Wednesday, December 16, 2009

Bernanke Gets Time Person of the Year Award; Fed Holds Rates At Record Low Levels

These two items are related. Federal Reserve Chairman Ben Bernanke got kudos from Time Magazine as it announced Bernanke as Time's Person of the Year. That had quite a bit to do with the way Bernanke shaped Fed policy and attempted to forestall the crashing credit markets, the real estate market crash, and the recession.

He did so by lowering interest rates to historic record lows. Watch for the Fed to continue holding interest rates at those low levels through 2010.
Still, Fed Chairman Ben Bernanke and his colleagues gave no signal that they're considering raising rates anytime soon. They noted that consumer spending remains sluggish, the job market weak, wage growth slight and credit tight. Companies are still wary of hiring, they said.

Against that backdrop, the Fed kept its target range for its bank lending rate at zero to 0.25 percent, where it's stood since last December. And it repeated its pledge, first made in March, to keep rates at "exceptionally low levels" for an "extended period."

In response, commercial banks' prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will remain about 3.25 percent. That's its lowest point in decades.

Super-low interest rates are good for borrowers who can get a loan and are willing to take on more debt. But those same low rates hurt savers. They're especially hard on people living on fixed incomes who are earning measly returns on savings accounts and certificates of deposit.
Once the Fed moves away from the record lows, all the rates that are tied to the fed rate will start rising. That includes mortgage interest rates - particularly the adjustable rate mortgages. So, once the rates rise in a couple of years, we'll be right back in a market bubble because borrowers will suddenly face massive increases in their monthly payments and find themselves incapable of repaying their obligations.

That, in part, caused the recession as the real estate market soured and adjustable rate mortgages went sour as the rates adjusted at the end of the 5 and 7 year periods that many locked themselves into following the low levels established by the Fed in the aftermath of the 9/11 attacks.

Record low interest rates may work for someone with a fixed mortgage, but can be hellish on adjustable rate mortgages once the rates adjust upwards. The low interest rates also means that the Fed doesn't have any ammo left in its monetary policy in case of another situation requiring an infusion of money into the marketplace to spur sales. There is very little room for the Fed to maneuver at this point should there be another mass casualty attack in the US akin to 9/11 or another economic crisis, since the Fed can't lower interest rates any further than it already is.

No comments: