Release Date: December 16, 2008
The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.
What’s up with the “range” of rates? Well, they’d look pretty foolish if they said they wanted the rate to be at .25% and the market was already trading fed funds futures at .14% as of this morning. Calling the rate at .25% would be sort of like predicting yesterday’s weather.
Since the Committee’s last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. No arguments there. Financial markets remain quite strained and credit conditions tight. I’m not sure that a lot of people are as aware of the strain on the financial markets as they should be. Overall, the outlook for economic activity has weakened further. Enough said there….
Meanwhile, inflationary pressures have diminished appreciably. Saying that inflationary pressures have diminished is being modest. Inflation is dead for now. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters. For inflation to moderate any further, deflation will become a huge issue. Let me rephrase that, in light of the Consumer Price Index report this morning, it’s pretty apparent that deflation is an issue.
The Federal Reserve will employ all available tools (available tools – oh and since we’re running out of ammo in our normal tools, we’re going to come up with some new ones. We hope that they work and we hope that they persuade people to start spending and borrowing money again) to promote the resumption of sustainable economic growth and to preserve price stability. Price stability – yeah, we are kind of concerned about that deflation thing and we’re afraid that all of the money we are printing is going to have a very negative effect on the value of the dollar and the value of our stock market investments, but we’ll worry about that some other time. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time. You know the era of cheap credit? That period that Fed Chairman Bernanke presided over that created the credit bubble that is in the process of bursting? The one that has inflicted so much pain over the last year or so? We want that back and we’re going to keep rates low for as LONG as we have to in order to get people to start getting back into debt and engaging in “retail therapy.”
The focus of the Committee’s policy going forward will be to support the functioning of financial markets we need to make sure the banks not only stay solvent, but also start writing more loans and stimulate the economy through open market operations Open market operations – I think we can translate that into – we’re going to buy mortgages, buy treasuries and buy lots of other things (virtually anything) in order to keep the markets moving to keep the borrowers borrowing and keep the spenders spending and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. High level – they’ll print as much money as they have to in order to get the economy going. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. We already said that we’re going to buy $500,000,000,000 and if conditions warrant (meaning if we need to and if it makes a difference) we’ll buy more. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities We can’t really figure out what good that would do, but it sounds good to say that we’re evaluating it. There are a lot of other things we’re evaluating too. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses translated – to buy credit card balances and car loans off of banks so they can go make more loans.. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity. We’ve got a printing press and we’re not afraid to use it.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.
Tom here – as I’m sure you could figure out, my comments are in bold and the italics are the actual written text. A couple of thoughts about it further:
- We truly are in historic times and I’m not sure it’s a positive thing. The fact that our government is lowering rates that far due to economic stress is quite something.
- There are several “lengths” of Treasuries are currently yielding less than .25%. As of yesterday, 3 month Treasuries were paying a negative .3%. Essentially that means that when someone buys a 3 month Treasury bond, they are saying, I’ll give you my money for 3 months and I’ll pay you for the privilege of knowing that I’ll be able to get 99.7% of the principal back. That shows that all isn’t well in the economy.
- When the Japanese lowered their rates to zero in the 1990s, it really didn’t work out very well for them.
- Like I’ve written previously, the fact that short term rates are plummeting doesn’t necessarily mean that long term rates will follow. We’re talking apples and oranges and the oranges are impacted by things that the apples aren’t. One of the big differences is that the long term rates can’t be manipulated by the Fed the way short term rates can. The Fed can say, “We’re going to .25% for short term rates.” However, for long term rates to drop, the market has to be inclined to push rates in that direction. How can it do that? The direction of short term rates does have an impact. However, so do things like inflation, deflation, the value of the dollar, investor appetite for mortgage backed securities and the overall direction of the economy. So, don’t hold your breath waiting for 4.5% or any other particular rate because who knows whether it’s going to happen.
- The stated goal behind this effort to lower rates is to get the housing market going again. According to information I read, assuming the average price of a home in the nation (a little over $220,000) and a 20% downpayment, a 1% drop in rates would make approximately a $90 a month difference. Is that enough to get the housing market going?
- The long term effects of the type of market intervention that the Fed is doing are not known yet and I really think we’re going to find that unintended consequences are not going to be fun.
So, do I expect mortgage rates to drop a little bit? Yes I do. Do I expect the “euphoria” in the stock market to last? Not for very long – maybe until after the New Year. Do I expect that these attempts to help the economy will be successful? No I don’t. And why not? Because they don’t deal with the number one problem right now and that is consumer confidence.
So what is the answer? It can be described in 1 word (four letters):
JOBS
Stay tuned.
Robert Kerr says:
So what is the answer? It can be described in 1 word (four letters): JOBS
I agree. 100%.
But with an economy that is 75% consumption, is it even possible to restart our job engine without first changing the fundamental make-up of our GDP?
It seems to me that an economy based so heavily on consumption is mathematically unsustainabale over the long term.
In other words: We can’t consume our way back to prosperity.
Agreed?
December 17, 2008 — 5:31 am
Tom Vanderwell says:
A couple of thoughts:
1. I’m not so sure that it’s a matter of changing the GDP as it is changing us from a credit to a savings society. People are learning that they need to save more than they currently are and stop borrowing for everything.
2. A variation on your last statement – we can’t borrow our way back to prosperity?
Tom
December 17, 2008 — 6:19 am
Jeff Brown says:
Superb effort, Tom.
As I’ve been saying for the last year or so (in our phone conversations sometimes), though I firmly believe inflation results from overuse of the Treasury’s printing press, it still must be putting more money in the economy than can be efficiently used. The analogy might be the addition of water into a glass. If the amount of water added overflows the glass, we have inflation. If the glass retains some capacity, it ain’t inflation.
Jobs certainly will do wonders, but your point about saving vs credit hits the mark. It reminds me of the old caveat —
Borrowing continuously from Peter to pay Paul often results in a sore Peter.
December 17, 2008 — 9:41 am
David Shafer says:
Hmmm, first you are right it is all about jobs.
Next, I really don’t think eliminating debt is the be-all of everything. Debt has made this world go round for over 100 years and will continue to. That is not to say that overleveraged investment banks weren’t wrong or that giving everyone a real estate loan isn’t stupid, but in Clinton’s last few years we were starting to get a handle on the national debt. Hopfully, in the next growth period we will do the same.
As for any comparision to Japan, it doesn’t fly. For example the asset bubble in Japan was at a very different place than here. The average P/E ratio for Japanese stock market peaked at 80. We were never above 25 and now we are at 12-14. The value of Japanese real estate went up to the point that its total value eclipsed the total value in the US a country many times as large.
Finally, I don’t buy that the only good jobs are manufacturing jobs. We are moving to a society that is based on creativity and information, which are jobs just as useful as any on the automobile lines!
Down the line inflation is a given because of all the government spending, but if we continue to increase productivity we can keep it under control.
December 17, 2008 — 11:01 am
Joe Strummer says:
The difference between 2004-2005 and today is that in 2004-2005 you had historically low rates – 5.5-6.0 – coupled with a willingness to lend to anyone who had a pulse. That meant a lot of credit was pushed out into the market, which was inflationary with regard to lots of things, but most particularly housing. That’s what a credit bubble is.
Today you have extremely low rates – 4.5-5.0 – but much more restrictive lending as compared to 3 years ago. That means that the effective credit availability in the marketplace is FAR lower today than it was in 2005, and that would be the case EVEN IF THE mortgage rates went to below 4.0 percent. Why? Because banks who were willing to loan money at low rates because they believed they would be repaid, are no longer confident that they will get money back from risky borrowers.
(They were confident they would get the money back from such borrowers in 2005 because it looked like the rise in market prices would at least mean they could foreclose on a home worth more than the loan. But we can’t recreate that now.)
The result is that fewer loans are going to be made until the point at which banks have some confidence that borrowers are good bets. Inflation will be bottled up, until that point hits.
But when that point hits, the balloon of credit now housed in banks is going to explode a second time. This time it’s going to cause a massive inflationary effect that will be rapid and sustained.
The only way this can be averted is for the Fed to rapidly raise the price of credit and reduce the money supply, which would mean mortgage rates at 20-25 percent. That will kill the market, but at least it would get the money supply in check, and keep us from facing runaway inflation.
Buy gold.
December 17, 2008 — 12:17 pm
Kam Hubbard says:
Jim Cramer is now bullish on Ben Bernanke and predicts mortgage rates below 4% by Spring 2009: http://www.cnbc.com/id/28264766
December 17, 2008 — 12:46 pm
Dave Phillips says:
“Do I expect the “euphoria” in the stock market to last?”
I’d call it schizophrenia.
It is hard to buy into the save more spend less when we witness a fed policy copied from a Doritos commercial – We’ll print more!
December 17, 2008 — 1:24 pm
Jeff Brown says:
‘Jim Cramer is now bullish on Ben Benanke…’
For the record, I’ve, for better or worse, time will surely tell, been a Bernanke Kool-Aid mixer/drinker from Day 1.
He’s said from the moment he was confirmed that saving real estate was the #1, 2, and 3 tasks on his A+ list. He’s done his way, but he’s avoided total collapse, which is the only victory available.
December 17, 2008 — 4:32 pm
Robert Kerr says:
He’s said from the moment he was confirmed that saving real estate was the #1, 2, and 3 tasks on his A+ list.
If Bernanke’s trying to save real estate then he’s doing it all wrong. Neither credit access nor mortgage rates are a major problem … yet that’s precisely where his recent actions are focused.
When affordability returns, when price:rent and price:income come back down to the long term ratios, then real estate can start to recover, and not a moment sooner.
Trying to keep prices propped up with monetary policy isn’t going to help.
December 17, 2008 — 7:51 pm
Sean Purcell says:
Tom,
Another great post. Lots of interesting comments too. Here’s my two cents worth:
Tom, you and I have discussed many of the aspects that affect housing, rates, inflation, macro-economic movement and whatever arcane econ stuff for quite some time now. We both enjoy it more than most (maybe too much?). So here’s my much clearer take – the one I use to explain things to clients who are interested… but not that interested. The market moves to hurt the most people. ALWAYS. ALWAYS. ALWAYS.
That is a truth learned by anyone trading in a free market atmosphere (which we are most definitely not in right now). It is very similar to the old saw: follow the money. When enough people bought homes… home values collapsed. When enough institutions had money in hedge funds trading off-line credit default swaps… the market collapsed. I know, I know, I’m glossing over all the fun details. But this shortcut allows us to take a little better look at what may be coming next.
Speaking of next, the Fed is buying everything in sight including 10 year notes. That is how they can affect long term rates as well as short term: they become the market. The Fed is printing money at an unprecedented rate and if I am sure of only one thing when it comes to the Fed, I am confident of this: they react too late and for too long.
It is estimated that when the Fed is done with this spending spree their balance sheet will be up around $3 trillion (which is way too many zeros for a blog comment). That kind of monetary base is not sustainable. I share the implied fear of Alan Blinder, professor of economics at my alma mater and former vice chairman of the Federal Reserve, when he said, “At some point, and without knowing the timing, the Fed is going to have to destroy all that money it is creating.”
One of the keys, IMHO, to financial success is picking one of two viable strategies and sticking with it. Either buy things based on fundamentals and hold them, or try to stay a step ahead of the markets. They can both work. Buying and holding is not difficult and right now is a tremendous time to do that with houses. Or… I believe it was Joe Strummer above who advised buying gold. Damn skippy. But if you choose to play the “time the markets” game, you’ll want to know what’s coming: INFLATION. The market moves to hurt the most people. Always has and always will.
December 17, 2008 — 9:59 pm
Thomas Johnson says:
“The market moves to hurt the most people.”
If this is true, then deflation would be the choice. In a deflationary spiral, society itself is at risk, where the value of beans and bullets exceeds all other commodities.
December 18, 2008 — 10:36 am