How the New Fed Reserve Interest Rate Cut Will Affect Your Business
by Larry Slusser on April 2nd, 2008
The Federal Reserve again cut the short-term interest rates to 2.25 percent, which is three-quarters of a point lower than it has been since the end of 2004. The thought was that the decision was made due to the $30 billion in financing it gave to JPMorgan Chase for the acquisition of Bear Stearns. The question that remains is that will this move help the economy in any way?
The Fed’s decision is to help keep consumers spending and borrowing, which is good for businesses. The lowering of the short-term interest rates will also keep asset prices higher. However, the long term effect will lower the dollar which is the exact opposite of what the nation needs. The decrease in the value of the dollar had led to the rise in inflation, particularly energy.
Unfortunately, the nation is already underway into a recession, which means the country needs to focus on high-saving and low-spending-opposite of what the country is used to doing at this time. Going through a recession will force people to make that change. Lowering the short-term interest rates will only prolong the inevitable, dragging out the process.
The reason that lowering the short-term interest rates are not a good idea is that people are already stretched as it is. If the Fed’s take steps to promote consumer spending, then the consumers will become even more stretched which will hurt worse in the long run; thus reducing consumer spending is what is needed.
Additionally, mediating an orderly reduction of asset prices, such as homes and bonds will help the economy sooner rather than later. Home prices could potentially fall another 15 to 20 percent. Unfortunately, investors will have lost many millions of dollars due defaults and write-downs of residential mortgages, corporate debt, commercial mortgages, credit cards and other loans, once the dust settles after the recession, this is provided that any de-leveraging does smoothly, which probably means that the loss could be upwards of two to three times any estimated loss.
The loan that JPMorgan Chase received from the Federal Reserve is surprising and somewhat concerning because of the dicey mortgage loans, which totaled upwards of $46 million. This is one of the reasons why JPMorgan Chase offered $2 a share, which is about 20 cents on the dollar. This could pose a problem and the Federal Reserve will need to take the lead in ensuring and enforcing that the accounting practices are in compliance.
Credit card debt is not as much of a concern because there is not a 90-day window for defaults to occur as with mortgages. Plus credit card companies, since they have been dealing with low-quality borrowers for a long time, have developed policies where the interest rate is raised, anywhere up to 40 percent interest on the balance. Even with this, it is the high-risk or subprime lending mortgages, as well as the high amounts of loans people could take out which has raised the consumer-debt bubble. People are so overstretched that they are taking hardship withdrawals from their 401(k) plans or selling off stocks, just to pay the mortgage.
In essence, while the lowering of the short-term interest rate may be good in the short-term, it only prolongs the economical problems that the country is going through, which could be even more devastating; thus worse for businesses.