Twelve weeks ago the Federal Reserve cut the benchmark interest rate by 25 basis points (0.25%) and signaled that further cuts were unlikely. Six weeks ago they cut again by 25 basis points as house prices continued to drop, spending continued to slow, and banks continued to tighten their lending standards.
And in an unscheduled session this morning, the Feds have further cut the benchmark interest rate by 75 basis points (0.75%):

The Federal Reserve lowered its benchmark interest rate in an emergency move for the first time since 2001 after stock markets tumbled from Hong Kong to London and the U.S. economy showed increasing signs that it’s headed into a recession.

The central bank cut the target overnight lending rate to 3.5 percent from 4.25 percent, the Federal Open Market Committee said in a statement in Washington. Policy makers weren’t scheduled to gather until next week. It’s the biggest single reduction since the Fed began using the rate as the principal tool of monetary policy around 1990.

And once again we ask, will the cuts help revive our national housing market? And of course, what impact (if any) will the cuts have on mortgage rates closer to home?
The Federal Reserve Cuts Benchmark/Discount Rates By 0.25% [SocketSite]
It’s Déjà Vu All Over Again: Fed Cuts Benchmark/Discount Rates .25% [SocketSite]
Fed Cuts Rate 0.75 Percentage Point in Emergency Move [Bloomberg]

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Comments from “Plugged-In” Readers

  1. Posted by tipster

    They can cut all they want to, I doubt it will help housing much.
    If you had the opportunity to buy on leverage pets.com stock at a very favorable interest rate when it started coming off its peak at the end of the prevous bubble, would you go back and do so? What about Cisco, Sun or Oracle, none of which have ever recovered, despite being “prime” stocks.
    Neither would I. Some people did and they lost it all. Most people understood it was the end of a bubble and used that money for something else.
    Which, of course, brings us to the present situation.

  2. Posted by Satchel

    I agree with the comment that lower interest rates will not save housing. No chance.
    However, it will slow down the price declines, assuming that the Fed can manage to continue to guide LIBOR lower, which should ease the burden of upcoming ARM resets on prime loans in the high value target states like CA and NY.
    But the timing of the cut is bad. They should have waited for the meeting, and gone 50. The market is trying to force an unwind of the whole leverage mess, and the Fed has thrown down a gauntlet of sorts. This is where the bears get ready to rumble.

  3. Posted by Jimmy (Bitter Renter)

    I would regard the 0.75% emergency Fed rate cut as a spectacular vote of confidence — confidence in the idea that the Fed will do whatever is in its member banks’ best interest regardless of the impact on the broader economy.
    Is anyone else slightly suspicious that all may not be well with the economy when the Federal reserve holds an emergency meeting to cut rates by a record amount (not seen since 1984), on the heels of a global stock market sell-off? Somehow this doesn’t send a message of tremendous confidence in the economy.

  4. Posted by "Dave"

    On the contrary, low interest rates would help housing in a huge way. Most of the bubble deflation we’ve witnessed has been cause by (first) the raising of rates and (second) tightening in the credit markets. It would not re-inflate the bubble (a good thing) but it would create a floor for prices.
    The bigger question is whether the cuts will actually loosen up credit markets. The spread between Fed money and mortgage money has been widening (due to perceived risk), especially for non-prime, non-conforming products. Lower Fed rates won’t necessarily impact the spread.

  5. Posted by badlydrawnbear

    “it will slow down the price declines”

    And this is probably the best we can hope for, an orderly decline vs. a panic. While panic selling can be amazing to watch it is bad for everyone. An orderly decline that allows people to absorb what is going on and shift money and resources around appropriately and prevent things like massive layoffs as corporations panic and try to do anything to shore up their stock is much preferable, IMHO.

  6. Posted by Trip

    Dave, I don’t think the deflating of the bubble we’re seeing now had much at all to do with rising rates we’ve seen over the last couple years (which remained fairly low at all times). It had a lot to do with buyer mentality shifting to the sense that we are now in a bubble that is either going to deflate or pop, and it was accelerated by the very recent significant tightening of lending standards. Neither will be affected by rate cuts. You can cut rates to zero, but if buyers (1) think prices will decline further and (2) don’t have the high downpayment, income, and FICO score to get a loan, the demand element of the supply-demand curve will continue to exert downward price pressures.

  7. Posted by "Dave"

    Trip, I think you give buyer mentality too much credit. We went from 1% Fed Funds to 5% from 2003 to 2006. Rates didn’t reach a “high” rate by historical standards, but a 4% swing off of astronomically low rates is a dramatic move. Most people peg the top of the market at 2005, so you tell me what came first…
    If any dumbass with a pulse could still get a loan, things would still be inflating. Subprimers would just serially refinance every 2 years (just like their broker told them they could!) and their ARMs would never explode. That inability to get credit eliminated willing buyers from the market while simultaneously creating inventory by eliminating the refi-bailout-options for overstretched borrowers.
    Now, will rates at zero encourage borrowing? No, you’re absolutely right. But independent of demand for debt, I’d argue that supply is a bigger factor. Just because the Fed will give away free money, it doesn’t mean that banks (or Chinese investors or CDOs or pension funds via the MBS market) will lend it, especially on depreciating assets.
    Your argument about FICOs and downpayments have nothing to do with the demand side of the “money” equation but rather the supply side. That’s lender mentality, not buyer mentality. Lending availability is keeping far more people out of the market today than is savvy on the part of the buyer…

  8. Posted by Rillion

    Satchel: “But the timing of the cut is bad. They should have waited for the meeting, and gone 50.”
    The problem with that is most people believe we need more then a 50 bp cut, so if they waited until the meeting then cut 50, it would not have done anything. Why borrow money now if you think that the Fed is going to have to cut rates more next time it meets? If you think the Fed is going to cut the rate each time it meets for the next six months, then you wait until you think the Fed is done cutting rates before you borrow. One of the worst things the Fed can do is cut the rate in small amounts and say “more rate cuts are likely”. If you want to spur borrowing you cut hard and fast and say: “There it is, we’ve lowered the rate enough to spur the economy.”

  9. Posted by arlo

    I think that there has been a sea change in buyer mentality in the past few months – across the whole economic spectrum and all geographic markets (except perhaps in Noe Valley). It just seems like everyone now acknowledges that housing prices were in a bubble and now must drop (or continue to drop).
    I no longer trust the Fed and Helicopter Ben and I agree with Satchel that the rate cut should have been done at the normal meeting. It seems like the govt’s main priority is to do what is best for Goldman Sachs – not most Americans. Didn’t they say in the 1960′s that what was good for General Motors was good for the country? It seems like we just replaced GM with Wall Street. I guess we need to keep Goldman alums like Paulson, Jim Cramer and Eddie Lampert happy.

  10. Posted by mktwatcher

    I ran into a friend who is an agent at Vanguard over the weekend. He described the current market in SF as “street to street”. So we’ve gone from San Francisco vs. East Bay to district to district to street to street. Anybody want to guess what comes next?

  11. Posted by John

    The significance of the rate cut is that the Fed finally switched from “fighting inflation” to “saving economy”.
    How would this impact the economy? It is most likely that we will come out the recession with high inflation. In two years (I am still betting the RE bottom is end of 2009), the RE price won’t look so high anymore when the price of everything else (including rent) increase 20%.

  12. Posted by MarkSFCA

    The fed rate cut helps people with home equity lines of credit, which are usually tied to the bank’s prime rate and is directly affected by this fed rate cut.

  13. Posted by Dude

    John, you pre-empted my question: What’s the implication for inflation? Much academic conjecture now that we’re setting ourselves up to repeat the cycle of the 70s, and Bernanke or his successor will have to dramatically raise rates (ala Paul Volcker in the late 70s/early 80s) eventually. And the ensuing recession may be longer and deeper as a result. Thoughts anyone?

  14. Posted by dub dub

    The fed has access to more real data than we do, so maybe there was a reason behind this we are unaware of — e.g., using an interest rate to battle an imminent leverage/meltdown event we on this board know nothing about.

  15. Posted by Trip

    Dave, we obviously disagree on the cause and effect between rate increases and the decline in housing prices — that’s fine; I concede your hypothesis is plausible. But I don’t think we really disagree on the other issues. The sudden cutting off of financing to an enormous percentage of potential buyers certainly hit the supply side of the lending equation, but that in turn hit the demand side of the home buyer equation. Those many wanna-be buyers now failing even to qualify for any financing are no longer potential buyers, drying up demand for housing purchases. The double whammy is that, as you point out, the same lending restrictions add to the supply as a certain number are forced to sell (or the bank does it for them) with the refi options for overstretched buyers gone. With increasing supply and a smaller number of ready, willing, and able buyers, it is pretty easy to see how prices are affected independent of interest rate moves.
    That said, the cheaper money will certainly help creditworthy businesses out there (especially the big banks) which should stanch some of the bleeding of late in the larger economy even if it only affects housing around the margins.

  16. Posted by LJ

    Do we really want to revive the housing “market”? Housing has become unaffordable for many because of the price run-up due to easy credit. I don’t understand how buying and selling real estate can sustainably be a major player in our economy unless we have a booming population…otherwise there’s no added value, right?

  17. Posted by Satchel

    Guys, all this talk about inflation! In the 1970s, we had a very modestly levered economy. Monetary inflation (printing) was rampant, and interest rates were sky high.
    Today, we have the opposite. Monetary printing is nonexistent, and all monetary “inflation” has been on the back of lending against assets, which are now deflating, taking down the far money credit aggregates.
    Most importantly, we have an EXTREMELY leveraged economy. Any serious monetization would feed through to higher interest rates IMMEDIATELY. Bond traders watch the near money aggregates (like monetary base, M0 and M1) like hawks! the Fed does not set rates – it merely follows them. This is because the Fed only controls around $900 billion of assets, a very small number relative to the total size of the credit markets (in the US alone, well in excess of $50 trillion). These higher rates would tank housing (among other leveraged asset classes) and we would quickly return to lending guidelines and standards that prevailed in other high interest rate environments (like the 1970s in the US) or countries (Argentina today, e.g.).
    It seems to me that a homebuyer today has to engage in a huge exercise in cognitive dissonance. On the one hand, he must expect high inflation in order to justify the high price of the asset today (on the theory that equivalent rent will skyrocket, and that generalized price inflation will feed through to wage inflation, making the purchase easier to carry). On the other, he must assume continued LOW interest rates (never before seen in inflationary regimes) in order to support contued high asset prices in the future (otherwise he would be forecasting a capital loss – not good!). I guess anything could happen, but this seems like a bad bet to me.

  18. Posted by David

    1) It’ll drop ARMs a bit, and not move FRMs more than an eighth of a point.
    2) Never in financial history has a bubble been “reflated.” Ever. Remember the 4 most expensive words in English “It’s different this time.”
    3) It’s possible to have inflation elsewhere, but not in home prices. It happened in the late ’70′s IIRC. The housing market had problems (relating to sky-high rates that were being implemented to whip inflation), while everything else–wages, commodities, services were inflating away.
    It would seem not too outlandish to be able to get a house for a low FRM payment now to T+12 months (if you lowball), and watch inflation in other areas grow. Your house probably won’t appreciated much in the next 5 years, but if you can get low payments locked in and it’s break-even or better than renting, it’s not a horrible idea to buy. But you could always another year or two or three and buy the same house for the same price or less than now.
    David

  19. Posted by gumbo

    I think for SF housing market it’s more important to focus not on ARM’s vs FRM but jumbo vs non jumbo. There won’t be many buyers in the SF market until something happens in regards to the disparity between the 2 come back to historical norms or they raise the cap for ‘special markets like this one.
    Anyone want to take a guess as to when that’s going to happen ????

  20. Posted by Satchel

    @ dub dub,
    “The fed has access to more real data than we do, so maybe there was a reason behind this we are unaware of ”
    I suspect that you are very right. Take a look at “nonborrowed reserves” in the banking system. Banks are hoarding all the money they can and keeping it in vault cash. This number NEVER goes negative, and NEVER strays more than a few percent from the average. Except now.
    http://www.federalreserve.gov/releases/h3/Current/
    (Look at the last table, under “nonborrowed” and notice the wipeout from prior periods.)
    Also, look at the fed auctions today. A lot of liquidity added, even though nothing was maturing.
    http://www.gmtfo.com/reporeader/OMOps.aspx
    (Look under “net add” for 1/22/08)
    Some bank or banks are in a world of hurt. (Actually, I’m fairly certain that most of the major money center banks are balance sheet insolvent, but they can keep going because the Fed, the SEC and the accountants/lawyers are looking the other way….)

  21. Posted by cooper

    Satchel –that’s not quite correct. The Fed controls a bit more than 900 billion.
    There is around 40 trillion of debt outstanding in the US. 25% of that is mortgages with 1.3 trillion on top of that in credit card debt and home equity lines. Most of which is tied to prime which just fell 75 basis points. Vast amounts of debt, including most ARMS is tied to Libor which as we’ve seen should drop 75 bps with the Fed lowering. The Fed controls a lot more than 900 billion in debt. The Commerical paper market has also seen major relief dropping from 6 percent to 3.6/3.8 right now. The Fed is a huge factor–at least for the time being. We need another 50-100 bp of easing for the Fed to be at least partially done. Hopefully we’ll get that next week.

  22. Posted by Satchel

    cooper,
    But about $900 billion (mostly short term treasuries) – last time I looked – is all the Fed OWNS. Only market FAITH in the Fed “controls” all the other debt. Think about the very late 1970s/early 1980s. Wouldn’t it have been easier for Volcker to set long-term rates down, rather than endure the recessions of ’80-’82 and ’83-’84?
    Once this faith is lost, the game is over, and rates will go where they want to. In a monetization, they will want to go higher. Maybe much higher! All the Fed can do is jawbone, and lower the overnite rate (through temporary repo). Unless, of course, it starts printing little green squares without the Treasury issuing offsetting treasuries to “sterilize” the money issuance. (Incidentally, that is what China is doing, and is one of the reasons they are getting food riots over there – not good!)
    If the Fed starts printing prior to a managed deflation of the credit bubble, IMO we will get the mother of all wipeouts. I really don’t see this happening, just to bail out an overleveraged household sector. I hope I am right!

  23. Posted by cooper

    If the point you are making is that the Fed doesn’t control long term rates without printing money that’s correct. But also keep in mind that a lot more consumer and corporate financial instruments are pegged to short term rates such as libor. As far as the Fed growing the money supply to get out of this, keep in mind it’s been keeping money growth tight for quite some time. And given how bad things are, I’d say it kept it tight just a bit too long and should have started small cuts back in March. Agree on China, but that’s a function of trying to keep their exchange rate low by printing domestic currency which of course is inflationary. Althogh I definitely appreciate the cheap stuff at Walmart. Not sure how much longer that can last especially with this latest crisis. Big financial crisis always see big changes in places where you least expect it.

  24. Posted by "Dave"

    Trip, you raise good points. All I’m saying is that expensive, highly leveraged purchases are extremely sensitive to interest rates.
    Average buyers–excluding the highly informed readers of this blog–don’t know jack about rates. They only know that a mortgage on a home priced at X means a monthly payment of Y. (Reason #1 why so many were and will be caught off guard by ARMs.)
    If mortgage rates completely decouple from the Fed due to perceived risk, you’ll see more extreme negative pressure on asset prices. (Or, more likely, you’ll see Fannie/Freddie get authorized by Congress to buy every mortgage in the market.)

  25. Posted by Satchel

    Hey coop, you’re not one of those economists that I am always insulting, are you? :) (Just kidding)
    Of course you are right, that TODAY there is a lot of debt tied to LIBOR and other short term rates. These sorts of rates are (for obvious reasons) tied to the implied forward rates on the front end of the yield curve. But, once faith is lost as a result of monetization, this type of lending disappears, because the lenders know that lending long on an adjustable loan is a recipe for disaster if the Fed is going to pursue inflationist policies, keeping real short term rates (and hence returns to lenders) negative. So TOMORROW becomes the problem.
    I do think monetary policy has been tight, but I think it was necessary, and – if anything – should stay tight until the credit bubble unwinds some more. Credit inflations have to end in either deflationary collapses or hyperinflationary blowouts. The Fed IMO is trying to walk a narrow line here, a “managed” deflation of credit that is not too destabilizing. So far, I think they are suceeding, but we’ll see….

  26. Posted by cooper

    Nope not an economist. Most economists think like you do which is the Fed has been doing a good job. The fed has not been managing the credit bubble at all in fact they have been tight because of fears of inflation. Specifically managing to the price of oil rather than managing the credit and real estate bubble. The bubble is imploding in a rather uncontrolled fashion. I am not sure I would call it managed in any way.

  27. Posted by viewlover

    The national market has been in a lot of hurt for a while, we just have not made it our priority. There are apparently a surprisingly bold series of steps to stimulate the economy down the pipeline. The gov’t is panicking and that is what I’m getting a kick out of. Bush seems to be ready to go along with anything now. These attempts may be ill-planned as usual, but there will ultimately be a cushion for the local market to soften the fall. And regardless if you agree with them or not, it’s basically pick-your-poison time for the nation. If nothing is done, we are all screwed.
    The national market has driven these steps and the correction will start there. As lenders’ confidence starts to rise on a national level, the local market may stabilize and hold steady, being the last to fall but fall on the debris of the others.
    If you are able to weather the storm, I would have that as a goal, because regardless of the doomsayers, it will get better…in time.

  28. Posted by akrosdabay

    “If you are able to weather the storm, I would have that as a goal, because regardless of the doomsayers, it will get better…in time.”
    In how much time?
    It is more than evident that easy lending which made most of the appreciation in the local market possible. How long before those same easy lending standards and NINJA loans come back?

  29. Posted by Satchel

    cooper,
    “The bubble is imploding in a rather uncontrolled fashion. I am not sure I would call it managed in any way.”
    Take a look at Indonesia circa 1997 or Russia 1998 (both hyperinflationary depressions) or even the 1930s US for prime examples of unmanaged credit deflations/defaults! Japan following 1990 or so is – in my mind – an example of a managed deflation of (in that case) twin credit bubbles, and i am guessing that what we are in for need not be even so bad as Japan’s. But it will still be bad!

  30. Posted by viewlover

    I just don’t think that most people are going to run out of their homes, or they shouldnt, just because of the current market. A home is a place to live, it has other value that the current market price. And the market will stabilize. Why walk out on such a big investment, at some loss, if you don’t have to? How long for what? For prices to get back to the current level? Who cares, just as long as when you get ready to sell the market is good, until then why panic. If you have to sell because you are having trouble, then might as well get out while you can.
    I just don’t believe that most of the SF owners are the latter. Could be wrong, I could be right.

  31. Posted by Annony

    This 75bps is huge, and benefits those with debt tremendously. 30yr conforming mortage rates are now 5.25%, where they were just 6% a month ago. That is a $300/month cash savings.
    Fed is likely to cut another 50bps this year, and some by as early as next week.
    I wouldn’t underestimate the cash flow impact of millions of Americans with this rate cut.

  32. Posted by Neezer

    The rate cut is simply a way for banks to print “free money” to offset their losses.
    Make no mistake, bank lending standards will get tougher and the rate banks charge for borrowed money will go higher despite the fact that banks can now borrow at lower short-term rates from the Fed (this spread difference is the creation of “free money” to replenish what was lost on mortgage/credit mistakes). The Fed has simply chosen to inflate ourselves out of this crisis and make the problem smaller by diminishing the value of the US dollar.

  33. Posted by Satchel

    With the stock market futures indicating another potential stock market wipeout today, Bernanke has run out of bullets (having shot the first two or three into his own foot during the fall – I think he is saving the last for his head!). I am always struck by the comments here, which seem to demonstrate a continued faith in the Fed and its policies. The Fed is the entity that got us to this point through its foolish attempt to avoid deep recessions in 1990 and 2001, and now we are likely to get the mother of all recessions. It seems appropriate to quote a real economist here:
    “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” ~Ludwig von Mises
    I’m sort of losing my belief that the Fed can manage the upcoming credit deflation/unwind.

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