February 13, 2008
JustQuotes: It’s Not About The Rates But Rather The Spreads
"The Federal Reserve's interest-rate cuts last month have failed to lower borrowing costs for many companies and households, increasing the chance of further reductions from the central bank.
Companies are paying more to borrow now than before the Fed reduced its benchmark rate by 1.25 percentage point over nine days in January, based on data compiled by Merrill Lynch & Co. Rates on so-called jumbo mortgages, those above $417,000, have increased in the past month, making it tougher to sell properties and risking further price declines."
∙ Fed Interest-Rate Cuts Fail to Lower Borrowing Costs [Bloomberg]
First Published: February 13, 2008 8:19 AM
Comments from "Plugged In" Readers
Is it that the lowered rates are not being passed on to the consumer and instead the widened spread between the fed rates and consumer rates is increasing the profit margin to the consumer lending banks ?
Just a non finance beverage trying to make sense out of this situation.
Posted by: The Milkshake of Despair at February 13, 2008 10:21 AM
Milkshake, as I understand it the reason the rates aren't likely to drop is because the problem isn't liquidity or confidence (which lower rates would help) but one of solvency.
Many of the loans the banks and lenders made over the last several years are bad loans. The problem is we just don't know how many of them are bad. Estimates range from 200-500 Billion. So far the banks have written off 100 Billion. So we are either at the half way point of finding all the 'dead bodies' or we are still just getting started.
Posted by: badlydrawnbear at February 13, 2008 10:39 AM
Here's the way I understand it. In the past few years, the way the residential and commercial real estate financing market has changed pretty dramatically. The majority of real estate financing in the last few years has been originated by banks and mortgage brokers, bundled together into financial instruments by Wall Street (CDO's etc.) and then sold to institutional investors. The demand for these investment vehicles was greater than the previous financing model (portfolio lending and Fannie Mae/Freddi Mac repurchase of loans) so that caused lenders to ease their standards in order to fulfill the higher demand for these investments by the institutional investors. The quality of these loans and hence the financial instruments (CDO's etc.) then eroded and couple with the declining real estate market throughout most of the US, these financial instruments were realized to be far riskier than original advertised so the end institutional users stopped buying them roughly in the middle of 2007. Two things have happened since then: (1) a lot of the players in this game (the originating banks & investment banks especially) have a backlog of bad loans from the last 6-9 months on their books that they can't shuffle off onto investors; and (2) nobody is really sure who is the most exposed to the losses coming from these financial instruments. Specifically, it turns out that the banks originating the crap loans were also buying up the CDO's of their re-packaged crap loans as investors. There's also a question of possible lawsuits and legal liability against the banks for partaking in this charade. So that brings us to the present moment when the banks have got way more loans on their hands than they want because they can't sell them downstream to Wall Street/investors AND they are looking at losses and possible lawsuits from these crap loans, so now they are hoarding cash to strengthen their balance sheets. From what I've heard, the financing spigot for a lot of commercial deals - large and small - has been cut WAY back in the last 6 months. And as everyone here notes, the availability of financing for homes is significantly more restricted than a year ago. So overall, with financing you have to consider more than just the rate, but also the terms of the loan, and the availability of that financing. While rates are somewhat lower, the terms are much more strict (no stated income loans and more money down required) and the availability is definitely constricted, so that equals a tightening financing environment. If you want to read more on the mess that is going on the financial markets and banks (like the problem with the derivative trade and bond insurers), I find Mish (globaleconomicanalysis.blogspot.com/) and Naked Capitalism (www.nakedcapitalism.com/) to have some pretty good insight - but there are a ton of other economics blogs out there also.
Posted by: Miles at February 13, 2008 11:25 AM