March Madness - The Fed Cuts Again

The madness isn't just on the hardcourt.

You may have heard that the FED cut rates again last week; another .75%, bringing the fed funds rate to 2.25%. Contrary to popular opinion this does not translate to a lower 30 yr. fixed rate, in fact rates have started to rise again.

When you look at the last 5 rate cuts dating back to 9/18/07, the fixed rates have increased each time within days of each cut. The simplified explanation for this phenomenon is that fixed rates (bonds) dislike inflation and the rate cuts tend to be inflationary long term.

There's a lot of debate about how involved the FED should be in bailing out banks like Bear Stearns and other banks that took a "gamble" on these high risk loan portfolios. The free market people are calling for passivity and less involvement so the market can self correct.

A large segment of the investors that are or will have a lot to lose are asking for help to mitigate their losses. They argue that to let a bank like Bear Stearns collapse would be detrimental to ALL investors and the entire banking system.

We tend to side with the free market side of the argument. A lot of the self correction has already occurred and the people who took extra risks to get a better return need to be held accountable to their choices.

We also agree to a smaller extent that some intervention needed to happen in the Bear Stearns case because of the long ranging effects of it's collapse. We ALL would've been negatively impacted by a loss like that.

Why is the FED being so aggressive with their rate cuts? We believe that part of it is because banks are no longer loaning money to each other like they were prior to Aug. '07, so the banks need another source of money to meet their deposit requirements.

But, even more than that, we believe the FED has been agressively cutting rates to mitigate the impact of $400 billion to $600 billion in Adjustable Rate Mortgage (ARM) resets in this year alone. By agressively dropping the Fed Funds, the other short term rates like the LIBOR, CMT, MTA and the T Bills also drop.

For instance the 1 MTH LIBOR has dropped over 3% since August '07. Now when these ARM's start to adjust this year, the new rate will be closer to the starting the rate and the payment shock will be less which means more people should be able to keep making payments which means less defaults and foreclosures. This in turn helps to stimulate the housing market again.

Stay tuned for more madness, both the good (Spartans win the Championship) and the not so good.