability to get out of it (much as there was in the depression where people saved money even when it was in their interest to participate in some consumption). But time will tell. :)

shimon• 19 years ago

This is a pretty good explanation of the situation. At least as far as I can tell, being a coder who's recently tried to learn a lot about macroeconomics.

One detail that could use correction:

"The way the fed aim to control interest rates is via the amount of money that they issue into circulation."

It's kinda the opposite, actually. When you hear that the Fed's cut its interest rate, that means they've reduced what's called the Discount Rate -- the rate at which the Fed makes overnight loans to major banks. If you're a major bank, and you need some cash, you can get these overnight loans from the Fed or you can take money from other places, and your decision is probably based on whatever's cheapest. Since the Fed is always there as a last resort lender for banks, interest rates for other loans between banks and from banks to businesses will generally reflect changes to the Fed Discount rate. That's how the Fed rate has a rippling influence on liquidity supply throughout the banking industry.

Of course, the thing that's special about the Fed is that, unlike typical banks, it's not loaning out assets it has on deposit. It's creating new money when someone takes out a Fed loan, and it's destroying that money when the loan is repaid. Since this increases the money supply, it risks creating inflation if the economy isn't growing proportionately. High inflation is bad because it encourages spending your money now rather than investing it, and long-term growth depends on a lot of investments -- education, equipment, research, etc.

dcurtis• 19 years ago

I keep hearing the word "recession," but no one has exactly defined what that is, or if we're "in a recession" yet. Are there values that define when you can say we're in a recession?

Dauntless5• 19 years ago

A recession is a decline in a country's gross domestic product (GDP), or negative real economic growth.

bayareaguy• 19 years ago

A decline in GDP for two or more consecutive quarters.

jey• 19 years ago

This seems apt: http://news.yahoo.com/nphotos/Ben-Bernanke-Ben-Bernanke-Fede...

misterbwong• 19 years ago

Recommended reading for anyone interested in what's going on in the world economy. These are just starting points.

http://www.marketthoughts.com/z20060921.html (yen carry trade)

http://en.wikipedia.org/wiki/Fiat_currency (fiat currency)

Fed cuts interest rates to 3.5%

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