Wednesday, March 19, 2008

More government action -lower rates and more mortgage purchasing power

The Fed lowered interest rates by 75 bps yesterday. While some market participants were expecting 100 bps, this was the right action by the Fed. The Fed still has room to further lower rates if needed, but they should not use all of their power to lower the Fed funds rates too early. The credit crisis seems to have had ebbs and flows with changes in information. There still needs to be further writedowns and we do not know what mortgage foreclosures will look like as the overall economy deteriorates.

A further concern should be the the chance of a liquidity trap which we saw in Japan during the 1990's. This is a real issue when there is a combination of a slowing economy and interest rates close to zero. The Fed's statement yesterday pays lip service to inflation, but this is also a serious concern. Real rates are strongly negative.

This chief policy issue is now getting banks to lend appropriately while still selectively lowering excess leverage. As important as the lowering of rates by Fed yesterday is the increase in lending lines by Fannie Mae and Freddie Mac. Regulators approved $200 billion in purchasing power. Refinancing when rates are falling relieves payment pressures.

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