Latest US Housing Situation - What Can the Federal Reserve Do?

Dear Friends,

Check out this video clip that discusses the latest US Housing situation. As long as the US Housing Prices continue to fall, there will not be any hope of the US economy coming out of the recession.

The Lowering of Federal Reserve Rate to 1.5% Does Not Help Lower the Housing Mortgages Rate

What is interesting is that Ben Bernanke has just lowered the Federal Reserve FOMC Interest Rate to 1.5%, and yet, the 30 Year Housing Mortgage Rates has just gone up to 6.74% p.a.

The FOMC Interest Rate is the interest rate that the Federal Reserve (US Central Bank) lends to banks. So, whilst the banks are getting cheaper and cheaper interest rate, they are charging the people who are suffering from high home mortgage interest rates, even higher mortgage rates. Something just doesn't jive here. No wonder the US economy is not functioning properly.

The Lowering of FOMC Rate has the General Impact of Reducing the Interest Income to Depositors

What's more, the reduction of the FOMC Interest Rate normally translates to lower interest rate for depositors. When banks get cheap interest rate from the Government, they will then tell depositors that the fixed deposit interest rates have to be lower, since the borrowing cost from the Central Bank is now lower.

With even less interest income, this causes depositors to earn less, and thus, spend less, which aggravates the economy even further. This interest rate policy is especially damaging to retirees who rely on interest income to survive.

The Government Should Encourage People with Money to Spend More, Instead of People Without Money to Spend


What the US Government seems not to understand is that there is a need to get people with fixed deposits, who can earn more interest income to spend more, and not get people who are already way over their head in debt, to borrow more, so that they can spend more. Again, something doesn't jive. The solution here seems logical, but perhaps it is due to the fact that such people are the minority in the US, and thus, the whole US Economy is reliant on people who are already way into debt.

Is it Appropriate for the Government to Encourage People with Insufficient Money to Spend More and Go Deeper into Debt?

If this is true, i.e. that the US Economy is reliant for the most part on people in debt to spend more, then the world economy is in DEEP TROUBLE. The solution of getting people who are already way in debt to spend more doesn't work; unless we want a short term blip upwards in the economy, at the expense of an even bigger problem in the form of a much more severe recession / depression in the longer term.

The Government Should Instead Encourage People to Manage their Personal and Family Finances Well, as a Long Term Solution to Economic Growth

I notice that many people in the US Government keep on talking about more credit being given to the US public so that they can spend more. I think that this is the most unhealthy activity the Government can do. The Government should instead encourage people to manage their personal and family finances well, and when this happens, the economy will be in a very good shape.

Why? Because when people are in good financial shape, and like most human beings who have money (Warren Buffett being a significant exception, haha ), people will eventually spend more, without having to be told by their Government to do so, when the right time comes.

In summary, the Economic Solution of Lending to Consumers so that They Can Spend More is an Unhealthy Practice. The Government should Encourage Prudent Personal and Family Financial Management, and this will eventually translate into more Consumer Spending once the Consumer's Financial Position is in Better Shape.

What about Increasing the Federal Reserve Interest Rate instead of Lowering it?

An increase in the FOMC rates will send the housing mortgage rates and business loan rates even higher up the stratosphere. Unless the Federal Reserve is willing to set up some new laws to manage the spread between bank loan rates and the FOMC rate, the banks are at full liberty to do anything they want.

In normal circumstances, the situation is not too bad because if one bank charges exceeding high loan rates, the consumer is smart enough to shop around, and go to the bank next door. However, today's situation is such that practically all the banks NEED to charge high interest rate to cover for their losses, and thus, an even higher FOMC rate will only mean HIGHER loan rates, but a lower FOMC rate will also mean HIGHER interest rate. Heads, I win, Tails, I win. Pay up!

So, what can the Federal Reseve do?


In normal circumstances, a central bank has control over the interest rate policy of banks because the banks tend to set their deposit rates and loan rates in accordance with standard spreads to the FOMC Rate. This is one unique situation where a central bank has lost control of the situation. As mentioned, the only way is to legislate, regulate and control the spread.

The Mother of All Negative Economic Situations - The Perfect Storm Scenario has been Averted Thus Far

The situation is bad, but there is an even more worrisome scenario where a central bank can lose control over the bank interest rate, i.e. where the central bank itself is forced to set very high interest rate. Such a scenario would arise where, due to a bank liquidity crisis AND a currency devaluation crisis, the central bank has no choice but to keep the central bank interest rate high.

Thus, far, the US$ seems to have averted a currency devaluation crisis, and if anything, the world banking system claims to have been very short of US$ in the last few weeks, due mostly to losses on investments made in US$.

Should the Perfect Storm Scenario arise, i.e. one where there is a banking liquidity crisis, housing property crash crisis AND a currency devaluation (Hyper Inflation due to the printing of too much money by a Government) crisis, then, we have no choice but to be prepared for a Depression; not necesssarily a Great Depression, but a Depression none the less.

So far, this has not been the case. Let us pray that the current Financial Tsunami Situation is the only adverse situation we face. This is my value added analysis to the informaion on the video clip.

Best wishes,

Ooi

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