Posted by: Michael Mandel on February 05
Here’s a thought…maybe part of the reason the credit markets are in such bad shape because the Fed raised rates too fast and too high. Think about it—they started raising rates in June, 2004. It was a quarter point increase, from 1 to 1.25. Two years later, the Fed funds rate was up to 5.25. That’s four percentage points in only two years.
And who was affected by the increase in the Fed funds rate? Well, not corporations: They saw their rates fall over this period. Conventional mortgages edged up by half a percentage point. Credit card interest rates rose by about a percentage point.
The big losers were precisely one group: Holders of adjustable rate mortgages who could not refinance into fixed rate mortgages. Did I hear someone say ‘subprime’?
Basically the Fed took a sledgehammer to the subprime sector in order to slow the economy…they should not be surprised that it broke.
In retrospect it would have been better for the Fed to have stopped at 4% and waited for a while to see what happened. If we assume that it takes 12-18 months for the effect of rate changes to propagate through the economy, they basically showed too much impatience.
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.