Why the Fed Should Consider Cutting Rates Sooner rather than Later

Posted by: Michael Mandel on March 12

When faced with a budding financial crisis, the good central banker does a two-step dance. First, he (or she) staunches the bleeding, closing insolvent financial institutions, tightening lending standards, and otherwise making sure that bad loans stop being made. The good central banker then takes the second step: Pumping liquidity into the markets, to make sure that otherwise solvent institutions do not go under because the bad ones close.

The Fed and other financial regulators are considering tightening the standards on subprime lending. If they go through with their proposal, then quite a few subprime borrowers would be unable to refinance. Good central banking practices would suggest that an interest rate cut would be in order as well.

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Reader Comments

Joe Cushing

March 12, 2007 11:32 PM

While I agree with being more strict on who we loan to for initial loans, trapping sub prim borrowers in bad loans with no hope of refinancing is a bad move. If a sub primers can't fix their rates, many of them will lose their homes and more importantly their ability to borrow in the future at better rates.

eightnine2718281828mu5

March 13, 2007 02:33 AM

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Good central banking practices would suggest that an interest rate cut would be in order as well.
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And what does Ben do about the smoking crater the dollar's gonna make?

eightnine2718281828mu5

March 13, 2007 02:45 AM

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If they go through with their proposal, then quite a few subprime borrowers would be unable to refinance.
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You're also forgetting that the people in trouble now were forced into these gimmick loans because they couldn't qualify for the fixed-rate mortgages available 2-3 years ago.

Check your charts; rates were much lower then. And Brother Ben won't be pulling those sorts of rates out of his hat any time soon.

Looks like he's gonna need a whole squadron of mighty big helicopters to help these folks.

OhioOrrin

March 13, 2007 12:40 PM

remember tho, that defaulted real estate retains intrinsic market value.

therefore, the real estate market itself remains at value assuming the porfolio wasn't overloaned at the onset.

and effected financial institutions may expect taxpayer-financed, corporate welfare by reducing capital gains thru deducting losses regardless of poor management.

wiseguy

March 13, 2007 01:19 PM

I could not disagree with Mr Mandel more. The problem of subprime loan is not new and should be anticipated LONG ago by any knowledgeable person. A good central banker has the courage to tighten up the lending standard at that time. To tighten the standard now sounds like closing the barn door after the sheeps have run away.

Secondly, it is utterly irresponsible to try to lower the interest rate and pump up the liquidity at this stage. The interest rate has lots of implications like economic growth, inflation rate and currency market. Lowering interest rate just to undo bad decisions by some irresponsible persons in the past is plainly wrong. And frankly there are still many persons who will NOT be affected by the subprime problem and will be greatly benefited by higher interest rate. So, why should a good central banker sacrifices one (responsible) group for another (less responsible one)?

Tom Ngi

March 13, 2007 05:55 PM

Ultra low interest rates and ridciulously lax lending practices are there to keep the economy from sliding under water after the Tech Bust and 9/11. A classic case of delaying the pain at the expense of causing a bigger problem sometime down the road, hopefully for someone else. But many people made out like bandits, or at least it seems that way until the chickens come home to roost. We are about to live in much more interesting times.

eightnine2718281828mu5

March 13, 2007 06:02 PM

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remember tho, that defaulted real estate retains intrinsic market value.
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Real estate may have intrinsic value as shelter, but an intrinsic market price? Not so much.

John

March 13, 2007 06:25 PM

I am a finance manager for Domestic Car Dealership, and here is a thought, if I am wrong please tell me so. Here it is with all the problems in the subprime market, and housing, yes tighten up on some of the policies determining who is approved, however, my understanding is that most of these sub priime loans are ARMS, being 1, 2, 5 years or what ever the terms are. Things were probably fine before they reset, now alot of them are either defaulted, in forclosure, late, or bancruptcy, WHY NOT give a term extension, AND NOT RESET THE ARM, for another term, 1, 2, 5years, this has to be better than whats happening now, if the customer is making payments, then leave it alone for a while, instead of forcing default, whats wrong with leaving it alone, getting the original payment cant be as bad as reciieving nothing. At least thats what I think, to me this sounds like a quick and easy fix.

eric

March 14, 2007 09:44 AM

this whole subprime lending fiasco reminds me of the savings and loans crisis...

drbrightside

March 14, 2007 11:19 PM

I agree 100% that the next step for the Fed is to cut rates. With the 10 year at 75 basis points below the Fed Funds rate the writing is on the wall. They will continue to saber rattle about inflation, but behind closed doors you know they want to cut. With nominal growth now below the Fed Funds rate and the economy in cooling mode the sooner the better.

Doug Terry terryreport.com

March 15, 2007 02:40 AM

Everyone seems to be blamming rising default rates when, in fact, the current problems stem from banks cutting off the subprime lenders from further financing. It could easily turn out that the subprime financial operations, like New Century, were not making "subprime" loans to many of their customers, but were making sub-subprime loans. Since the game is to resell the paper as soon as possible after the loan is made, the trick is to get the loan made and move on. How careful have the buyers of mortgages been over the last five years? Have they simply accepted a statement, for example, from the first lender that proper procedures were followed or did they, at least, spot check the actual loans? When you have this sort of crackdown on risky loans, it is, in part, an admission on the part of those up and down the line that they have not been careful enough in their business practices. On top of relaxed lending, there has been way too many "creative" changes made in types of loans. Interest only is a joke to anyone other than someone who knows they will be getting a huge sum of money at a predictable point in the future. For anyone else, it is a kind of economic death trap, where you might technically own your house, but are actually renting it.

Shashank Garg

March 15, 2007 07:44 AM

i know every body relates interest rate to real estate business but from last year or 2 UK has produced quite contrary results ..we are almost touching 5.5 n real state growth rate is 7+%

any take on that?

Rohan Samant

March 18, 2007 09:12 AM

The Fed is facing a dilema where economy is moderating but inflation is still not lagging. To save the shirts of the sub prime borrowers it wont be prudent to cut interests rates.

christian

May 8, 2007 09:10 PM

time to pay the piper. why? you ask

want to but head in sand 1 more time since u enjoy your "comfy" life so much

"Printing money to solve a nation's economic problem can never be sustained. Eventually, it will lead to the debasing of a nations currency and run-away inflation. Yet for a short period, it can create an artificial prosperity, deluding the masses into believing this new prosperity can be sustained. it can't and won't. the result is a recession or a depression like hit.

we have rising inflation and a slowing economy. the fed can raise intrest rates and ALLOW the economy to slow and "correct" itself with a bit of a recession. or we can drop rates allow other country's to begin the sell-off and when there done the money will be so devalued and the buying opportunity of a life time will commence for the elite "super rich". inflation will soar and because we assumed we could prop the economy up by artificially increasing the money supply it's time to pay the piper. and the super rich can't wait.

Larry Rogers

August 4, 2007 03:39 PM

You look quite prescient now!! They should have cut rates and just stated clearly what they were trying to accomplish with respect to the financial markets rather than waiting for a panic to arise.

Everyone else trying to complain about why were are where we are is useless. The Fed has to deal with the economy as it is today, not where it was ten years ago.

If they wait for a recession to be visible, we will already be in one.

Joan

August 13, 2007 02:47 PM


When are we going to stop trying to bail out all the irresponsible people both on the lending side and the borrowing side and start making them all accountable for their actions? This nation is 200 years old but we have people in this country who refuse to grow up and start dealing in reality. Just because you want it you don't get to have it unless YOU can pay for it. As a reponsible citizen, I learned a long time ago that if I get into a mess, I have to get myself out of it not whine and complain. Grow up time.

Joan

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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